What to Expect From Bernanke's Jackson Hole Speech
There are a number of policy moves the Fed could make, but in this political environment hesitation is more likely.
It has become more or less the consensus that given what the Federal Reserve has done already with ZIRP, QE1, and QE2, the US central bank is “out of ammunition” and can do nothing to help the economy at this point.
This skepticism has raised the stakes for Fed Chairman Ben Bernanke’s annual speech at Jackson Hole. The prospect of an economy and financial market without credible Fed support is creating much anxiety.
The Policy Menu
In truth, the Fed has many policy options to counteract contractionary and deflationary forces. What could they do?
It is true that some proposals that have been floated are unlikely to gain traction given their limited expected effectiveness in the current environment relative to their costs/risks. For example, lowering the interest rate the Fed pays banks for holding excess reserves is a policy that would entail many risks with relatively few discernible benefits. I have also argued that an “Operation Twist” would make little sense in the current environment.
On the other hand, certain Fed alternatives are viable in an emergency. First, the pledge to keep the Fed funds rate at 0% for two years is a more significant policy initiative than many have given it credit for. Second, I have laid out a powerful menu of policy options that the Fed has to prevent a debt-deflation depression scenario from unfolding. Indeed, I have argued that the Fed has thus far hardly touched the potential of the tools at its disposal.
For example, a policy framework based on “nominal GDP targeting” could provide the institutional “patina” that the Fed would need to be able to effectively implement some of the more radical options outlined in my policy menu. It also would provide political cover with the center-right as this approach is actually more “rules-based” and less discretionary than the current framework -- a policy virtue sought after by conservatives.
Furthermore, I've floated an idea which I believe holds some promise as a potential means for the Fed to engage in monetary stimulus. Specifically, I believe that the Fed has an opportunity to tackle the housing problem in the US in a way that can be economically significant. And I believe that a policy specifically targeted at the housing market -- and low and middle-income households in particular -- would have widespread political appeal.
The idea behind these proposals is not to make policy, but rather to try to imagine what the Fed could do, and what it is inclined to do. Determining capability and inclination is very important from the perspective of investment management -- whether it be equities (SPY, DIA, QQQ) or fixed income (^TNX, TLT, JNK).
The Fed's Proclivities
From Bernanke’s past writings, speeches, and more importantly from his actions as Fed Chairman, it is clear that he favors activist policy in the face of any threat of depression or deflation.
At the same time, it is clear that the Fed does not operate in a political vacuum. In this regard, there does not appear to be widespread political consensus for aggressive Fed intervention at this time.
What to Expect From Jackson Hole
It is my assessment that Ben Bernanke will not announce any concrete actions in the course of his Jackson Hole speech due to the current lack of political consensus regarding Fed action.
I believe that he will wait until the economy is unmistakably in dire straits before actually “pulling the trigger” on some of the aggressive alternatives available to him.
Having said that, I think Bernanke may choose to remind financial markets and the public at large that the Fed is far from powerless in the event that the economy showed confirmed signs of deteriorating further. He might suggest various potential courses of action that the Fed could eventually take in such a circumstance.
The knowledge that the Fed is not “powerless” could have a reassuring effect on markets -- which is precisely what Bernanke’s intention would be in giving such a speech.
I believe that Chairman Bernanke will use the Jackson Hole platform to signal the Fed’s intent to act aggressively in the case of a severe economic contraction and/or deflation.
At the same time, I believe that the Fed will make no policy commitments. Bernanke will merely say that the Fed is closely monitoring the situation and stands ready to act, if necessary.
In my opinion, this approach will neither energize markets nor disappoint them. I expect the initial reaction to the speech to be muted.
However, for reasons that I have outlined elsewhere, I believe that the US stock market will soon focus on the terrible August data to be reported in September. Furthermore, companies may begin to issue lowered guidance. Thus, it is possible that the Fed may soon be forced into action.
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