Thoughts on Bernanke

BNP Paribas - Chairman Bernanke's speech contained little new information
on implementation of QE2, however it confirmed that further action is
likely. The speech seems to be an effort to lay out a longer term
framework for policy making in the new era of low inflation. The
Chairman talked about how we are in the midst of a transition from
decades of worrying about high inflation to a new era of low inflation
that really began with the recession of 2001. He started his speech by
stating that "retaining...credibility is of the utmost importance" and
goes on to say that "clear communication about the longer-run objectives
of monetary policy is beneficial at all times but is particularly
important in a time of low inflation and uncertain economic prospects
such as the present." The importance of communication is related to the
fact that they must rely on unconventional policies and "we have much
less experience in judging the economic effects of [these] policy
instruments, which makes it challenging to determine the appropriate
quantity and pace of [asset] purchases and to communicate this policy
response to the public." That being said, these new challenges are not
going to hold the Fed back, Bernanke defined the "longer-run sustainable
rate of employment" to be between 5.25% and 6.25%, well below the
current rate which he attributes mainly to economic weakness rather than
structural factors. He defined the "mandate-consistent inflation rate"
to be "about 2% or a little below" and noted that we are well below that
and risks are to the downside even factoring in his expectation that
growth will pick up modestly in 2011. He then went on to say that "given
the Committee's objectives, there would appear--all else being
equal--to be a case for further action" although he noted that the
process of developing a framework for making decisions about
unconventional policies has "dictated that the FOMC proceed with some
caution in deciding whether to engage in further purchases of
longer-term securities." Market participants may have hoped for a more
aggressive tone, or for more details about the upcoming new phase of
stimulus. However the speech appears to be more of an explanation of the
process the FOMC has been in for the past six months developing a new
framework for policy. Given the communication from other members of the
FOMC and economic developments that have confirmed slow growth and
continued deceleration in inflation, today's speech does not alter our
forecast that they will announce a package at the November meeting that
amounts to close to $100bn in additional securities purchases per month.


Bernanke also discussed the possibility that the FOMC would
"modify the language in the statement in some way that indicates that
the Committee expects to keep the target for the federal fudns rate low
for longer than markets expect" although he noted a potential drawback
of doing so is conveying policy intentions "with sufficient precision
and conditionality." The inflation or price level targeting advocated by
Presidents Dudley and Evans might be one way of doing this, although it
does not appear to be an imminent change in policy as Chairman Bernanke
noted "the Committee will continue to actively review its
communications strategy."