Is this the beginning of the end of QE3? Federal Reserve Board watchers have speculated in recent days that the bank could ease off the highly accommodative monetary policy sooner than expected as it weighs the looming risks of its current course of action.
But Fed Chairman Ben Bernanke had a message for Congress on Tuesday: Not so fast.
The Fed chief indicated that while the central bank would weigh the policy's potential costs, it still saw the benefits as the dominant side of the equation.
Right now, the Fed is buying $85 billion each month in longer-term Treasury securities and mortgage-backed securities in an effort to bring down long-term interest rates and stimulate economic growth. The program is the third of its kind, and often referred to as QE3 (the QE stands for “quantitative easing,” another name for the large-scale asset purchases). The central bank has also said it plans to keep interest rates near zero until unemployment reaches 6.5 percent, so long as inflation remains contained. Right now, the unemployment rate is 7.9 percent and has barely budged in recent months.
Critics of the Fed’s easy policies can be found in university economic departments, think tanks, and Congress—generally on the Republican side of the aisle. They have mounted three main arguments against it, and Bernanke responded point-by-point in testimony prepared for Tuesday’s hearing. Here’s a look at what they worry about, and how the Fed chairman responded:
1) The concern: The Fed’s policies will lead to higher future inflation. A worry is that if people lose confidence in the Fed’s ability to tighten policy when the time is right, price stability could take a hit as inflation expectations climb.
Bernanke’s response: “The [bank’s policy-setting] Committee remains confident that it has the tools necessary to tighten monetary policy when the time comes to do so.” Inflation is contained at the moment and inflation expectations, just as important, are currently “well anchored” with no signs of significant inflation pressures developing.
2) The concern: The Fed’s low interest rates could drive investors to risky behavior. Investors making low returns might be inspired to take risks to improve those returns and undermine the nation’s financial stability in the process.
Bernanke’s response: “Although a long period of low rates could encourage excessive risk-taking, and continued close attention to such developments is certainly warranted, to this point we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation.” Also, he adds, some risk-taking is part of a healthy recovery. And the Fed’s accommodative policies encourage firms to rely more on long-term funding and reduce debt service costs, which, in turn, reduce risk. The Fed is monitoring the system for risky behavior closely.
3) The concern: The Fed’s will have less money to remit to Treasury—and thus to help bring down the deficit. The Fed earns interest on the assets it holds in its portfolio. As it has grown its portfolio through asset-purchase programs, the bank has earned more interest. After subtracting some money for its operations, the Fed gives the rest of the money to the Treasury Department. But as the Fed backs off its easy-money stance and raises interest rates, those remittances will decline.
Bernanke’s response: “It is highly likely that average annual remittances over the period affected by the Federal Reserve’s purchases will remain higher than the pre-crisis norm, perhaps substantially so.” Plus, if the Fed helps the economy grow by keeping its foot on the monetary-policy gas pedal, that, too, contributes to deficit reduction—even more than its remittances to Treasury.
After delivering his testimony, Bernanke will respond to questions from lawmakers on the Senate Banking and House Financial Services Committees on Tuesday and Wednesday, respectively. These concerns are certain to crop up again in the question-and-answer period.