Fed moves toward open-ended bond purchases to satisfy Bernanke

Washington: Federal Reserve Chairman Ben S. Bernanke says the US economy is “far from satisfactory”. His colleagues are moving to embrace policies that will stay in place until he’s satisfied.

Four Fed presidents have come out in favour of an open-ended strategy for bond buying, with three calling for the programme to begin now. Rather than specify a fixed amount of bonds to purchase by a certain date, such a strategy would leave the Fed able to announce a pace of purchases that it could adjust as the economy gets closer to Bernanke’s goals.

“You would be able to react to the incoming data in an incremental way and not be in a situation where you have to either drop the bomb or do nothing,” St Louis Fed President James Bullard said in an interview last week during the Fed’s annual monetary policy symposium in Jackson Hole, Wyoming.

Bernanke used the forum to defend unorthodox policies such as bond purchases and made the case for further action to reduce an unemployment rate that he called a “grave concern”. Stocks and Treasuries jumped after the speech as investors increased bets the Fed will opt for further easing as soon as its next meeting September 12-13.

“It is important to achieve further progress, particularly in the labour market,” Bernanke said last week. San Francisco Fed President John Williams, Chicago’s Charles Evans and Boston’s Eric Rosengren have joined Bullard in endorsing open-ended bond-buying to push down an unemployment rate stuck above 8 per cent for 42 consecutive months.

Flow of purchases

“That might take the form of announcing a flow of purchases of securities per month” that would continue “for as long as appropriate,” Williams said in an interview at Jackson Hole. The Fed would then “adjust this programme as time goes on, either to increase it or decrease it, end it sooner or later, depending on how economic conditions develop”.

“There has been more talk among members of the FOMC of an open-ended programme,” Dean Maki, chief US economist at Barclays Plc said in an interview at Jackson Hole. Such a programme would be more effective because it “would emphasize the unlimited nature of the Fed’s balance sheet and that they’re willing to do as much as necessary”.

The minutes of the Federal Open Market Committee’s July 31-August 1 meeting showed that many policy makers said a new bond-buying programme should “be sufficiently flexible to allow adjustments, as needed, in response to economic developments or to changes in the committee’s assessment of the efficacy and costs of the programme”.

The strategy for more bond-buying “could be open-ended purchases, meaning that they would continue at a certain rate until there was clear evidence of improvement in economic conditions,” Evans said in an August 27 speech in Hong Kong. “To me, one example of clear evidence would be a resumption of relatively steady monthly declines in unemployment for two or three quarters.”

Evans has also argued that the Fed should hold interest rates near zero until the jobless rate falls below 7 per cent, so long as inflation does not breach 3 per cent.

The unemployment rate probably held at 8.3 per cent in August, according to the median forecast of economists surveyed by Bloomberg News ahead of Labor Department figures September 7. Payrolls may have grown by 125,000 following a gain of 163,000 in July.

Joseph LaVorgna, chief U.S. economist for Deutsche Bank Securities Inc in New York, said the Fed may be unable to reach consensus on such strategies. LaVorgna said his baseline forecast doesn’t include more asset purchases in any form because the economy isn’t at risk of deflation.

Unable to agree

While it would “make more sense for the Fed to say we’re not going to raise rates until we get a certain set of economic conditions,” policy makers may be unable to agree on terms, LaVorgna said. “The problem you have is very different scenarios. Unemployment could come down more slowly while inflation picks up more quickly or vice-versa.”

The debate has international resonance. Adam Posen, whose three-year term as a policy maker at the Bank of England ended last week, said setting thresholds acknowledges economies are in a special set of circumstances and gives the public something they can understand and monitor.