Until the middle of 2013, the Bernanke method was very clear: Use anything and everything to revive the currency’s nimbleness and avoid the risk of deflation spreading throughout the economy with monetary policy tools that were discussed in 2002. He has been able to account for everything … except maybe the end, or at least how to stop the monetary machine.
Let us go back to the start of the financial crisis in August 2007 for a moment; we see that the exceptional need for liquidity kicked off an unprecedented and coordinated reaction from central banks around the world. During the first year of the crisis, the U.S. Federal Reserve used traditional tools, but the unprecedented strength of this crisis led him to use tools that were not only innovative for their function, but their scope.
Who other than Bernanke was even developing these tools? An artist, the most published economist, the most renowned specialist on deflation, went into action.
Extraordinary measures allowed the economy to rebound; American stocks (unlike Europe’s, which are normally a good indication of consumer confidence and the economy) have once again hit a historic high. All of this went down as if the head of the Fed had accomplished the master stroke of restarting the machine after a crisis that could have been harder and more severe than what happened in the ‘30s.
Even if some consider the impact on investors as psychological, it is obvious there is also a quantitative impact. You can’t deny that it explains the recovery and the recent high American stock market results. Investors are simply just encouraged in their risk taking by a Fed that appeared to be the last line of defense against the crisis. During the past few years, when three stock market recoveries have faltered, the Fed systematically used some new supportive measures.
However, recent growth figures for the U.S. economy and the job market lead us once again to ask some questions on the durability of this support. The unconventional methods put in place stay longer than ever, but the end seems near.
There was the famous concept of “tapering,” where every investor since the middle of 2013 has obviously pushed back somewhat, but you mustn’t forget that he already replaced the concept of an “exit strategy” in a speech in February 2010 at the central American bank titled “Federal Reserve’s Exit Strategy Before the Committee on Financial Services,” Ben Bernanke ended by assuring: “However, we have been working to ensure that we have the tools to reverse, at the appropriate time, the currently very high degree of monetary stimulus. We have full confidence that, when the time comes, we will be ready to do so.”
The idea of buying $800 billion in American debt already scared the markets and the international community. But the misfortunes of Europe and the debt crisis and a chain of bank failures have finally allowed the endgame to be postponed indefinitely.
For the Fed hasn’t stopped adding fuel to the system without ever negotiating between one monetary tool and another: an announcement of setting the refinancing rate to zero for several years (August 2011), a twist operation that would shelter short-term debt held by the Fed with long-term debt (third quarter 2011) and a final quantitative easing (QE3) that has allowed the purchase of $85 billion of American mortgage titles each month since December 2012. This does not have any clear end date.
Until the middle of 2013, the Bernanke method was very clear: Use anything to revive the currency’s nimbleness and keep the risk of deflating from reaching the economy. Don’t forget that Ben Bernanke made himself rather famous for a speech (that I will mark as a reference as it is enlightening) from November 2002 titled “Deflation: Make Sure It Doesn’t Happen Here,” which summarized a large part of his theories regarding monetary policy and notably presents tools that would be put in place some years later. He had thus predicted everything.
Except maybe the end, or at least how to stop the monetary machine.
In the referenced text above, where he alludes to the tools [that were] called on in a very precise manner, the last part is telling. The situation he mentions was, at the time, very improbable owing to the “the force of the underlying economy” of the United States. Thus, it remained fundamental and academic theory. It also insisted on the fact that these tools could bring up some practical problems in their application and grading of their economic effects. However much these tools have been analyzed, similar analysis on taking them out has been weak.
Thus, it rather clear that none of it had been planned, and that the risk of a final negative grade is as all-important as it was grading the different actions. However, the exercise appears a lot more complicated because it’s about now to take sides as the crisis ends (what isn’t sure: all of it!).
The present communication from the Fed shows how delicate the subject is and how opinions diverge. The recent declarations from Ben Bernanke on Nov. 27, “Slower growth in productivity might have become the norm,” show that he isn’t rushed to begin to reverse the process, and that the lasting effects of the crisis are well present. You must thus do like him and bet “on the fact that when the time comes, they will be ready.” Let’s hope so! In any case, the Fed will have to prove one day that it has the ability to reverse the process. The next chair, Janet Yellen, will certainly have the chance to show her determination. Paradoxically, when the U.S. economy picks up, they will have to act quickly as soon as the first red flags for inflation happen, which may cause a mini meltdown.