Where's the link to the fact that the Fed is buying up equities?
Bernanke is Using His 2002 Playbook to Combat Deflation... Here's What's Coming Next
June 22, 2011 4:48 PM EDT
One of the most important takeaways from Wednesday's conference call with Fed Chairman Ben Bernanke was that QE3 is not currently in the cards, since it is believed the recent slowdown is temporary. While this may be the case, Bernanke signaled that any signs of deflation will be met with more support from the Fed.
As Mr. Bernanke didn't discuss the specifics of what QE3 would look like if needed, he essentially said a program like the current bond buying program may not be effective.
Interestingly in the Q&A, Fed Chairman Ben Bernanke referred back to his speech on deflation 10 years ago, often called the "helicopter Ben" speech. Here's what he said Wednesday in response to a question about the U.S entering its own lost decade similar to Japan.
"Well, I'm a little bit more sympathetic to central bankers now than I was 10 years ago. I think it's very important to understand that my comments, both in my comment in the -- published comment a decade ago, as well as in my speech in 2002 about deflation, my main point was that a determined central bank can always do something about deflation. After all, inflation is a monetary phenomenon, the central bank can always create money, and so on."
Looking back to the 2002 speech, it reads like a playbook for the current economic crisis. The thesis of the speech is - while the U.S. would not likely enter a deflationary environment, here is what we can do if it happens.
Mr. Benanke was wrong in assuming the U.S. would never enter this type of situation, and the moves the central bank has recently taken to combat deflation have, in effect, been a play-by-play of his 2002 suggestions.
Benanke's playbook reads: take rates to zero (check), if that doesn't work, expand assets purchases (check).
If that doesn't work...
"begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years)."
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...Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years.
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If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities.
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The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt...
Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange....
Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.
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In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.
- or -Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.
So this is the playbook. Please pay attention. It is happening right in front of our eyes.