Jun 21, 2013

    Bernanke keeps investors in suspense


    FEDERAL Reserve chairman Ben Bernanke seemed a little nervous at his news conference on Wednesday.

    Formally unperturbed, Mr Bernanke said he was leaving policy unchanged - but in trying, yet again, to elucidate the Fed's thinking, he tacitly admitted that something had gone wrong.

    Quantitative easing (QE) is an experiment and involves risks. Under the current circumstances, every course involves risk. Tightening monetary policy prematurely, as Mr Bernanke has often explained, courts the greatest danger - that of bringing a hesitant recovery to a stop.

    He triggered the recent rise in long-term bond yields when he said last month that "in the next few meetings, we could take a step down in our pace of purchases".

    The implication was that investors thought the Fed was bringing forward its plans not just to taper QE but also, crucially, to start raising short-term interest rates.

    Mr Bernanke tried to address the confusion this week. He emphasised that the decision on tapering QE is separate from the decision to raise short-term rates.

    All being well, tapering would probably start later this year, he said, with asset purchases continuing next year until unemployment falls to 7 per cent. Interest rates won't rise, the Fed has previously said, until unemployment has fallen to 6.5 per cent.

    And, Mr Bernanke added, perhaps not even then: These numbers are "thresholds", not "triggers".

    He means to assure the markets that stimulus won't be withdrawn abruptly or too soon. QE will be tapered as the labour market strengthens, and not stopped suddenly.

    But if you ask under precisely what circumstances the stimulus will eventually start to be withdrawn - which is what investors want to know - the new refinements don't help.

    I sympathise. There are two underlying problems. One is the complexity of the situation the Fed needs to address. Central bankers want to retain some discretion.

    Second, the Fed has many policymakers, and they often disagree. Forward guidance has to be vague enough to accommodate not just the complexity of future decisions, but also different opinions on the Federal Open Market Committee.

    That vagueness, in turn, allows for bond-market glitches like the one of the past few weeks, as investors ask, "What on earth did the Fed mean by that?"