Six Questions For Ben Bernanke

Tomorrow's Bernanke testimony will be eagerly watched by all, not so much for anything that may be revealed in the prepared remarks (those will not disclose anything not already known), nor for the Q&A (because unfortunately the people in Congress who understanding the first thing about monetary policy can be counted on two fingers), but because it is not every day that the undisputed and underrepresented ruler of the not so free world gets to sit down in a kabuki theater in which he pretends to be accountable to some 300+ million peasants and a couple million compulsive gamblers and kleptomaniacs. All in all good, wholesome, TiVoable, and, luckily, just biannual fun. Yet for those who hope to get something out of this meeting than merely a popcorn overdose, we recommend the following Testimony Preview from Goldman's Hatzius & McKelvey, which goes through not only the background of the spectacle but focuses on some oddly relevant questions which our Congressmen may be wise enough to ask. We point out the latter, because we know full well that nobody will ever ask the really relevant questions (until it is too late), unless of course Alan "Taz" Grayson is wearing his dollar tie, In which case all bets are off.

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US Daily: Bernanke Preview: Focus on the Q&A

Chairman Bernanke’s semiannual testimony on Wednesday and Thursday is unlikely to produce much news regarding the monetary policy outlook, at least as far as his prepared statement is concerned.  Both the chairman individually and the Federal Open Market Committee (FOMC) collectively have just reaffirmed their policy guidance that the federal funds rate will stay “exceptionally low…for an extended period,” and there has been no important news since then that could be expected to change this assessment.

Thus, attention will be focused on the question and answer session.  In this part of the hearing, it would be valuable to get the chairman’s views on issues such as the link between the committee’s view of the output gap and its outlook for inflation; its reluctance to aim for a faster drop in the unemployment rate via additional monetary stimulus; what indicators the committee watches to decide whether inflation expectations are still “low and stable”; its expectations for mortgage rates after the end of the MBS purchases; and its view of whether a higher inflation target would help minimize the risk of renewed difficulties with the “zero bound” on nominal interest rates in the future.  If today’s decision by the Treasury to ramp up its Supplemental Financing Program (SFP) comes up, he will likely characterize that as another technical move to keep excess reserves from rising further from the current $1.1 trillion (trn).

Chairman Bernanke will deliver his semiannual monetary policy testimony this week, before the House Financial Services Committee on Wednesday and before the Senate Banking Committee on Thursday.  Historically, this event (formerly known as the “Humphrey-Hawkins” testimony) has been a key event on the Fed calendar.

But while “Humphrey-Hawkins” continues to attract a lot of attention from market participants, its importance is considerably lower now than it was a few years ago.  Much of this change reflects the Federal Reserve’s move toward greater transparency in its decision making.  The FOMC now publishes more informative post-meeting statements, more timely minutes (three instead of six weeks after the meeting), and a full set of “central tendency” forecasts four times a year (instead of twice a year in the Humphrey-Hawkins report).

This time, the importance of the chairman’s testimony is further diminished.  This is because he just delivered a detailed account of the Fed’s plans for its “exit strategy” in his testimony to the House Financial Services Committee on February 10.  On that occasion, he reaffirmed the Fed’s plan to keep the federal funds rate “exceptionally low…for an extended period.”  Moreover, the full FOMC used the same phrase in the press release accompanying its discount rate hike on February 18.  Since then, there has been no news that would justify any change in the committee’s policy leanings.  If anything, the 0.14% drop in the consumer price index excluding food and energy in January—probably the most important data release since the discount rate hike—would have reinforced the committee’s leanings.  Hence, a failure by the chairman to repeat the policy commitment would be a huge surprise.

This suggests that the more interesting part of the testimony—beyond any nuances in Bernanke’s assessment of the economic and policy outlook—will be the question and answer session.  Many questions will undoubtedly stray from monetary policy.  But if members want to focus on the chairman’s “day job,” here are a few questions for which it would be useful to get his answers:

1. Why does the FOMC expect underlying inflation to stop falling in the face of an output gap that is likely to remain very large by its own assessment?

Over the past two years, measures of underlying inflation such as the CPI or PCE deflator excluding food and energy or the “trimmed-mean” CPI and PCE indexes have slowed by an average of 1½ percentage point, from the 2½%-3% range then to around 1%-1½% now.  The FOMC’s central tendency forecasts have core PCE inflation remaining at 1½% and are therefore saying that the decline in inflation is essentially behind us.  In our view, this expectation is difficult to square with the presence of an output gap that remains huge by the FOMC’s own estimates.  While the FOMC’s forecasts are more optimistic than our own, the committee nevertheless expects an unemployment rate of 8.4% by the end of 2011.  This is more than 3 percentage points above the committee’s expectation of the “longer-run” unemployment rate, which most observers would take as the committee’s estimate of the “natural” rate.  Under these circumstances, most models of inflation would predict further declines in core inflation, at least if one assumes that inflation expectations do not break out to the upside (see “Has Inflation Surprised on the Upside?” US Daily, January 27, 2010).  It would be useful to get the chairman’s view on why this is not the case under the FOMC’s forecasts.

2. Why is the FOMC so reluctant to provide additional monetary stimulus beyond the low level of nominal short-term interest rates, and what would it take to overcome this reluctance (e.g., extend/restart the asset purchase program)?

Even under the FOMC’s forecasts for 2011, the committee will badly miss both parts of its dual mandate—maximum sustainable employment at low inflation—on the weaker side, by 3 percentage points in the case of employment and ½ percentage point in the case of inflation.  Nevertheless, it is clear that the hurdle for additional stimulus—e.g. in the form of an expansion of the Fed’s asset purchase program beyond the $1.725 trillion target that is now slated to end in March—is quite high.  In fact, we believe that our forecast—a slowdown in real GDP growth to below 2% in late 2010 and ongoing core disinflation to well below 1%— constitutes the minimum of what would be required for Fed officials to consider additional purchases, and they would probably need to see significant weakness in the financial markets to be persuaded that such a move was warranted.

It would be useful to hear the chairman explain why the FOMC is not inclined to provide more stimulus, and what would be required to change the committee’s mind on this issue.  In particular, does the reluctance reflect concerns that additional measures would be ineffective, that inflation expectations could become unhinged, or do committee members perceive substantial costs associated with additional measures of stimulus, either in market dislocations or in complications for the ultimate exit from the current posture of unusual accommodation?

3. What indicators does the FOMC watch to gauge whether inflation expectations are still “low and stable”?

Fed officials typically answer questions of this sort by saying they watch a variety of measures.  In this case, the candidates include breakevens in the TIPS market (which have fallen back a bit in the past couple of weeks), the Philadelphia Fed’s Survey of Professional Forecasters (which has edged down slightly over the past year from 2.5% to 2.4%), and the University of Michigan’s median expectation for inflation over the next 5 to 10 years (which has fluctuated without trend between 2.6% and 3.4% over the past 18 months).

Although Chairman Bernanke may resist elevating one of these gauges over the others, it would be worth some effort to get him to do so, as each has its own characteristics.  For example, the market participants who determine TIPS breakevens have the most at stake in being right, but they represent only a tiny sliver of the population whose behavior ultimately determines whether and how changes in inflation expectations affect inflation itself.  At the other extreme, the Michigan data draw from consumers, who matter the most in this regard, but the basis on which they form expectations is presumably much more instinctive.  In between, the economists surveyed by the SPF work from various models of the inflation process but have neither as much riding on the outcome as the TIPS traders nor as much influence over the outcome as the households surveyed by the University of Michigan.

4. What are the committee’s current expectations for mortgage rates after the end of its MBS purchase program? [Steve Liesman, read this]

In a recent speech Brian Sack, manager of the Federal Reserve’s System Open Market Account, said that the Fed’s asset purchases had lowered MBS spreads by 100bp.  However, he did not opine on the likely impact that the end of these purchases, which will occur next month.

Economists and market participants are divided on this issue.  Many of them—and most Fed officials—believe that Fed purchases exert their impact on interest rates by reducing the amount of securities that need to be held by the private sector.  In other words, they focus on the stock of Fed holdings as a determinant of interest rates.  This would imply that the Fed’s actions will only push up interest rates if and when they start selling, but not when they stop buying.  Others—including many traders—believe the impact occurs via a reduction in the flow of new securities that needs to be absorbed by private investors.  This would suggest that the Fed’s actions might already push up interest rates when they stop buying.

5. Should the Fed target (either now or at some point in the future) a higher inflation rate over the business cycle?

Olivier Blanchard, the chief economist of the International Monetary Fund, recently suggested that a 2% inflation target may be too low to provide enough room to guard against a re-run of the “zero bound problem” on nominal interest rates (see Olivier Blanchard, Giovanni Dell”Ariccia, and Paolo Mauro, “Rethinking Macroeconomic Policy,” IMF Staff Position Note, February 12, 2010).  If the target were, say, 4%, this would provide a larger cushion in the case of substantial disinflationary or even deflationary pressure.  Indeed, John Williams, the research director at the San Francisco Fed, published a study last fall that had similar implications (see “Heeding Daedalus: Optimal Inflation and the Zero Lower Bound,” Brookings Papers on Economic Activity, forthcoming).

The FOMC’s view on this issue has been that stable inflation expectations are essential to its ability to conduct an expansionary policy during periods of economic weakness, and we are frankly sympathetic to this position.  An increase in the (implicit) inflation target from 2% to 4% would likely raise nominal long-term interest rates sharply.  Indeed, it would not be surprising if long-term rates rose by more than 200 basis points, as some market participants would worry that the Fed would tolerate even higher inflation later on.  In that case, the loss of credibility plus any short-term costs in terms of lost economic activity could outweigh the long-term gains of avoiding the zero bound.  Again, however, it would be useful to hear the chairman explain the FOMC’s position on this issue in more detail.

6. Does today’s announcement by the Treasury that it is ramping the Supplemental Financing Program back up to $200bn signal other impending reserve drains, and why are Fed officials thinking about draining reserves when bank loans are falling?

Fed officials are clearly uncomfortable with the large volume of excess reserves in the banking system—currently $1.1trn.  That said, Chairman Bernanke would undoubtedly stress, as he and others did with respect to last week’s discount rate increase, that ramping up the SFP to $200bn from $5bn currently is not a precursor to near-term reserve operations of significant size.  In fact, it will simply prevent reserves from rising further as the Fed books the last $225bn of MBS purchases.  Until now, most of the asset purchases have been offset by the unwinding of the special liquidity facilities, but they are now down to tag ends ($30bn counts as tag ends in a $2.2trn balance sheet).

Jan Hatzius/Ed McKelvey

Comments

[Recovery3000]

Withdrawing stimulus would at least start the process of creative destruction.  We own several large retail centers and we are glad the banks extended us, but one of the fundamental reason for the lack of investment in the economy is that formerly productive assets are now unproductive due to the basis of these assets being to high for the value they could produce.  Conversely, the billions of equity dollars sitting idly waiting to take advantage of distress remain untapped as the bank extensions have created huge gaps in the bid-ask and unfortunately new jobs need new investments.  Greenspan for his faults is right that the big players are making money off the stimulus while the smaller players are getting hammered on a daily basis. 

[Anonymous]

FYI: Grayson happen to be in the building next to the palace when shots rang out during the coup in Niger last week. He might be in a PTSD mood this week. Sorry, no link.

[Anonymous]

Wow; if Grayson had been shot in Niger (thank God he wasn't) just imagine the conspiracy theories!

[Anonymous]

my 6 questions are a bit more pointed.

1. when are you going to resign?
2. when are you going to stop lying?
3. when are you going to grow up?
4. when are you going to stop meddling in the economy?
5. when are you going to stop assisting your bankster friends?
6. when are you going to die?

[DavidC]

I live in hope that 'Taz' Grayson will be on the case!

DavidC

[Recovery3000]

I can't tell if he actually believes what he says or not

[Anonymous]

I am confused here. I thought usually it is GS who tells BB what to say in those testimonies. Unless,now and after "dollar death"shouts,BB decided to severe any and all phone calls with GS?!!

[35Pete]

Question #7

Dear Uncle Ben:

Were you born a douchebag?

[ED]

No, it requires considerable application. Why do you ask?

[chindit13]

"You're either with us or against us"

With Bernanke on tap on the Hill, all of those Congresspeople who claim to want to audit the Fed, get to the bottom of things, etc., have a chance to s*** or get off the pot and make that pig squeal (plus use any other cliche I may have left out).  Fed buying Greek debt?  Equities or index futures?  What price collateral?  Etc.

Bring it on or join UE3 come November, ladies and gentlemen.

[DavosSherman]

7.) Bail out Greece lately.

8.) Are you financially illiterate Ben?

[strike for retu...]

7. Is there any market in which Treserve is not attempting to manipulate prices?

And a follow-up question, how much ego is required to think that you are capable of doing this without destroying the United States?

[Anonymous]

These are the key questions for Bernanke:

1) Will you confirm the substance of Fed Governor Kevin M. Warsh's letter of September 17, 2009, to the Gold Anti-Trust Action Committee, to the effect that the Fed has gold swap agreements with foreign banks and insists on keeping those agreements secret? (For a copy of Warsh's letter, see http://www.gata.org/node/8192.)

2) What is the purpose of the Fed's gold swap agreements?

3) Have any of these agreements ever been implemented? If so, exactly how, why, and when?

4) How do those agreements affect the U.S. gold reserves?

5) Why must the Fed keep these agreements secret? What would happen if the public, the markets, and Congress knew what the Fed was doing in the gold market? Will the Fed disclose those agreements to Congress? If not, why?

If you're a U.S. citizen, you can help put these questions to Bernanke and thus hasten the end of the gold price suppression scheme by urgently contacting your U.S. representative and U.S. senators and ask them to see that Bernanke is asked about the gold swaps. You especially can help if your U.S. representative or either of your U.S. senators is a member of the House Financial Services Committee or the Senate Committee on Banking, Housing, and Urban Affairs, the committees that will question Bernanke directly.

You can find a list of members of the House Financial Services Committee here:

http://financialservices.house.gov/members.html

A list of the members of the Senate Banking Committee is here:

http://banking.senate.gov/public/index.cfm?FuseAction=CommitteeInformati...

You can identify and locate your U.S. representative here:

http://www.house.gov/

You can identify and locate your U.S. senators here:

http://www.senate.gov/

For this to have a chance with Bernanke's testimony next week, you'll have to try to reach your U.S. representative and senators on Monday. Please do try. All it will take is one member of Congress to raise the issue during the hearings. Thanks for your help.

[MarketTruth]

+1 trillion $$$

[Anonymous]

#7) Is there any way to bypass the inefficient QE process and just transfer newly printed dollars directly to the employees of Goldman Sachs?

[Anonymous]

FYI: Grayson was in the building next to the palace when shots rang out during the coup in Niger last week. Might be a little jumpy this week. Sorry no post.

[Anonymous]

conspiracy and / or warning shots for Grayson ?

[Irrational Exub...]

Ben...YES OR NO.   Are you going to bail out Greece (and in trun GS)?

[Ned Zeppelin]

"because it is not every day that the undisputed and underrepresented ruler of the not so free world gets to sit down in a kabuki theater in which he pretends to be accountable to some 300+ million peasants and a couple million compulsive gamblers and kleptomaniacs."

TD, you SO rock.

Really good post by the way. Nice and granular. The end of QE will really be something to watch. If mortgage rates rise by 100 bps, look out. Right now, outside of government guaranteed mortgages, forget the bid/ask - there is no bid to speak of, at any rate. Feels like. . .

[MarketTruth]

NOTE TO CONGRESS

Here is a novel idea, please allow the guys/gals with a true knowledge about financing get all the time they need to ask highly qualified and pertinent questions. Those less than educated on finances members of congress should allow their time to be given to those who have a 'clue'. When the less than educated ask 'stupid' questions it only makes them look bad PLUS those of us who vote will use their less than educated knowledge about finances against them during the next election as we will stand outside of poling places and make sure their constituents know about their less than active role and educating may have helped to cause this recent financial disaster. So give your time to those who have great knowledge in this matter so Bernanke can be asked quality questions so We The People find out the truth versus just wasting your and my time, plus less than knowledgable questions from you make you look less than what you hope your voters see you to be... come election time.

[Ned Zeppelin]

Ah, but the whole point is to use up the time so that short thrift can be given to the questions that matter. All part of the script.

[Anonymous]

Those questions suck. These are better:
1. Ben, what country to you plan to hide in after the collapse?

2. Ben, give us the name of your boss(es)

3. Ben, why do you want to facilitate the downfall of America as a sovereign nation?

4. Who are the five guys?

5. Ben, show us what your plan is for the next year regarding the securities markets - what prices have you programmed in for stocks, bonds, commodities, and credit spreads?

[Anonymous]

With respect to Question 2. Monetary Easing was only half the story. The other half was a mission in reconnaissance - after one year of internal evaluation this has largely played out.

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