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BLOOMBERG News (BN) Date: Nov 19 2010 3:12:09
Bernanke Defends Fed’s Treasuries-Purchase Program (Full Text)


Nov. 19 (Bloomberg) -- The following is a reformatted
version of Federal Reserve Chairman Ben S. Bernanke’s speech
today at a central-banking conference in Frankfurt.

Rebalancing the Global Recovery

The global economy is now well into its second year of recovery
from the deep recession triggered by the most devastating
financial crisis since the Great Depression. In the most intense
phase of the crisis, as a financial conflagration threatened to
engulf the global economy, policymakers in both advanced and
emerging market economies found themselves confronting common
challenges. Amid this shared sense of urgency, national policy
responses were forceful, timely, and mutually reinforcing. This
policy collaboration was essential in averting a much deeper
global economic contraction and providing a foundation for
renewed stability and growth.

In recent months, however, that sense of common purpose has
waned. Tensions among nations over economic policies have
emerged and intensified, potentially threatening our ability to
find global solutions to global problems. One source of these
tensions has been the bifurcated nature of the global economic
recovery: Some economies have fully recouped their losses while
others have lagged behind. But at a deeper level, the tensions
arise from the lack of an agreed-upon framework to ensure that
national policies take appropriate account of interdependencies
across countries and the interests of the international system
as a whole. Accordingly, the essential challenge for
policymakers around the world is to work together to achieve a
mutually beneficial outcome--namely, a robust global economic
expansion that is balanced, sustainable, and less prone to
crises.

The Two-Speed Global Recovery
International policy cooperation is especially difficult now
because of the two-speed nature of the global recovery.
Specifically, as shown in figure 1, since the recovery began,
economic growth in the emerging market economies (the dashed
blue line) has far outstripped growth in the advanced economies
(the solid red line). These differences are partially
attributable to longer-term differences in growth potential
between the two groups of countries, but to a significant extent
they also reflect the relatively weak pace of recovery thus far
in the advanced economies. This point is illustrated by figure 2,
which shows the levels, as opposed to the growth rates, of real
gross domestic product (GDP) for the two groups of countries. As
you can see, generally speaking, output in the advanced
economies has not returned to the levels prevailing before the
crisis, and real GDP in these economies remains far below the
levels implied by pre-crisis trends. In contrast, economic
activity in the emerging market economies has not only fully
made up the losses induced by the global recession, but is also
rapidly approaching its pre-crisis trend. To cite some
illustrative numbers, if we were to extend forward from the end
of 2007 the 10-year trends in output for the two groups of
countries, we would find that the level of output in the
advanced economies is currently about 8 percent below its
longer-term trend, whereas economic activity in the emerging
markets is only about 1-1/2 percent below the corresponding (but
much steeper) trend line for that group of countries. Indeed,
for some emerging market economies, the crisis appears to have
left little lasting imprint on growth. Notably, since the
beginning of 2005, real output has risen more than 70 percent in
China and about 55 percent in India.

In the United States, the recession officially ended in mid-2009,
and--as shown in figure 3--real GDP growth was reasonably strong
in the fourth quarter of 2009 and the first quarter of this year.
However, much of that growth appears to have stemmed from
transitory factors, including inventory adjustments and fiscal
stimulus. Since the second quarter of this year, GDP growth has
moderated to around 2 percent at an annual rate, less than the
Federal Reserve’s estimates of U.S. potential growth and
insufficient to meaningfully reduce unemployment. And indeed, as
figure 4 shows, the U.S. unemployment rate (the solid black line)
has stagnated for about eighteen months near 10 percent of the
labor force, up from about 5 percent before the crisis; the
increase of 5 percentage points in the U.S. unemployment rate is
roughly double that seen in the euro area, the United Kingdom,
Japan, or Canada. Of some 8.4 million U.S. jobs lost between the
peak of the expansion and the end of 2009, only about 900,000
have been restored thus far. Of course, the jobs gap is
presumably even larger if one takes into account the natural
increase in the size of the working age population over the past
three years.

Of particular concern is the substantial increase in the share
of unemployed workers who have been without work for six months
or more (the dashed red line in figure 4). Long-term
unemployment not only imposes extreme hardship on jobless people
and their families, but, by eroding these workers’ skills and
weakening their attachment to the labor force, it may also
convert what might otherwise be temporary cyclical unemployment
into much more intractable long-term structural unemployment. In
addition, persistently high unemployment, through its adverse
effects on household income and confidence, could threaten the
strength and sustainability of the recovery.

Low rates of resource utilization in the United States are
creating disinflationary pressures. As shown in figure 5,
various measures of underlying inflation have been trending
downward and are currently around 1 percent, which is below the
rate of 2 percent or a bit less that most Federal Open Market
Committee (FOMC) participants judge as being most consistent
with the Federal Reserve’s policy objectives in the long run.1
With inflation expectations stable, and with levels of resource
slack expected to remain high, inflation trends are expected to
be quite subdued for some time.

Monetary Policy in the United States
Because the genesis of the financial crisis was in the United
States and other advanced economies, the much weaker recovery in
those economies compared with that in the emerging markets may
not be entirely unexpected (although, given their traditional
vulnerability to crises, the resilience of the emerging market
economies over the past few years is both notable and
encouraging). What is clear is that the different cyclical
positions of the advanced and emerging market economies call for
different policy settings. Although the details of the outlook
vary among jurisdictions, most advanced economies still need
accommodative policies to continue to lay the groundwork for a
strong, durable recovery. Insufficiently supportive policies in
the advanced economies could undermine the recovery not only in
those economies, but for the world as a whole. In contrast,
emerging market economies increasingly face the challenge of
maintaining robust growth while avoiding overheating, which may
in some cases involve the measured withdrawal of policy stimulus.

Let me address the case of the United States specifically. As I
described, the U.S. unemployment rate is high and, given the
slow pace of economic growth, likely to remain so for some time.
Indeed, although I expect that growth will pick up and
unemployment will decline somewhat next year, we cannot rule out
the possibility that unemployment might rise further in the near
term, creating added risks for the recovery. Inflation has
declined noticeably since the business cycle peak, and further
disinflation could hinder the recovery. In particular, with
shorter-term nominal interest rates close to zero, declines in
actual and expected inflation imply both higher realized and
expected real interest rates, creating further drags on growth.2
In light of the significant risks to the economic recovery, to
the health of the labor market, and to price stability, the FOMC
decided that additional policy support was warranted.

The Federal Reserve’s policy target for the federal funds rate
has been near zero since December 2008, so another means of
providing monetary accommodation has been necessary since that
time. Accordingly, the FOMC purchased Treasury and agency-backed
securities on a large scale from December 2008 through March
2010, a policy that appears to have been quite successful in
helping to stabilize the economy and support the recovery during
that period. Following up on this earlier success, the Committee
announced this month that it would purchase additional Treasury
securities. In taking that action, the Committee seeks to
support the economic recovery, promote a faster pace of job
creation, and reduce the risk of a further decline in inflation
that would prove damaging to the recovery.

Although securities purchases are a different tool for
conducting monetary policy than the more familiar approach of
managing the overnight interest rate, the goals and transmission
mechanisms are very similar. In particular, securities purchases
by the central bank affect the economy primarily by lowering
interest rates on securities of longer maturities, just as
conventional monetary policy, by affecting the expected path of
short-term rates, also influences longer-term rates. Lower
longer-term rates in turn lead to more accommodative financial
conditions, which support household and business spending. As I
noted, the evidence suggests that asset purchases can be an
effective tool; indeed, financial conditions eased notably in
anticipation of the Federal Reserve’s policy announcement.

Incidentally, in my view, the use of the term “quantitative
easing” to refer to the Federal Reserve’s policies is
inappropriate. Quantitative easing typically refers to policies
that seek to have effects by changing the quantity of bank
reserves, a channel which seems relatively weak, at least in the
U.S. context. In contrast, securities purchases work by
affecting the yields on the acquired securities and, via
substitution effects in investors’ portfolios, on a wider range
of assets.

This policy tool will be used in a manner that is measured and
responsive to economic conditions. In particular, the Committee
stated that it would review its asset-purchase program regularly
in light of incoming information and would adjust the program as
needed to meet its objectives. Importantly, the Committee
remains unwaveringly committed to price stability and does not
seek inflation above the level of 2 percent or a bit less that
most FOMC participants see as consistent with the Federal
Reserve’s mandate. In that regard, it bears emphasizing that the
Federal Reserve has worked hard to ensure that it will not have
any problems exiting from this program at the appropriate time.
The Fed’s power to pay interest on banks’ reserves held at the
Federal Reserve will allow it to manage short-term interest
rates effectively and thus to tighten policy when needed, even
if bank reserves remain high. Moreover, the Fed has invested
considerable effort in developing tools that will allow it to
drain or immobilize bank reserves as needed to facilitate the
smooth withdrawal of policy accommodation when conditions
warrant. If necessary, the Committee could also tighten policy
by redeeming or selling securities.

The foreign exchange value of the dollar has fluctuated
considerably during the course of the crisis, driven by a range
of factors. A significant portion of these fluctuations has
reflected changes in investor risk aversion, with the dollar
tending to appreciate when risk aversion is high. In particular,
much of the decline over the summer in the foreign exchange
value of the dollar reflected an unwinding of the increase in
the dollar’s value in the spring associated with the European
sovereign debt crisis. The dollar’s role as a safe haven during
periods of market stress stems in no small part from the
underlying strength and stability that the U.S. economy has
exhibited over the years. Fully aware of the important role that
the dollar plays in the international monetary and financial
system, the Committee believes that the best way to continue to
deliver the strong economic fundamentals that underpin the value
of the dollar, as well as to support the global recovery, is
through policies that lead to a resumption of robust growth in a
context of price stability in the United States.

In sum, on its current economic trajectory the United States
runs the risk of seeing millions of workers unemployed or
underemployed for many years. As a society, we should find that
outcome unacceptable. Monetary policy is working in support of
both economic recovery and price stability, but there are limits
to what can be achieved by the central bank alone. The Federal
Reserve is nonpartisan and does not make recommendations
regarding specific tax and spending programs. However, in
general terms, a fiscal program that combines near-term measures
to enhance growth with strong, confidence-inducing steps to
reduce longer-term structural deficits would be an important
complement to the policies of the Federal Reserve.

Global Policy Challenges and Tensions
The two-speed nature of the global recovery implies that
different policy stances are appropriate for different groups of
countries. As I have noted, advanced economies generally need
accommodative policies to sustain economic growth. In the
emerging market economies, by contrast, strong growth and
incipient concerns about inflation have led to somewhat tighter
policies.

Unfortunately, the differences in the cyclical positions and
policy stances of the advanced and emerging market economies
have intensified the challenges for policymakers around the
globe. Notably, in recent months, some officials in emerging
market economies and elsewhere have argued that accommodative
monetary policies in the advanced economies, especially the
United States, have been producing negative spillover effects on
their economies. In particular, they are concerned that advanced
economy policies are inducing excessive capital inflows to the
emerging market economies, inflows that in turn put unwelcome
upward pressure on emerging market currencies and threaten to
create asset price bubbles. As is evident in figure 6, net
private capital flows to a selection of emerging market
economies (based on national balance of payments data) have
rebounded from the large outflows experienced during the worst
of the crisis. Overall, by this broad measure, such inflows
through the second quarter of this year were not any larger than
in the year before the crisis, but they were nonetheless
substantial. A narrower but timelier measure of demand for
emerging market assets--net inflows to equity and bond funds
investing in emerging markets, shown in figure 7--suggests that
inflows of capital to emerging market economies have indeed
picked up in recent months.

To a large degree, these capital flows have been driven by
perceived return differentials that favor emerging markets,
resulting from factors such as stronger expected growth--both in
the short term and in the longer run--and higher interest rates,
which reflect differences in policy settings as well as other
forces. As figures 6 and 7 show, even before the crisis, fast-
growing emerging market economies were attractive destinations
for cross-border investment. However, beyond these fundamental
factors, an important driver of the rapid capital inflows to
some emerging markets is incomplete adjustment of exchange rates
in those economies, which leads investors to anticipate
additional returns arising from expected exchange rate
appreciation.

The exchange rate adjustment is incomplete, in part, because the
authorities in some emerging market economies have intervened in
foreign exchange markets to prevent or slow the appreciation of
their currencies. The degree of intervention is illustrated for
selected emerging market economies in figure 8. The vertical
axis of this graph shows the percent change in the real
effective exchange rate in the 12 months through September. The
horizontal axis shows the accumulation of foreign exchange
reserves as a share of GDP over the same period. The
relationship evident in the graph suggests that the economies
that have most heavily intervened in foreign exchange markets
have succeeded in limiting the appreciation of their currencies.
The graph also illustrates that some emerging market economies
have intervened at very high levels and others relatively little.
Judging from the changes in the real effective exchange rate,
the emerging market economies that have largely let market
forces determine their exchange rates have seen their
competitiveness reduced relative to those emerging market
economies that have intervened more aggressively.

It is striking that, amid all the concerns about renewed private
capital inflows to the emerging market economies, total capital,
on net, is still flowing from relatively labor-abundant emerging
market economies to capital-abundant advanced economies. In
particular, the current account deficit of the United States
implies that it experienced net capital inflows exceeding 3
percent of GDP in the first half of this year. A key driver of
this “uphill” flow of capital is official reserve accumulation
in the emerging market economies that exceeds private capital
inflows to these economies. The total holdings of foreign
exchange reserves by selected major emerging market economies,
shown in figure 9, have risen sharply since the crisis and now
surpass $5 trillion--about six times their level a decade ago.
China holds about half of the total reserves of these selected
economies, slightly more than $2.6 trillion.

It is instructive to contrast this situation with what would
happen in an international system in which exchange rates were
allowed to fully reflect market fundamentals. In the current
context, advanced economies would pursue accommodative monetary
policies as needed to foster recovery and to guard against
unwanted disinflation. At the same time, emerging market
economies would tighten their own monetary policies to the
degree needed to prevent overheating and inflation. The
resulting increase in emerging market interest rates relative to
those in the advanced economies would naturally lead to
increased capital flows from advanced to emerging economies and,
consequently, to currency appreciation in emerging market
economies. This currency appreciation would in turn tend to
reduce net exports and current account surpluses in the emerging
markets, thus helping cool these rapidly growing economies while
adding to demand in the advanced economies. Moreover, currency
appreciation would help shift a greater proportion of domestic
output toward satisfying domestic needs in emerging markets. The
net result would be more balanced and sustainable global
economic growth.

Given these advantages of a system of market-determined exchange
rates, why have officials in many emerging markets leaned
against appreciation of their currencies toward levels more
consistent with market fundamentals? The principal answer is
that currency undervaluation on the part of some countries has
been part of a long-term export-led strategy for growth and
development. This strategy, which allows a country’s producers
to operate at a greater scale and to produce a more diverse set
of products than domestic demand alone might sustain, has been
viewed as promoting economic growth and, more broadly, as making
an important contribution to the development of a number of
countries. However, increasingly over time, the strategy of
currency undervaluation has demonstrated important drawbacks,
both for the world system and for the countries using that
strategy.

First, as I have described, currency undervaluation inhibits
necessary macroeconomic adjustments and creates challenges for
policymakers in both advanced and emerging market economies.
Globally, both growth and trade are unbalanced, as reflected in
the two-speed recovery and in persistent current account
surpluses and deficits. Neither situation is sustainable.
Because a strong expansion in the emerging market economies will
ultimately depend on a recovery in the more advanced economies,
this pattern of two-speed growth might very well be resolved in
favor of slow growth for everyone if the recovery in the
advanced economies falls short. Likewise, large and persistent
imbalances in current accounts represent a growing financial and
economic risk.

Second, the current system leads to uneven burdens of adjustment
among countries, with those countries that allow substantial
flexibility in their exchange rates bearing the greatest burden
(for example, in having to make potentially large and rapid
adjustments in the scale of export-oriented industries) and
those that resist appreciation bearing the least.

Third, countries that maintain undervalued currencies may
themselves face important costs at the national level, including
a reduced ability to use independent monetary policies to
stabilize their economies and the risks associated with
excessive or volatile capital inflows. The latter can be managed
to some extent with a variety of tools, including various forms
of capital controls, but such approaches can be difficult to
implement or lead to microeconomic distortions. The high levels
of reserves associated with currency undervaluation may also
imply significant fiscal costs if the liabilities issued to
sterilize reserves bear interest rates that exceed those on the
reserve assets themselves. Perhaps most important, the ultimate
purpose of economic growth is to deliver higher living standards
at home; thus, eventually, the benefits of shifting productive
resources to satisfying domestic needs must outweigh the
development benefits of continued reliance on export-led growth.

Improving the International System
The current international monetary system is not working as well
as it should. Currency undervaluation by surplus countries is
inhibiting needed international adjustment and creating
spillover effects that would not exist if exchange rates better
reflected market fundamentals. In addition, differences in the
degree of currency flexibility impose unequal burdens of
adjustment, penalizing countries with relatively flexible
exchange rates. What should be done?

The answers differ depending on whether one is talking about the
long term or the short term. In the longer term, significantly
greater flexibility in exchange rates to reflect market forces
would be desirable and achievable. That flexibility would help
facilitate global rebalancing and reduce the problems of policy
spillovers that emerging market economies are confronting today.
The further liberalization of exchange rate and capital account
regimes would be most effective if it were accompanied by
complementary financial and structural policies to help achieve
better global balance in trade and capital flows. For example,
surplus countries could speed adjustment with policies that
boost domestic spending, such as strengthening the social safety
net, improving retail credit markets to encourage domestic
consumption, or other structural reforms. For their part,
deficit countries need to do more over time to narrow the gap
between investment and national saving. In the United States,
putting fiscal policy on a sustainable path is a critical step
toward increasing national saving in the longer term. Higher
private saving would also help. And resources will need to shift
into the production of export- and import-competing goods. Some
of these shifts in spending and production are already occurring;
for example, China is taking steps to boost domestic demand and
the U.S. personal saving rate has risen sharply since 2007.

In the near term, a shift of the international regime toward one
in which exchange rates respond flexibly to market forces is,
unfortunately, probably not practical for all economies. Some
emerging market economies do not have the infrastructure to
support a fully convertible, internationally traded currency and
to allow unrestricted capital flows. Moreover, the internal
rebalancing associated with exchange rate appreciation--that is,
the shifting of resources and productive capacity from
production for external markets to production for the domestic
market--takes time.

That said, in the short term, rebalancing economic growth
between the advanced and emerging market economies should remain
a common objective, as a two-speed global recovery may not be
sustainable. Appropriately accommodative policies in the
advanced economies help rather hinder this process. But the
rebalancing of growth would also be facilitated if fast-growing
countries, especially those with large current account surpluses,
would take action to reduce their surpluses, while slow-growing
countries, especially those with large current account deficits,
take parallel actions to reduce those deficits. Some shift of
demand from surplus to deficit countries, which could be
compensated for if necessary by actions to strengthen domestic
demand in the surplus countries, would accomplish two objectives.
First, it would be a down payment toward global rebalancing of
trade and current accounts, an essential outcome for long-run
economic and financial stability. Second, improving the trade
balances of slow-growing countries would help them grow more
quickly, perhaps reducing the need for accommodative policies in
those countries while enhancing the sustainability of the global
recovery. Unfortunately, so long as exchange rate adjustment is
incomplete and global growth prospects are markedly uneven, the
problem of excessively strong capital inflows to emerging
markets may persist.

Conclusion
As currently constituted, the international monetary system has
a structural flaw: It lacks a mechanism, market based or
otherwise, to induce needed adjustments by surplus countries,
which can result in persistent imbalances. This problem is not
new. For example, in the somewhat different context of the gold
standard in the period prior to the Great Depression, the United
States and France ran large current account surpluses,
accompanied by large inflows of gold. However, in defiance of
the so-called rules of the game of the international gold
standard, neither country allowed the higher gold reserves to
feed through to their domestic money supplies and price levels,
with the result that the real exchange rate in each country
remained persistently undervalued. These policies created
deflationary pressures in deficit countries that were losing
gold, which helped bring on the Great Depression.3 The gold
standard was meant to ensure economic and financial stability,
but failures of international coordination undermined these very
goals. Although the parallels are certainly far from perfect,
and I am certainly not predicting a new Depression, some of the
lessons from that grim period are applicable today.4 In
particular, for large, systemically important countries with
persistent current account surpluses, the pursuit of export-led
growth cannot ultimately succeed if the implications of that
strategy for global growth and stability are not taken into
account.

Thus, it would be desirable for the global community, over time,
to devise an international monetary system that more
consistently aligns the interests of individual countries with
the interests of the global economy as a whole. In particular,
such a system would provide more effective checks on the
tendency for countries to run large and persistent external
imbalances, whether surpluses or deficits. Changes to accomplish
these goals will take considerable time, effort, and
coordination to implement. In the meantime, without such a
system in place, the countries of the world must recognize their
collective responsibility for bringing about the rebalancing
required to preserve global economic stability and prosperity. I
hope that policymakers in all countries can work together
cooperatively to achieve a stronger, more sustainable, and more
balanced global economy.