SpeechRead: Bernanke Defends The Fed

I've invented the term SpeechRead to refer to my service (or time-killer?) of reading important American political speeches so you don't have to.

 

Read the speech. 

 

Fed Chairman Ben Bernanke chooses to begin his remarks about the American economy with an anecdote about his boyhood hometown in South Carolina, where unemployment is 14%.  Even the Federal Reserve, reserved, impartial, calm, has a heart.  Bernanke calls the economic challenges of our time "extraordinary," in the sense that they are pervasive, largely unforeseen, and usually rapid in making themselves known. Most financial journalists are using that word in their lede stories.  Reading and understanding his speech is helpful for non-specialists like me, and I presume, most of my readers, even if you're inclined to disagree with the particulars.

Bernanke's speech reads to me as a defense of monetary policy since the crisis began; he argues, in essence, that had the Fed not done what it did, we'd be much worse off.  What's the Fed done? It lowered interest rates by 325 basis points in the space of a year, and it engaged in the practice of credit easing - or using the resources and authority of the Fed to try and unlock the credit markets. In the short term, as Bernanke says, success has been modest - but it has prevented some key interest rates from rising.  Still, as he acknowledges, "concerns about capital, asset quality, and credit risk continue to limit the

willingness of many intermediaries to extend credit, notwithstanding the access of these

firms to central bank liquidity."  The rational interventions of the Fed, in other words, haven't stemmed the crisis of confidence; investors, bankers and policy-makers seem to believe that major U.S. banks are insolvent and that their assets are worthless. Until that fear is eased, or until these big banks get solvent, "intermediaries" won't lend to anyone.  The same goes for the commercial paper markets, which are, as Bernanke notes, a "major source" of credit for businesses, in particular. Liquidity provided by the Fed, he asserts, has helped stabilize the market, although for borrowers with anything below the best credit ratings, it remains as locked as an old tennis player's scapula.  

 

The Fed's action, Bernanke says,  "is a principal reason that liquidity pressures around the end of the year-- often a period of heightened liquidity strains--were relatively modest."  The turnaround of the money market mutual fund industry, which is growing now despite nearly collapsing last year, is also a result of the Fed's intervention, he says.

 

What about the balance sheet?  Bear Stearns and AIG together account for about 5% of the Fed's 2 trillion dollar gross worth; they are, I had to reminded, assets, in the sense that the Fed owns them.  Fed action often leads to increases on both sides of the ledger; "For example, the purchase of $1 billion of GSE securities, paid for by crediting the deposit

account of the seller's bank at the Federal Reserve, increases the Fed's balance sheet by

$1 billion, with the acquired securities appearing as an asset, and the seller's bank's

deposit at the Fed being the offsetting liability."   

 

I don't know much about monetary policy beyond what you'd learn from reading Megan McArdle and standard economics textbooks, but if the Fed's balance sheet has doubled in a year, wouldn't all that extra money lead to inflation?

Bernanke anticipates the question from simpletons like me.

 

The Fed's lending activities have indeed resulted in a large increase in the reserves held by banks and thus in the narrowest definition of the money supply, the monetary base. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed.

 

Back to economics class: the more expansive definitions of money - M1 and M2, Bernanke says, haven't grown by nearly the amount as the most "narrow" definition.