Ben Bernanke about Quantitative Easing


Yesterday, the US Federal Reserve Chairman Ben Bernanke gave an argumented speech in defense of Large Scale Asset Programs (also called Quantitative Easing in the Financial jargon) initiated in 2009 and that have been since then continued and expanded. Being a former academic researcher, Professor Bernanke was very careful in explaining his vision and his speech was both nice to read and very informative.

What are the Large Scale Asset Programs?

The role of LSAP is to continue easing financial conditions in the economy when the Central Bank's benchmark rates have reached the zero lower bound. This program is called unconventional because it lacks a standard model explaining why and how it should be used, and has been little used in history. It consists in letting the Central Bank purchase government assets (Treasury boons, or bonds issued by government sponsored agencies) so as to reduce the yield of such assets. 

Quantitative evidence

Econometric evidence presented by Bernanke showed they managed to reduce yields by between 0.8% and 1.2%. As in a domino effect, reducing the yield of such assets have wide-ranging consequences on the real economy: it helps lift stock prices, reduces mortgage rates, increases total output and increases employment. The Fed's estimates find that thanks to this program, output (aka GDP) has been increased by 3% and 2 million jobs have been created.

Towards a new round of Quantitative Easing?

Although this program has been successful in boosting output and employment, those two measures are still at uncomfortably low levels (GDP is close to what it was 5 years ago in real term and unemployment is at 8.3% - source: July 2012 - Bureau of Labor Statistics). Does that mean that the scale of the program was too low and therefore not ambitious enough? Could the Fed improve current economic situation by massively increasing its LSAP? The issue here is that as far as I know, there are no models that integrate the cost and benefits of such a program into a macroeconomic model. So what does common sense tell us?

First, the benefits of such a program are likely to be marginally decreasing at some point. As described by Bernanke, there is a finite supply of assets the Fed is allowed to purchase and a too large involvement of the Fed into the securities market is likely to be disruptive for financial markets. Second, since these types of programs are relatively new, we have very little evidence about what the risks might be and even if we can foresee some of them, it would be extremely difficult to quantify them without any data.

Faced with high uncertainty, I think it would be wise for the Fed (and other Central Banks facing similar issues) to act prudently with such tools as LSAP. After years  - or decades - of imbalances (for example excessive borrowing and risk taking by some agents), it is not surprising that reverting to a more sustainable path would take time and pain. Following one of the biggest financial crisis ever, a sharp decline in housing, the risk of an implosion of the Eurozone and sharp deceleration of Chinese economy and other emerging markets, I think the USA are not doing too bad after all: the economy is still growing at a slow but steady pace (average of 2.2% annual GDP growth over the last 3 years), unemployment is high but not skyrocketing (8.3% in July 2012, down from a cyclical high of 10%). Maybe the Fed can help a little bit more, but we shouldn't count on it too much.

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