Federal Reserve Chairman Ben Bernanke did not deliver another Jackson Hole speech in today's testimony to the Senate. Instead, he stuck to his usual style of delivering just the facts, or at least his version of the facts, and letting us pick apart the implications for monetary policy. On on critical issue, the jobs report, he takes both sides of the debate:
This apparent slowing in the labor market may have been exaggerated by issues related to seasonal adjustment and the unusually warm weather this past winter. But it may also be the case that the larger gains seen late last year and early this year were associated with some catch-up in hiring on the part of employers who had pared their workforces aggressively during and just after the recession. If so, the deceleration in employment in recent months may indicate that this catch-up has largely been completed, and, consequently, that more-rapid gains in economic activity will be required to achieve significant further improvement in labor market conditions.
On net, I think Bernanke would like to see more data before he committed to further easing, which would push additional action into later this summer or early fall. The near-term path of fiscal policy is also weighing on his mind:
Another factor likely to weigh on the U.S. recovery is the drag being exerted by fiscal policy. Reflecting ongoing budgetary pressures, real spending by state and local governments has continued to decline. Real federal government spending has also declined, on net, since the third quarter of last year, and the future course of federal fiscal policies remains quite uncertain.
He later covers much of the previous ground on fiscal spending - maintain short-run stimulus while defining a path to longer-term consolidation. Overall, though, the fiscal cliff is also an issue that does not need immediate attention.
As an aside, note that Bernanke's repeated warnings about the fiscal cliff imply something interesting about his views on the limits to monetary policy. Specifically, he does not think the Federal Reserve can offset entirely the negative impact of the cliff. If the Fed could offset the impact, then why worry about it? After all, the fiscal cliff does put the federal budget back on a sustainable path. He should just embrace the cliff and let the Fed compensate with additional easing. That is, of course, unless he thinks the Fed is really at the end of its rope.
The only real hint that easier policy is imminent is his concern about Europe:
Nevertheless, the situation in Europe poses significant risks to the U.S. financial system and economy and must be monitored closely. As always, the Federal Reserve remains prepared to take action as needed to protect the U.S. financial system and economy in the event that financial stresses escalate.
The question is if he sees the risks tilted to the downside, the view of his colleague Vice Chair Janet Yellen. If there is anything that will drive immediate action, it is the European risk. In the absence of that never ending crisis, he would treat the labor report as a wait-and-see issue. But if that situation continues to deteriorate and roil U.S. markets over the next two weeks, additional action seems likely. But of what form? Guidance, twist, or purchases? That still remains an open question.
The most disappointing part of the speech was his thoughts on inflation expectations:
Longer-term inflation expectations have, indeed, been quite well anchored, according to surveys of households and economic forecasters and as derived from financial market information. For example, the five-year-forward measure of inflation compensation derived from yields on nominal and inflation-protected Treasury securities suggests that inflation expectations among investors have changed little, on net, since last fall and are lower than a year ago.
Bernanke doesn't appear to see that the inability to hold market-based inflation expectations at a consistent level as a problem:
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What's wrong with this picture? Notice the volatility of expectations after the recession (Ryan Avent has made this point as well). The Fed claims to have some mythical "credibility," but it certainly isn't evident in this graph. If anything, it is clear that the Fed has failed miserably in establishing credible expectations for either 2% or stable inflation. Instead, what they have created is very unstable expectations because of start-stop policy. It is almost ludicrous to place so much blame on Congress for the unstable fiscal picture when they themselves are creating an unstable financial and economic environment.
The source of instability is the Fed's insistence on putting a time limit on every policy. When the U.S. economy was operating above the zero bound, the Federal Reserve would never issue a statement to the effect of "We instruct the New York open-market operations desk to target the federal funds rate at 3.75% for a period of six months." Of course, that would be silly. It would create too many discrete points in the policy-making process that are devoid of macroeconomic context. But that is exactly what the Federal Reserve does now - effectively setting policy to have an end date without a clear expectation of why that end date is important.
And it isn't important. It is just arbitrary. The Federal Reserve would have been better off to buy a set quantity of assets every week, adjusting that number as they might the interest rate, until certain macroeconomic objectives are met. This would let the expectations channel shoulder some of the work by laying out a clear path for monetary policy. Moreover, they would probably need to buy fewer assets overall. Instead, now we have policy scheduled to end discretely in the absence of the consideration of the macroeconomic backdrop, thus disrupting the expectations channel because market participants don't know what will trigger continuation of the policy. It simply isn't the way to manage the monetary affairs of the nation.
Bottom Line: Bernanke gives few hints. I think he would let the data play itself out a bit more before changing the current policy path. But the European crisis is throwing that wrench in his plans. And if market turmoil persists, and risks remain tilted to the downside, then more easing is coming.