My posts this week are all going to involve the Federal Reserve and answering some important questions revolving recent monetary policy and a soon to be newly appointed chairperson. Today I want to review the monetary policy under Bernanke’s reign as Chairman and discuss whether it was effective or not to lead our country. Many news outlets have given the Federal Reserve heat in recent years of their monetary policy and some have even compared Ben Bernanke to Walter White, the meth dealer on AMC’s hit show Breaking Bad. (#6 I believe is particularly true.) However, was the Federal Reserve policies from 2006 to now effective?
Ben Bernanke’s Qualifications
Bernanke graduated Harvard in 1975 with a B.A. in economics and in 1979 from MIT with a Ph.D. and held professorial appointments at MIT, NYU, Stanford and Princeton. He has long been involved in the economics of our country as a visiting scholar at the Federal Reserve Bank of Philly, Boston and NY from 1987-1996, an Academic Adviser to the Federal Reserve Bank of NY in 1990-2002, and a member of the Board of Governors from 2002-2005. This was all before becoming the Chairman of the Council of Economic Advisers (CEA), which is a twenty-person committee that advises the President on economic policy from 2005-2006. In 2006, President Bush appointed Bernanke as Chairman of the Board of Governors to succeed Alan Greenspan who held an 18-year term at the Federal Reserve (you can be reappointed despite a 14-year term ‘limit’). More or less, Ben Bernanke was highly qualified to become the Federal Reserve Chairman in 2006.
Monetary Policy under Bernanke 2007-2009 during the crisis
– The Federal Open Market Committee, FOMC, cut the discount rate, which is the lending rate from the Federal Reserve to banks, by a cumulative 325 basis points (3.25%) until it hit 2% in April 2008.
– In October 2008, the discount rate was cut to 1% and later to a target of 0-0.25% as the President Bush signed into law the Emergency Economic Stabilization Act of 2008, which TARP was set up under.
– The FOMC also cut the fed funds rate to a target of 0-0.25%. Both the fed funds and discount rate are in the same target range today.
– The Federal Reserve created emergency lending facilities and currency swap agreements with 14 central banks around the world. Emergency lending facilities examples are Term Auction Facilities, Primary Dealer Credit Facility and Term Securities Lending Facilities.
– Required banks to hold more capital after doing stress tests
– Bought long-term securities from banks of up to $600 billion via open-market operations in November 2008. The amount of securities bought was increased to $1.25 trillion dollars’ worth of mortgage-backed in March 2009, $200 billion worth of agency debt and $300 billion of long-term Treasury debt.
- When the Fed buys bonds the increased demand for them caused prices to go up and yields to go down. Continued buying of bonds “can signal that the central bank intends to pursue a persistently more accommodative policy stance than previously thought, thereby lowering investors’ expectations for the future path of the federal funds rate and putting additional downward pressure on long-term interest rates, particularly in real terms,” Ben Bernanke at the 2012 Jackson Hole Conference.
Additional Monetary Policy Post the “Great Recession”
– In November 2010, the FOMC announced it would by an additional $600 billion of longer-term Treasury securities until 2011. Another term for this is quantitative easing or QE2. QE 1 was considered the large Treasury security buying during the crisis. QE2 is considered for the period post crisis.
– In August 2011, the FOMC announced a new maturity extension program (MEP) in which the Fed would purchase $400 billion of long-term Treasuries and sells an equivalent amount of short-term securities. This program has been extended into 2013. The increased demand for long-term bonds by the Fed increases the price of the Treasuries while lowering the yield-to-maturity which puts a downward pressure on long-term interest rates.
A Brief Look at the Effectiveness of the Monetary Policy during the Crisis
There is no definitive answer to the question of whether monetary policy during the crisis was successful or not successful for two reasons. First, it is impossible to measure a counterfactual—what would the economy have been like with zero or less Federal Reserve intervention? It has been speculated that the economy would have taken longer to start to expand, but there is no alternative to measure this against. Second, it is hard to talk about the effectiveness of the Federal Reserve’s policies and programs in a measurable way. If we talk about the effectiveness as measured by the Federal Reserve’s ability to follow its dual mandate which states that:
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
then, monetary policy has been effective. The Federal Reserve has kept the price level relatively stable (inflation has been under 2% and not drastically changed over the past 4 years) and unemployment is contained and decreasing to our natural rate (unemployment has fallen from a 10% high to 7.3%.) However, if effectiveness is determined by economic growth and GDP growth than the Federal Reserve’s monetary policy has fallen short of the U.S.A.’s typical 2-3% GDP growth.
One of the positive consequences that some economists (paper 1, paper 2, paper 3) have estimated from the large scale asset purchases by the Fed are that 10-year Treasury securities have lowered by 80-120 basis points or 0.80%-1.20%. There has been significant decline on yields on both corporate bonds and mortgage-backed securities as well. Lowering yields allow companies to borrow to invest in their businesses at a cheaper cost. In March 2009, the stock market started to increase. The stock market is a leading economic indicator and its bolstered stock prices are indicative of a positive economic outlook.
However, a negative consequence is that large scale asset purchases are that the private market can be crowded out of private investment in bonds, which can lead to future problems with liquidity when the Federal Reserve phases out their large scale buying. This has generally not been true as private bond buying has not drastically been decreased. However, large scale buying by the Federal Reserve also lends itself into a moral hazard argument—the United States’ monetary authorities are ready to help with little regard to cost. The cost is not necessarily the monetary cost of buying bonds, but rather the future cost of increased liquidity—inflation. Further, banks can take on as much risk as they want and a bailout (not only via Congress), but through the open-market will occur. Although the Federal Reserve can always sell bonds, decrease liquidity, raise fed funds and discount rates to curb higher inflation, expected inflation expectations have increased slightly.
Why the Fed, under Bernanke, Chose the Policies they did
Bernanke has studied economic recessions and is widely considered an economic expert on the Great Depression. Other notable monetary economists such as James Tobin and Milton Friedman have shown in research that if the Fed bought long-term securities during the Great Depression it would have helped recovery. Further, during the Bank of Japan’s crisis in the 1970s, a large-scale purchase would have prevented deflation. This was due to very tight monetary policy in Japan and an illiquid market. Bernanke’s strategies were a drastic alternative to the Federal Reserve’s strategy (or lack thereof) after the Great Depression.
…But, Were the Policies the Best they Could be?
The two large recessions in our country’s history, the Great Depression and the Great Recession, had very different monetary policy solutions and a very different rate of recovery. Post the Great Depression, there were many stagnant growth years until WWII where economic output increased at dramatic rates. Meanwhile, following the most recent recession our country’s GDP was positively growing, but very slowly. I believe that only time, and a future recession in magnitude in which to compare to, will determine whether the Fed used the best policies during 2007-2009. Otherwise it is hard to determine whether recent monetary policy just serves as one extreme, while monetary policy following the Great Depression served as an opposite extreme.