Sunday, October 17, 2010

A kick in the asset purchase program

Hoist by his own petard?

Bernanke's Caution Doesn't Dim View On Asset Buys
While Federal Reserve Chairman Ben Bernanke was regarded as cautious about a second round of bond-buying to stimulate the economy, economists on Friday said the underlying message was still that some sort of program would be enacted.

"Bernanke knows that the market is allocating more than a 90% probability [of a second round of bond purchases]; he did nothing to slow down that rapidly moving train," said Lou Crandall, chief economist at Wrightson ICAP
.
`Liquidity Trap' Plagues U.S., More Stimulus Is Required, Fed's Evans Says
Central bankers, seeking ways to boost flagging growth after lowering interest rates almost to zero and buying $1.7 trillion of securities, are weighing strategies for raising inflation expectations as well as expanding the balance sheet by purchasing Treasuries, according to minutes of the Fed’s Sept. 21 meeting released this week.

Federal Reserve Bank of Chicago President Charles Evans said the U.S. is in a “bona fide liquidity trap” and needs “much more” monetary accommodation in the face of high unemployment and inflation that’s too low.
“I believe the U.S. economy is best described as being in a bona fide liquidity trap,” Evans said to the Boston Fed’s 55th Economic Conference. “This belief is not a new development for me; instead it is a dawning realization.In a liquidity trap, additions to the money supply fail to stimulate the economy.
With projections for unemployment to be at 8 percent and for inflation excluding food and energy to be at 1 percent by the end of 2012, “the Fed’s dual mandate misses are too large to shrug off,” Evans said.

He gave his support to a target for the path of the price level over a “reasonable period of time” that is communicated “regularly and often” to the public.

Such a policy could complement large-scale asset purchases and a change to the Federal Open Market Committee’s statement to include a pledge to keep rates near zero for longer than “an extended period.”

By encouraging Americans to believe prices will start rising at a faster pace, the Fed would reduce inflation-adjusted interest rates and stimulate the economy.

“The fact that Japan is still battling deflation highlights how pernicious deflation can be, and how difficult it is to counteract once it has been firmly established,” Rosengren said.

So, now, let's see. What we need is to keep interest rates low for an extended period of time to raise inflationary expectations? Is that right? Is that the prescription?

Well, that last article alluded to the Japanese experience. It included the following data points as well:
The Bank of Japan pledged last week to keep its benchmark interest rate at “virtually zero” until deflation has ended, after first introducing the rate policy in 1999.
So Japan tried this low interest rate policy for more than the last decade and just exactly how did that work out for them?

Guambat is dubious about comparisons of the same experiment in the US.

One very significant difference between the Japanese and US economy is the continuing significant decline in the Japanese population numbers, based both on lower births and on the refusal of Japan to welcome and integrate immigration. See, Getting a bit long in the ha.

Demand destruction in Japan results from social policy and Malthusian effect, not monetary policy, in that circumstance. Of course you're going to have deflationary outcomes, but born of totally different causes.

The structure and character of the Japanese economy and the US economy are not both apples, nor are they gooses and ganders. Guambat doesn't think that a medical experiment that proceeded with such faulty underlying assumptions would even pass FDA muster.

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