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Bernanke Speaks: Low Inflation Likely to Mean More Debt Purchases

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Amid an outpouring of Friday morning data signaling a persistently sluggish economy, Federal Reserve Chairman Ben Bernanke in a speech before the Boston Fed said the U.S. central bank will likely adapt its monetary policy to fight overly low inflation by buying large amounts of government debt.

Bernanke acknowledged that “monetary policymaking in an era of low inflation has not proved to be entirely straightforward” in a wide-ranging speech that touched on issues such as unemployment, consumer spending, and the housing market.

Bernanke delivered his comments Friday morning before the Revisiting Monetary Policy in a Low-Inflation Environment Conference at the Federal Reserve Bank of Boston.

According to a transcript of Bernanke’s speech, “Monetary Policy Objectives and Tools in a Low-Inflation Environment,” the formulation and conduct of monetary policy in a low-inflation environment is complicated by the fact that low inflation generally implies low nominal interest rates, which has indeed been the case lately in the markets.

Fed Relies on ‘Nonstandard Policies’

“Because the short-term policy interest rate cannot be reduced below zero, the Federal Reserve and central banks in other countries have employed nonstandard policies and approaches that do not rely on reductions in the short-term interest rate. We are still learning about the efficacy and appropriate management of these alternative tools,” Bernanke said.

That leaves the central bank with fewer options, and the most obvious one is the purchase of vast

quantities of government debt such as Treasury bonds and mortgage-backed securities.

“A means of providing additional monetary stimulus, if warranted, would be to expand the Federal Reserve's holdings of longer-term securities,” Bernanke said. “Empirical evidence suggests that our previous program of securities purchases was successful in bringing down longer-term interest rates and thereby supporting the economic recovery. A similar program conducted by the Bank of England also appears to have had benefits.”

Quantitative Easing Seen as Inevitable

Economists said the Friday data reinforced the Fed chairman’s assertion that inflation is now too low and needs to be addressed with the monetary policy tool of quantitative easing. The Fed already invested in a first round of quantitative easing last year, when it introduced a program of buying $1.4 trillion in mortgage-related securities and $300 billion in Treasury debt that the government is still paying off. The second round of easing may come with a $1 trillion price tag.

“The September CPI rose 0.1%, with the core unchanged; both readings were a tenth below the consensus forecasts. Core inflation is now just 0.8% y/y, reinforcing Chairman Bernanke's point in his speech this morning that inflation is ‘too low,’” said Ian Shepherdson, chief U.S. economist for High Frequency Economics Ltd., in Valhalla, New York, in an analyst note.

“This is a clear refutation of the arguments advanced by Fed hawks, some market observers and media outlets earlier this year, to the effect that QE1 would drive up inflation. It has not, and Mr. Bernanke is now clearly in favor of QE2,” Shepherdson added.

Pittsburgh-based PNC Financial Services’ economics group said in an analyst note that Bernanke in his speech had “all but announced” a new program of quantitative easing.

“We expect the formal announcement to come in the Fed’s scheduled Nov. 3 policy announcement,” the PNC economists said. “In our view, on Nov. 3, the day after Election Day, and the last day of a two-day Federal Open Market Committee meeting, the FOMC will announce a new program of quantitative easing. This could take the form of $500 billion to $1 trillion worth of Treasury bond purchases spread out over an approximately six-month interval, likely front loaded, beginning in early to mid-November, averaging $100 billion per month. The scope of the bond purchase program will ultimately be determined by financial market and economic conditions.”

Read about Bernanke and the Financial Stability Oversight Council’s first meeting at


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