Federal Reserve Chairman Ben Bernanke told conference attendees at the Federal Bank of Boston this morning that the first round of stimulus spending was Ã¢â‚¬Å“successfulÃ¢â‚¬Â and essentially confirmed that another round of quantitative easing is on the way. Dubbed by some as Ã¢â‚¬Å“QE2Ã¢â‚¬Â, Bernanke admitted that there is some risk associated with this approach, but the Fed feels the risk is acceptable.
Complicating the issue of course, is the fact that short-term interest rates have already been reduced as low as they can go. This has forced central banks to look at Ã¢â‚¬Å“nonstandard policies and approaches that do not rely on reductions in the short-term interest rateÃ¢â‚¬Â.
At the top of the FedÃ¢â‚¬â„¢s list of concerns, is the employment outlook which in a word, is discouraging. As Bernanke noted in his address, the private sector, which provides the true barometer for the employment situation, has only created on average, 85,000 new jobs per month. This rate of job production is simply not sufficient to reduce the current unemployment rate, and until the rate of creation increases, consumer spending will remain weak.
Part of the problem says Bernanke, is that credit for businesses looking to expand is still Ã¢â‚¬Å“quite unevenÃ¢â‚¬Â. Thanks to the first round of stimulus spending, larger firms generally have access to capital, but smaller firms are still struggling to obtain affordable credit.
With respect to growth, inflation is mired well below the ideal expansion rate of just under 2 percent year-over-year. This is where the Fed is really constrained by not being able to lower short-term rates further and this leaves the Fed with no alternative but to resort to further spending. Bernanke specifically mentions the possibility of the Fed expanding its holdings of longer-term securities as a way to reduce long-term interest rates.
Bernanke is quick to point out however, that there are two possible risks the Fed faces should it follow through with more stimulus spending. The first risk is that the Federal Reserve has very little experience in determining how much and at what rate to buy these securities and there is a chance that the Federal Reserve could get it all wrong. The second threat is how to exit the stimulus expansion without sending the economy back into a tailspin.
Despite these concerns, QE2 is as close to a sure thing as you can get. Overall the economy has improved in the past year but growth for 2011 is projected to be far below earlier estimates. It is also expected that unemployment will remain elevated through 2011 and when it does begin to improve, the pace of job creation will still be weaker than in the past. Thus, in BernankeÃ¢â‚¬â„¢s own words, Ã¢â‚¬Å“there would appear Ã¢â‚¬â€œ all else being equal Ã¢â‚¬â€œ to be a case for further action. However, as I indicated earlier, one of the implications of a low-inflation environment is that policy is more likely to be constrained by the fact that nominal interest rates cannot be reduced below zero.Ã¢â‚¬Â