Post-Mortem Of Bernanke's Prepared Remarks

From SocGen:

Bernanke downplays costs of easing

Here's Bernanke's list of the costs/risks associated with further asset purchases, and his assessment about the severity of those risks:

1. On the cost that concern about exit will undermine long term inflation expectations: In Bernanke's words, "the committee remains confident that it has the tools necessary to tighten monetary policy when the time comes to do so". He points to recent inflation trends which remain subdued, and to inflation expectations which remain well anchored in Bernanke's view.

2. On financial stability risks: The Fed's longstanding view is that monetary policy is too blunt a tool to deal with potential mispricing of risk in various asset markets and instead these concerns should be addressed through supervisory channels. Bernanke appears to cling heavily to this view. He notes in his testimony that the Fed has substantially expanded its monitoring of the financial system. The Fed's approach to supervision of financial firms has also taken a more systemic perspective since the crisis. Bernanke acknowledges that a long period of low rates could encourage excessive risk-taking, but concludes that the potential costs outweigh the benefits of promoting a stronger recovery and more rapid job creation.

3. On the risk of future capital losses and their implication for the federal budget: Bernanke acknowledges, in-line with recent Fed studies, that asset sales in a rising rate environment could lead to a period of capital losses. This, in turn, may force the Fed to suspend remittances to the Treasury, which could have an adverse impact on budget projections. Bernanke downplays these concerns and suggest that the Fed's activities have to be viewed holistically. He notes that even in the case of sharply reduced remittances to the Treasury in future years, total remittances during the entire balance sheet expansion will have been larger than during the pre-crisis period. He also underscores that better economic outcomes will ultimately improve the budget situation, implicitly arguing in favour of further asset purchases rather than against them.

Leaning against fiscal restraint

Bernanke also warns that the sequester could impose additional near-term burden on the recovery. He cites the CBO's estimate that it will contribute to 0.6% of fiscal drag this year. This is on top of the drag from tax increases that went into effect on Jan 1. In the context of the fiscal tightening currently underway, Bernanke does not seem to be in a hurry to scale back QE in the near future.

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Of course, none of the above commentary from SocGen does nearly enough justice to Bernanke's response to Senator Shelby whether the Fed's record balance sheet has ever been higher: "there are other central banks whose balance sheets have been this large, such as Japan."

Well, since it worked for Japan.

Finally this, which the market may want to pay attention to: Bernanke says there may be ‘frothiness’ in some asset classes.


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