In an opinion piece published in the Washington Post this evening Ben Bernanke says that QE is already working, but makes an absolutely crucial admittal in the article. He says QE adds no net new money to the system (sound familiar?) and will therefore not be inflationary. He also goes on to say that he is directly targeting higher equity prices and lower interest rates:
“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.
Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.
Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.
The Federal Reserve cannot solve all the economy’s problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.”
The keys here are several:
- First, notice that Mr. Bernanke admits that QE is just an asset swap. It does not add net new money to the system. Therefore, there is no reason to believe it is inflationary. I agree with the Fed Chairman. This policy will not cause inflation (wait, isn’t that the whole goal?).
- Second, he claims it has worked in the past by achieving lower interest rates. But in all three cases in the UK, Japan and the USA interest rates ROSE throughout the entirety of the programs.
- Third, the Chairman admits that he needs help. He most certainly does. In my opinion, the Fed Chairman has essentially admitted here that QE is a non-event aside from the psychological herding of investors into equities and corporate bonds. He needs fiscal help if he’s going to cause real inflation. After all, a helicopter drop isn’t even technically in his arsenal and he knows it.
Mr. Bernanke is claiming victory before the program even technically begins….This Fed Chairman will either go down as the genius of all Central Bankers or will be known as the man who caused the Federal Reserve to lose its independence.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.