Fed’s Bernanke Defends QE2, Slams China in Frankfurt Speech

Calls on "surplus countries" to enact policies that boost domestic spending

Ben Bernanke, chairman of the Federal Reserve, stirred the waters on Friday with a speech that took on QE2 critics and China alike. In remarks titled “Rebalancing the Global Recovery,” which he delivered at the Sixth European Central Bank Central Banking Conference in Frankfurt, Bernanke defended QE2 and took a swipe at China, although not by name, for keeping its currency undervalued. Many nations have been highly critical of the Fed’s monetary easing policy, accusing the U.S. of driving down the value of its dollar.

China came in for plenty of criticism in Bernanke’s speech. “The current monetary system is not working as well as it should,” he said. “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?”

China apparently thinks that what should be done is a further round of tightening bank reserves; it did so on Friday for the second time in two weeks, lifting required levels by 50 basis points. Reuters reported that this raises required reserve ratios (RRR) for large banks to 18.5%, which is a record high. The announcement was made after China’s domestic markets closed for the weekend. MarketWatch reported that U.S. stocks fell on the news.

In his address, Bernanke suggested that countries like China, with its trade surplus, “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.”

The Asian nation was not the only one to be assailed for its monetary policy. A chart accompanying Bernanke’s speech also highlighted Thailand, Taiwan, and Singapore for strategies similar to China’s.

Bernanke spoke of a “two-speed global recovery,” in which “international policy cooperation is especially difficult now. . . ” due to emerging market growth outstripping that in advanced economies. Citing a “particular concern” for “the substantial increase in the share of unemployed workers who have been without work for six months or more” and their accompanying hardship, as well as the impact of long-term unemployment on the labor force and its skills, Bernanke said such a threat to the “strength and sustainability of the recovery” called for “different policy settings.”

He characterized QE2 as an action “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.” He also challenged the characterization of the Federal Reserve’s policy as “quantitative easing,” saying instead that “securities purchases work by affecting the yields on the acquired securities and, via substitution effects in investors’ portfolios, on a wider range of assets.”

In defense of the policy, Bernanke said, "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."

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