US Federal Reserve Chairman Ben Bernanke said Wednesday that reductions of the US central bank’s $85 billion-per-month bond-buying program are “by no means on a preset course.” He added that the Fed could leave the program intact or even increase purchases, if warranted by a worsening jobs market, inflation or too-tight financial conditions.
On the other hand, if the economy performs better than the Fed expects, the central bank could start pulling back on bond purchases more quickly, Mr. Bernanke said in remarks prepared for delivery to the House Financial Services Committee Wednesday. The bond-buying program, known as quantitative easing, aims to drive down long-term interest rates, spurring hiring, investing and spending.
In a June 19 press conference, Mr. Bernanke said that if the economy improves the way the Fed expects, the central bank could begin reducing the amount of bonds it buys each month later this year. If the improvement continued along the lines of the Fed’s forecasts, the program could wrap up completely by mid-2014, at which point the Fed thinks the unemployment rate would be about 7%, down from the 7.6% level it was in June.
Investors balked, sending stock and bond markets tumbling. That sent bond yields sharply higher, which move inversely to bond prices, taking mortgage rates with them.
Mr. Bernanke said Wednesday that the timeline he plotted was the “likely trajectory of the program if the economy evolves as projected” and did not represent a change in policy.
Emphasizing that decisions on the bond-buying program are conditional on the economic outlook, Mr. Bernanke highlighted the risks to the economy that could force the Fed to revise its expectations for the economy.
Risks to the economy have diminished since last fall, but federal fiscal policy remains a threat, and could restrain growth over the next few quarters more than Fed officials expect, he said. He also warned that looming congressional debates over budget issues and the need for Congress to raise the federal government’s borrowing limit–known as the debt ceiling–later this fall could also hurt the recovery.
He focused on inflation, too, which has been running below the Fed’s 2% goal. “The softness reflects in part some factors that are likely to be transitory,” he said, and longer-term inflation expectations are “generally stable.” But Fed officials are “certainly aware that very low inflation poses risks to economic performance–for example, by raising the real cost of capital investment–and increases the risk of outright deflation,” Mr. Bernanke said, vowing to keep an eye on the inflation situation. The Fed “will act as needed” to ensure inflation, now running at about 1% according to the Fed’s preferred measure, will return to its 2% goal, Mr. Bernanke said.
Mr. Bernanke made clear that it is not just the jobs picture that would influence the Fed’s thinking on bond-buying.
Mr. Bernanke repeated his message from recent weeks that even if the Fed pulls back from the bond-buying program later this year, it intends to keep short-term interest rates pinned near zero for some time to come.
With the jobless rate still high and coming down “only gradually,” and inflation below the Fed’s 2% goal, “a highly accommodative monetary policy will remain appropriate for the foreseeable future,” he said.
He said the Fed’s so-called forward guidance — the statement in its formal policy statement that it will keep short- term rates near zero “at least as long as” the jobless rate remains above 6.5% — should be seen as a threshold, not a trigger for the Fed to increase short-term rates.
Rather, when the jobless rate hits 6.5%, Mr. Bernanke said, the Fed will then evaluate whether the jobs market, inflation and the broader economic conditions warrant an increase in rates.
For instance, Mr. Bernanke said, if the improvement in the jobless rate was judged to be largely the result of people dropping out of the labor force out of discouragement, the Fed “would be unlikely to view a decline in unemployment to 6.5% as sufficient reason to raise its target for the federal funds rate.”
The Fed would also be unlikely to raise rates if inflation remained “persistently below” the 2% target.
Mr. Bernanke also said that any increases in short-term rates, when they occur, will likely be done gradually.
Mr. Bernanke said that the Fed will hold all the bonds it has purchased on its balance sheet, rather than sell them, after the bond-buying program ends. Holding the bonds “will continue to put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.”
Separately, in the monetary policy report submitted to Congress, the Fed noted that rising and volatile interest rates may have curbed some risk-taking behavior among investors. The central bank had cautioned that an extended period of low interest rates may lead some investors to take excessive risks.
