Ben S Bernanke: US monetary policy and international implications
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at a high-level seminar "Challenges of the global financial system: risks and
governance under evolving globalization", sponsored by the Bank of Japan and the
International Monetary Fund, Tokyo, 14 October 2012.
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Thank you. It is a pleasure to be here. This morning I will first briefly review the U.S. and
global economic outlook. I will then discuss the basic rationale underlying the Federal
Reserve's recent policy decisions and place these actions in an international context.
U.S. and global outlook
The U.S. economy has faced significant headwinds, and, although the economy has been
expanding since mid-2009, the pace of our recovery has been frustratingly slow. The
headwinds include the effects of deleveraging by households, the still-weak U.S. housing
market, tight credit conditions in some sectors, spillovers from the situation in Europe, fiscal
contraction at all levels of government, and concerns about the medium-term U.S. fiscal
outlook. In this environment, households and businesses have been quite cautious in
increasing spending. Accordingly, the pace of economic growth has been insufficient to
support significant improvement in the job market; indeed, the unemployment rate, at
7.8 percent, is well above what we judge to be its long-run normal level. With large and
persistent margins of resource slack, U.S. inflation has generally been subdued despite
periodic fluctuations in commodity prices. Consumer price inflation is running somewhat
below the Federal Reserve's 2 percent longer-run objective, and survey- and market-based
measures of longer-term inflation expectations have remained well anchored.
The global economic outlook also presents many challenges, as you know. Fiscal and
financial strains have pushed Europe back into recession. Japan's economy is recovering
from last year's tragic earthquake and tsunami, and it continues to struggle with deflation and
persistent weak demand. And in the emerging market economies, the rapid snap-back from
the global financial crisis has given way to slower growth in the face of weak export demand
from the advanced economies. The soft tone of global activity is yet another headwind for the
U.S. economy.
Looking ahead, economic projections of Federal Open Market Committee (FOMC)
participants prepared for the Committee's September meeting called for the economic
recovery to proceed at a moderate pace in coming quarters, with the unemployment rate
declining only gradually. FOMC participants generally expected that inflation was likely to run
at or below the Committee's inflation goal of 2 percent over the next few years. The
Committee also judged that there were significant downside risks to this outlook, importantly
including the potential for an intensification of strains in Europe and an associated slowing in
global growth.
Federal Reserve's recent policy actions
All of the Federal Reserve's monetary policy decisions are guided by our dual mandate to
promote maximum employment and stable prices. With the disappointing progress in job
markets and with inflation pressures remaining subdued, the FOMC has taken several
important steps this year to provide additional policy accommodation. In January, the
Committee noted that it anticipated that economic conditions were likely to warrant
exceptionally low levels of the federal funds rate at least through late 2014 - a year and a
half later than in previous statements. In June, policymakers decided to continue through
year-end the maturity extension program (MEP), under which the Federal Reserve
purchases long-term Treasury securities and sells short-term ones to help depress long-term
yields.
At its September meeting, with the data continuing to signal weak labor markets and no signs
of significant inflation pressures, the FOMC decided to take several additional steps to
provide policy accommodation. It extended the period over which it expects to maintain
exceptionally low levels of the federal funds rate from late 2014 to mid-2015. Moreover, the
Committee clarified that it expects to maintain a highly accommodative stance of monetary
policy for a considerable period after the economic recovery strengthens. The FOMC
coupled these changes in forward guidance with additional asset purchases, announcing that
it will purchase agency mortgage-backed securities (MBS) at a pace of $40 billion per month,
on top of the $45 billion in monthly purchases of long-term Treasury securities planned for
the remainder of this year under the MEP. The FOMC also indicated that it would continue to
purchase agency MBS, undertake additional asset purchases, and employ other tools as
appropriate until the outlook for the labor market improves substantially in a context of price
stability.
The open-ended nature of these new asset purchases, together with their explicit
conditioning on improvements in labor market conditions, will provide the Committee with
flexibility in responding to economic developments and instill greater public confidence that
the Federal Reserve will take the actions necessary to foster a stronger economic recovery
in a context of price stability. An easing in financial conditions and greater public confidence
should help promote more rapid economic growth and faster job gains over coming quarters.
As I have said many times, however, monetary policy is not a panacea. Although we expect
our policies to provide meaningful help to the economy, the most effective approach would
combine a range of economic policies and tackle longer-term fiscal and structural issues as
well as the near-term shortfall in aggregate demand. Moreover, we recognize that
unconventional monetary policies come with possible risks and costs; accordingly, the
Federal Reserve has generally employed a high hurdle for using these tools and carefully
weighs the costs and benefits of any proposed policy action.
International aspects of Federal Reserve asset purchases
Although the monetary accommodation we are providing is playing a critical role in
supporting the U.S. economy, concerns have been raised about the spillover effects of our
policies on our trading partners. In particular, some critics have argued that the Fed's asset
purchases, and accommodative monetary policy more generally, encourage capital flows to
emerging market economies. These capital flows are said to cause undesirable currency
appreciation, too much liquidity leading to asset bubbles or inflation, or economic disruptions
as capital inflows quickly give way to outflows.
I am sympathetic to the challenges faced by many economies in a world of volatile
international capital flows. And, to be sure, highly accommodative monetary policies in the
United States, as well as in other advanced economies, shift interest rate differentials in favor
of emerging markets and thus probably contribute to private capital flows to these markets. I
would argue, though, that it is not at all clear that accommodative policies in advanced
economies impose net costs on emerging market economies, for several reasons.
First, the linkage between advanced-economy monetary policies and international capital
flows is looser than is sometimes asserted. Even in normal times, differences in growth
prospects among countries - and the resulting differences in expected returns - are the most
important determinant of capital flows. The rebound in emerging market economies from the
global financial crisis, even as the advanced economies remained weak, provided still
greater encouragement to these flows. Another important determinant of capital flows is the
appetite for risk by global investors. Over the past few years, swings in investor sentiment
between "risk-on" and "risk-off," often in response to developments in Europe, have led to
corresponding swings in capital flows. All told, recent research, including studies by the
International Monetary Fund, does not support the view that advanced-economy monetary
policies are the dominant factor behind emerging market capital flows.1 Consistent with such
findings, these flows have diminished in the past couple of years or so, even as monetary
policies in advanced economies have continued to ease and longer-term interest rates in
those economies have continued to decline.
Second, the effects of capital inflows, whatever their cause, on emerging market economies
are not predetermined, but instead depend greatly on the choices made by policymakers in
those economies. In some emerging markets, policymakers have chosen to systematically
resist currency appreciation as a means of promoting exports and domestic growth.
However, the perceived benefits of currency management inevitably come with costs,
including reduced monetary independence and the consequent susceptibility to imported
inflation. In other words, the perceived advantages of undervaluation and the problem of
unwanted capital inflows must be understood as a package - you can't have one without the
other.
Of course, an alternative strategy - one consistent with classical principles of international
adjustment - is to refrain from intervening in foreign exchange markets, thereby allowing the
currency to rise and helping insulate the financial system from external pressures. Under a
flexible exchange-rate regime, a fully independent monetary policy, together with fiscal policy
as needed, would be available to help counteract any adverse effects of currency
appreciation on growth. The resultant rebalancing from external to domestic demand would
not only preserve near-term growth in the emerging market economies while supporting
recovery in the advanced economies, it would redound to everyone's benefit in the long run
by putting the global economy on a more stable and sustainable path.
Finally, any costs for emerging market economies of monetary easing in advanced
economies should be set against the very real benefits of those policies. The slowing of
growth in the emerging market economies this year in large part reflects their decelerating
exports to the United States, Europe, and other advanced economies. Therefore, monetary
easing that supports the recovery in the advanced economies should stimulate trade and
boost growth in emerging market economies as well. In principle, depreciation of the dollar
and other advanced-economy currencies could reduce (although not eliminate) the positive
effect on trade and growth in emerging markets. However, since mid-2008, in fact, before the
intensification of the financial crisis triggered wide swings in the dollar, the real multilateral
value of the dollar has changed little, and it has fallen just a bit against the currencies of the
emerging market economies.
Conclusion
To conclude, the Federal Reserve is providing additional monetary accommodation to
achieve its dual mandate of maximum employment and price stability. This policy not only
helps strengthen the U.S. economic recovery, but by boosting U.S. spending and growth, it
has the effect of helping support the global economy as well. Assessments of the
international impact of U.S. monetary policies should give appropriate weight to their
beneficial effects on global growth and stability.