Bernanke Downplays Likelihood of QE3

In a speech delivered to conference attendees in Atlanta yesterday, Federal Reserve Chairman Ben Bernanke gave no definitive answer on the question of further quantitative easing. The Chairman did however, provide a frank assessment of the current state of the economy which he described as being “somewhat slower than expected”.

The major factor holding back the recovery according to Bernanke is the fact that consumer spending levels are still far below pre-recession levels. Consumer spending accounts for 70 percent of the total economy but uncertainty with respect to employment and the rising cost of energy and other necessities is accounting for an increasing share of each consumer dollar.

Inflation Outlook and Monetary Policy

In his address, Bernanke acknowledged the price increases and the possibility of increasing inflation in the coming months. Despite these factors, Bernanke minimized the threat of inflation noting that while some prices have increased sharply this year, longer-term inflation is expected to remain stable.

Underscoring this outlook, Bernanke unequivocally stated his support for maintaining the federal funds rate near zero for “an extended period”. Bernanke has been using this phrase to reference the length of time that the Fed will maintain the 0.25 percent cap for over a year now, and it is clear that this policy is destined to remain in effect until at least the end of the year. On the subject of another round of quantitative easing however, the Chairman was less direct.

Bernanke noted that the Federal Open Market Committee (FOMC) will complete the current round of quantitative easing by the end of this month. The program consisted of the purchasing of $600 billion in Treasury securities over the past eight months.

Keep in mind that the Fed has received considerable criticism from some pundits for its “easy money” policy. The intended effect of any loose money policy is to stimulate activity but an unintended side effect is the potential for rising prices and inflation.

The reality though is that all this cheap money has not been enough to get consumers spending again. Elevated unemployment and general market uncertainty have conspired to drag down consumer sentiment and spending remains muted as a result.

What we can glean from Bernanke’s speech is that while the Fed remains committed to its policy of reinvesting principle payments from security holdings, Bernanke stopped short of suggesting further large-scale quantitative easing was under consideration. Most observers are reading this as a sign that the Fed believes the even though the pace of the recovery is slower than hoped for, there is no significant benefit to be derived from further direct intervention.

Naturally, this approach could change in the future should conditions warrant:

“Under all circumstances, our policy actions will be guided by the objectives of supporting the recovery in output and employment while helping ensure that inflation, over time, is at levels consistent with the Federal Reserve’s mandate”.