–Retransmitting Story Sent 16:29 ET To Add Ben Bernanke In 1st Graph
–Reacting to Caruana Call For More Intl Monetary Policy Cooperation

By Steven K. Beckner

JACKSON HOLE, Wyoming (MNI) – Jaime Caruana, general manager of the
Bank for International Settlements, called Friday for greater
international monetary policy cooperation, but Federal Reserve Chair Ben
Bernanke suggested that might not be as easy as it sounds.

Caruana, speaking to a luncheon at the Kansas City Federal Reserve
Bank’s annual symposium, said international cooperation in financial
regulation has increased since the financial crisis, but said, “we need
more international cooperation in monetary policy.”

He said “much needs to be done in moving to more a cooperative
approach” on monetary policy since interest rate changes in a country
like the United States affects the markets and economies of other
countries.

“It’s not easy to cope with the spillover,” Caruana said.

But Bernanke posed a rare question after he had concluded his
remarks.

Noting that central banks’ monetary policies also have implications
for exchange rate policy, he observed, “the problem is, of course, that
a lot of exchange rate policy is not made by central banks; it’s made by
finance ministries and so on.”

“And so I think you’ve opened up a much more complicated
coordination problem than just the central banks sitting together and
reasoning together,” Bernanke said. “That’s my reaction.”

Caruana told Bernanke, “you’re right,” but said increasing monetary
policy cooperation should nevertheless be considered.

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,M$$CR$,MFU$$$,MGU$$$,MMUFE$]

- Reacting to Caruana Call For More Intl Monetary Policy Cooperation

By Steven K. Beckner

JACKSON HOLE, Wyoming (MNI) – Jaime Caruana, general manager of the
Bank for International Settlements, called Friday for greater
international monetary policy cooperation, but Federal Reserve Chair
suggested that might not be as easy as it sounds.

Caruana, speaking to a luncheon at the Kansas City Federal Reserve
Bank’s annual symposium, said international cooperation in financial
regulation has increased since the financial crisis, but said, “we need
more international cooperation in monetary policy.”

He said “much needs to be done in moving to more a cooperative
approach” on monetary policy since interest rate changes in a country
like the United States affects the markets and economies of other
countries.

“It’s not easy to cope with the spillover,” Caruana said.

But Bernanke posed a rare question after he had concluded his
remarks.

Noting that central banks’ monetary policies also have implications
for exchange rate policy, he observed, “the problem is, of course, that
a lot of exchange rate policy is not made by central banks; it’s made by
finance ministries and so on.”

“And so I think you’ve opened up a much more complicated
coordination problem than just the central banks sitting together and
reasoning together,” Bernanke said. “That’s my reaction.”

Caruana told Bernanke, “you’re right,” but said increasing monetary
policy cooperation should nevertheless be considered.

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,M$$CR$,MFU$$$,MGU$$$,MMUFE$]

WASHINGTON (MNI) – In its preliminary 2011 report on U.S. holdings
of foreign securities, the total was $6.763 trillion, 1.87% above 2010,
the Treasury Department reported Friday.

Table 1. U.S. holdings of foreign securities, by type of security,
as of survey dates[1] (Billions of dollars)

Type of Security Dec. 31, 2010 Dec. 31, 2011

Long-term Securities 6,362 6,481
Equity 4,647 4,502
Long-term debt 1,715 1,979
Short-term debt securities 402 360

Total 6,763 6,841

–

U.S. holdings of foreign securities, by country is issuer and type of
security, for the countries attracting the most U.S. portfolio
investment, as of Dec. 31, 2011. (In billions of dollars.)

Country or region Total Equit Long-Term Debt S-Term Debt

1 United Kingdom 989 642 285 62
2 Canada 736 359 329 48
3 Cayman Islands 709 488 218 3
4 Japan 509 391 57 60
5 Australia 334 129 142 63
6 France 306 209 88 8
7 Switzerland 292 278 5 9
8 Germany 266 174 82 10
9 Netherlands 242 119 110 13
10 Brazil 196 155 41 *
11 Bermuda 161 135 25 *
12 Ireland 149 114 35 *
13 Korea, South 146 117 28 2
14 Hong Kong 116 112 3 *
15 Sweden 115 54 34 28
16 Mexico 108 59 45 4
17 Luxembourg 93 31 61 1
18 China, Mainland 77 75 2 *
19 Spain 76 53 22 *
20 Taiwan 72 72 * 0
21 South Africa 71 59 12 *

* Greater than zero, but less than $500 million

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: MK$$$$,MI$$$$,MAUDS$,M$U$$$,MTABLE]

• Bernanke delivers Jackson Hole speech, highlights
• Hilsenrath writes 'Bernanke leaves little doubt he's gearing up to do more'
• Spain's Catalonia region downgraded to junk by S&P
• Canadian Q2 GDP 1.8% vs 1.6% exp
• Chicago PMI 53.0 vs 53.2 exp
• Final U Mich consumer sentiment 74.3 vs 73.6 prelim
• Fed’s Williams: should move toward open ended QE
• No ECB bond buying without conditionality; Dutch central banker
• ECB's Asmussen: New bond buying program would work better than the last
• ECB’s Weidmann didn’t threaten to resign – WSJ
• Large earthquake near Philippines, tsunami alert lifted
• Spanish 10-year yields +26bps to 6.86%
• Gold +36 to $1691
• S&P 500 gains 0.6% to 1407, down 0.3% on week
• On day, CAD leads, USD lags
• On week, CAD leads, NZD lags

The volatiltiy started well before Bernanke’s speech as the US dollar was dumped ahead of time. EUR/USD broke through the 1.26 barrier to 1.2625. EUR/USD initially dumped 50 pips on Jackson Hole and then stormed back to a session high at 1.2637. It was very choppy.

Later, the euro slipped back to 1.2560 on the Catalonia downgrade.

Cable also ran through stops above Thursday’s 1.5873 high but stalled ahead of 1.5900.

USD/JPY was on the defensive but the market picked it back up at 78.19, ahead of semi-official bids rumored at 78.00.

CAD was the big winner as Bernanke re-affirmed his put and GDP exceeded forecasts. USD/CAD closed at 0.9853, very close to the session low.

By Brai Odion-Esene

JACKSON HOLE, Wyoming (MNI) – Federal Reserve Chairman Ben Bernanke
argued the case for the role large scale asset purchases can play in
supporting the economy, but a certain amount of skepticism can be found
among the attendees at the showcase Kansas City Fed economic symposium
Friday.

Many in conversations with MNI took issue with the substance of
Bernanke’s remarks, and countered that a further expansion of the money
supply without addressing broken transmission channels that are impeding
the flow of credit is an exercise in futility.

The belief is that unless additional monetary stimulus from the Fed
is matched by corresponding action from the administration and Congress
to spark the economy, the economy’s struggles will continue.

One such skeptic is Glenn Hubbard, dean of Columbia Business
School, the chief economic advisor to GOP presidential candidate Mitt
Romney — and the man many say could replace Bernanke should Romney win
in November.

“I just don’t think that more asset purchases are going to make a
material difference to the recovery,” he told MNI. “I haven’t seen
consistent evidence that asset purchases have had real effects.”

He pointed to the fact that the monetary transmission mechanism is
“broken” due to problems with mortgage finance, meaning the Fed pumping
more money into the system would be unlikely to have any impact.

Princeton professor Alan Blinder, a former Federal Reserve vice
chairman, said he viewed Friday’s keynote speech by Bernanke as
indicating the Fed will act to do more at its September meeting.

“He did nothing to back off that,” Blinder said.

Asked by MNI to comment the issue of pumping more money in without
actually expanding the availability of credit, Blinder said the Fed
should do “what they can” to unclog transmission channels.

“Part of the brokenness has to do with spreads of MBS, let’s say,
over Treasuries — and the Fed did do a lot of good for that in QE2,” he
said.

Any third round of quantitative easing by the Fed ought to be
focused on that, he added.

Blinder pointed to the housing white paper released by the Fed
earlier this year, which contained a list of things outside the Fed’s
purview but with the implied message that “won’t you please do these
things because they are outside the Fed’s realm of authority.”

“So you can see them trying to push (fiscal policymakers),” Blinder
said, “but there is a limited amount the Fed can do about these other
things.”

One prominent central banker told MNI that his criticism of the
Fed’s large-scale asset purchases lies in the fact that once the Fed
injects the massive amounts of monetary stimulus into the financial
system, there is no way to track and ensure that the money is actually
making its way into the hands of consumers.

As such, it is difficult to actually quantify and measure — beyond
financial market upturns and down ticks — what benefits the Fed’s
actions are having on small businesses and consumers.

In addition, he said, the Fed has not attached any conditions — or
created any strong incentives — that would push banks to ship out the
cheap money they are receiving in the form of loans.

He pointed to the Bank of England’s stg80 billion Funding for
Lending scheme — implemented in conjunction with the UK Treasury — as
an ideal example of a central bank combining liquidity injections with a
direct effort to ensure credit ends up in the hands of businesses that
need it.

Under the FLS, banks and building societies that increase lending
to UK households and businesses will be able to borrow more in the
scheme, and do so at lower cost than those that scale back lending.

He criticized the Fed’s actions as simply funding the government’s
debt, without the government passing those savings onto the populace in
the form of economic stimulus programs.

The U.S. economy would benefit more, he argued, if the potential
third round of quantitative easing by the Fed was accompanied by a
targeted government spending program, for example on infrastructure.

This is a sentiment shared to a certain extent by Bank of Japan
Gov. Masaaki Shirakawa, who warned Friday that using unconventional
monetary policy tools to hold interest rates at very low levels for long
periods can lead governments of those countries to delay reducing their
budget deficits.

Shirakawa, commenting during a discussion period at the symposium,
said one cost of QE is that if rates are being held low “in a period of
budget adjustment,” unconventional policies can be effective in slashing
rates but at “the cost of prolonging the adjustment period.”

Policies that hold rates down “could mitigate the impact of budget
adjustment, but at the same time prolong the length of budget
adjustment,” Shirakawa said.

** MNI **

[TOPICS: M$U$$$,MFU$$$,MGU$$$,M$$CR$,MT$$$$,MMUFE$]

They are screaming, like Bill Gross, that QE3 is coming on September 13.

Gold is now up nearly $40 to $1691 and 10-year yields down 8 bps to 1.55% although FX and stocks are much more tentative.

I re-read the Jackson Hole speech after some time to digest and I must come down on the side of QE3.

There is definitely some hemming and hawing in the speech but it concludes on a firmly dovish note.

Bernanke says there is “no net improvement in the unemployment rate since January” and later says “it is important to achieve further progress, particularly in the labor market.”

The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.

He wraps up by saying the Fed will take “due account” of the uncertainties and limits of its tools but will do more.

If the employment and ISM numbers are in-line with recent data, I’m confident QE3 is coming.

Weekly positioning data in the Commitments of Traders report showed general dollar-selling.

• EUR short 102K vs 124K
• JPY long 22K vs 11K
• CAD long 61K vs 51K
• GBP long 2K vs 8K
• AUD long 78K vs 87K

I warned last week that AUD positioning had swung too far toward longs and that argued for AUD shorts. The Canadian dollar is edging toward similar territory but not there yet.

There isn’t a great takeaway from this report, although it’s interesting to see the EUR short position at the lowest since April.

RBNZ Governor Alan Bollard repeated that the New Zealand dollar is unsustainably high, given it’s current account deficit.

He also said the the World Trade Organization could be given a role in supervising foreign exchange but QE programs have clearly had an effect on exchange rates.

NZD/USD is up today after 6 days of losses. The key closing level is the 55-day moving average at 0.8022 (spot at 0.8032).

If not for Bernanke, Spain would have been the lead story in tomorrow’s papers/ The region of Catalonia was downgraded to junk, Bankia required another capital injection and bad bank plan was unveiled to tepid applause…

EUR/USD is off its afternoon lows in the high 1.2550s but still below the key area between 1.2585 and 1.2595 where the bulls can breath a sigh of relief on the close.

Stocks are gaining once again and Treasuries are near low yields for the day with Bill Gross finally going on record for a move to QE sooner rather than later. He sees such a move in “the next month”. Well the next meeting is September 12-13. I guess we have him reluctantly cornered into calling for a move at the next meeting, though he left some wiggle room.

By Steven K. Beckner

JACKSON HOLE, Wyoming (MNI) – Bank of Japan Gov. Masaaki Shirakawa
said Friday using unconventional monetary policy tools to hold interest
rates at very low levels for long periods can lead governments of those
countries to delay reducing their budget deficits.

Shirakawa, commenting during a discussion period at the Kansas City
Federal Reserve Bank’s annual symposium, also said forward guidance on
the path of short-term interest rates controlled by the central bank can
be just as effective as asset purchases.

Shirakawa was drawing on the experience of the BOJ, which was the
first to face the zero short-term interest rate bound and to experiment
with both quantitative easing and forward guidance.

Echoing recent warnings by Dallas Federal Reserve Bank President
Richard Fisher in an MNI interview, Shirakawa said one cost of Q.E. is
that if rates are being held low “in a period of budget adjustment,”
unconventional policies can be effective in slashing rates but at “the
cost of prolonging the adjustment period.”

Policies that hold rates down “could mitigate the impact of budget
adjustment, but at the same time prolong the length of budget
adjustment,” Shirakawa said.

That was not one of the costs which Fed Chairman Ben Bernanke
listed in his keynote address Friday morning. He said a “credible” plan
of deficit reduction is needed but repeated past warnings against
reducing the deficit too rapidly.

Bernanke seemed to put more emphasis on using forward guidance than
on resorting to further Q.E. if the Federal Open Market Committee
decides more easing is needed to boost the economy, and Shirakawa
seemed to lend support to that approach.

He said Q.E. effects on rates “can be replicated by guidance.”

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,M$$CR$,MFU$$$,MGU$$$,MMUFE$,M$J$$$]

PARIS (MNI) – The Eurogroup, the Eurozone’s finance ministers,
released the following statement late Friday with regard to the decision
by Spain’s bank restructuring agency, FROB, to complete the
restructuring of troubled lender Bankia by October as agreed and to
inject capital immediately to ensure the bank is compliant with minimum
regulatory standards:

“Today BFA-Bankia published its financial accounts as of 30 June
2012, pursuant to its obligations under the Spanish Securities Markets
Law. As expected, these published figures show continued financial
strain on BFA-Bankia. These figures confirm the importance of the
Financial Assistance of up to EUR 100 billion for the Recapitalisation
of Financial Institutions, which was agreed and entered into operation
in July, in providing a credible and readily available backstop for the
Spanish banking sector.

The Eurogroup welcomes today’s reiteration by the Spanish
authorities, and the statement by the Board of BFA-Bankia, of their firm
commitment to complete the restructuring plan for BFA-Bankia by October,
as foreseen by the Memorandum of Understanding. This will allow the
restructuring plan to be approved by the European Commission in November
for immediate entry into force and to be accompanied by the necessary
capital injection from the Programme.

The Eurogroup welcomes the intention of the FROB to proceed with a
bridge recapitalisation of BFA-Bankia with a view to making the group
compliant with minimum regulatory standards of capital adequacy, pending
the full recapitalisation and restructuring process which is ongoing
under the terms of the financial assistance programme.

Against this background, the Eurogroup recalls the approach of the
financial assistance programme, and its significant benefits which will
start to materialise very shortly:

— The financial assistance programme foresees the necessary
recapitalisation of all viable Spanish banks for which a capital
shortfall exists. The preliminary information released today for
BFA-Bankia suggests that BFA-Bankia will be a main beneficiary of this
programme and will be adequately recapitalised in line with the
identified capital shortfalls and its restructuring plan.

— BFA-Bankia’s balance sheet will, as those of all banks receiving
external support, be thoroughly cleaned up through the transfer of
impaired assets to an external asset management company.

— BFA-Bankia will be restructured in order to secure its long-term
viability and a full protection of deposits.

— Recapitalisation, the segregation of assets and the
restructuring of Bankia will restore the bank to financial health.
Solvency and long-term viability will secure the group’s continued
access to all necessary sources of external funding.

The Eurogroup also recalls that the programme provides for a
backstop in case of emergency to cover unexpected interventions
necessary to restore confidence.”

[TOPICS: M$X$$$,M$$EC$,MGX$$$,MT$$$$,M$S$$$,M$$CR$]

Iron ore was up today for the first time in two weeks but has been the chatter of the markets for a few weeks because of the nearly 50% drop in prices in the past year.

Analysts at Icap are defending what it means for China. They note that imports are in-line with projections and say the demand side doesn’t point to any precipitous slowdown. They blame an abundance of new supply.

That’s reassuring for global growth but less so for AUD.

Iron ore export prices aren’t necessarily a driver for AUD. What’s important is investment. Signs of an abundance of supply aren’t going to encourage companies to invest billions in new production.

PARIS (MNI) – Spain’s bank restructuring fund, FROB, said Friday it
would inject capital immediately into troubled Spanish lender Bankia.

The agency said the upfront infusion of new capital to the banking
group was an advance against the money it will provide later this year
after it receives funding from its EU partners in accordance with a bank
bailout agreement for up to E100 billion.

FROB did not disclose the sum of the immediate capital injection it
plans to make. In May, Bankia, which was nationalized, said it needed a
total capital infusion of E19 billion.

The group announced today that it lost E4.448 billion in the first
half, compared with bad debt set asides of E2.7 billion.

FROB said the losses “confirm the relevance of the financial
assistance program” agreed with the EU.

As part the bank bailout agreement, the EU said it would put aside
E30 billion in emergency funds which could be used more quickly than the
remaining E70 billion.

The FROB’s decision to inject its own money into Bankia for now
will allow it to delay imposing haircuts on Bankia’s junior debt
holders. That’s because the EU bailout deal requires that banks getting
aid money from the European bailout fund force the junior creditors to
share some of the burden.

Inflicting losses on those creditors is politically sensitive
because most of them are retail customers who were convinced by banks to
buy the notes with junior status.

[TOPICS: M$X$$$,M$S$$$,MT$$$$,MGX$$$,M$$CR$]

–Fed Not Distorting Markets, Asset Purchases Form of Monetary Policy

WASHINGTON (MNI) – San Francisco Federal Reserve Bank President
John Williams said Friday he does not expect the Fed will see the need
to raise rates for another three years based on his assessment of the
economic outlook.

In an interview with CNBC on the sidelines of the Kansas City Fed’s
Jackson Hole symposium, Williams also said the Fed’s asset purchases are
simply a more direct way of conducting monetary policy in an environment
where the federal funds rate is at zero, and are not distorting markets.

Williams said he is concerned “we could be stalling at the current
high level of unemployment,” and “I don’t personally think that we would
be raising rates until probably sometime in mid-2015.”

He noted the Fed’s statements now indicate rates will remain low
until late 2014, but “my own view is that I would be willing to
communicate out further.”

Williams dismissed criticism the Fed’s asset purchase program is
distorting markets.

“I don’t think we’re distorting the market, I think we’re doing
monetary policy by slightly different means,” he said.

“The mechanism has always been that the Fed funds rate movements
would affect other interest rates, so by moving more directly on those
other interest rates I think we’re doing what monetary policy always
does but working in a world where the short-term interest rate is
already at zero,” Williams said.

He said he favors using a more “open ended” policy in announcing
asset purchases, which instead of the current announcement of the lump
sum of planned purchases would “allow us to adjust both the rate at
which we purchase and the amount which we purchase based on economic
conditions.

“A basic premise of good monetary policy is you adjust policy based
on what is happening in the economy, the outlook, so the open-ended
approach allows you to do that better, I think,” Williams said.

Asked about the Fed’s communications strategy more broadly, he
said, “I would really favor an approach that allowed us to communicate
our lift-off in terms of economic conditions rather than a calendar
date.”

He acknowledged this is harder to achieve — and focusing on any
one number would be misleading — and said “it’s hard to come up with
something I think that would be clear. I still hope that can come up
with ways to do that.”

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$]

Continued

By Steven K. Beckner

Woodford questions how much the Fed’s asset purchases have actually
lowered bond yields and suggests that, to the extent yields have fallen,
they have done so in good part because of economic data, safe haven
effects and so forth. He says this is particularly true of Treasury bond
buying.

“While central banks like the Federal Reserve and the Bank of
England have been willing to expand the size of their balance sheets
rather dramatically in response to the recent crisis, they have often
preferred to do this by purchasing extremely safe Treasury securities
… in the hope that such purchases will improve general financial
conditions without more direct involvement by the central bank in
extending credit to particular sectors of the economy,” he writes.

“Unfortunately, neither of the theories typically relied upon to
explain why that should be the case — the quantity-theoretic doctrine
that expansion of the monetary base must inevitably lead to increased
aggregate nominal spending, or the particular kind of preferred-habitat
model of the term structure that would imply the existence of a
‘duration-risk channel’ — has a robust theoretical basis … or finds
much support from experience thus far,” he adds.

Woodford says that bond purchases may be able to help the Fed send
signals about future monetary policy and thereby lower yields but
asserts, “if a central bank’s intention in announcing such purchases is
to send such a signal, the signal would seem more likely to have the
desired effect if accompanied by explicit forward guidance, rather than
regarded as a substitute for it.”

He also says the quantitative easing and forward guidance are more
likely to be effective if the central bank lets it be known that the
resulting increase in the monetary base will be permanent.

The Fed should not assume that asset purchases can signal a future
low rate stance in the absence of an explicit, less conditional forward
guidance statement, Woodford cautions.

“It would be hard to defend the use of such a policy as a signal in
order not to have to make any verbal commitments about policy,” he
writes.

Woodford says a “don’t-talk-but-buy-assets” plan “runs both a
greater risk of tying the central bank’s hands in a way that turns out
to be awkward ex post — because it cannot allow an interest-rate
commitment that is contingent on how the economy subsequently evolves —
and a greater risk of failing to influence expectations in the desired
way, because it relies upon market participants to correctly analyze the
central bank’s future incentives rather than directly stating its
intentions.”

Quantitative easing accompanied by a verbal commitment would be
better, but “remains an awkward and possibly costly form of signal,
because the thing that the central bank should wish to signal is not a
commitment to keep interest rates low for a fixed calendar period, but
rather a commitment to maintain policy accommodation until the nominal
GDP target path is reached,” he continues.

Woodford argues that “a more logical policy would rely on a
combination of commitment to a clear target criterion to guide future
decisions about interest-rate policy with immediate policy actions that
should stimulate spending immediately without relying too much on
expectational channels.”

But buying Treasuries is not the best approach, in any case, he
contends. Buying MBS would be better, but even that is not assured of
success.

“Additional purchases of MBS by the Fed might instead still be
useful as a way of reducing the cost of mortgage borrowing, though it is
hard to be certain that additional purchases now would reduce MBS yields
by the amount that the Fed’s purchases under (QE1) apparently did, given
the less perilous situation of private financial intermediaries now, and
it is hard to be certain that reductions in MBS yields would be passed
on to mortgage rates.”

A program that would be more likely to be effective is something
like the Bank of England’s “Funding for Lending Scheme (FLS),” which
subsidizes lenders for increasing the amount of loans that they make,
according to Woodford.

But he says that program has a “fiscal policy” character and
requires the participation of the Treasury, as in the UK.

Woodford goes on to suggest that monetary/fiscal policy
coordination, as politically awkward as that might be, would be the most
effective approach.

“The most obvious source of a boost to current aggregate demand
that would not depend solely on expectational channels is fiscal
stimulus — whether through an increase in government purchases, tax
incentives for current expenditure such as an investment tax credit, or
subsidies for lending like the FLS,” he writes.

“At the same time, commitment to a nominal GDP target path by the
central bank would increase the bang for the buck from fiscal stimulus,
by assuring people that premature interest-rate increases in response to
rising economic activity and prices would not crowd out other types of
spending than those directly affected by fiscal policy,” he continues.

“And the existence of the central bank’s declared nominal GDP
target path should also limit the degree of alarm that might arise about
risks of unbridled inflation when special fiscal stimulus measures are
introduced,” he goes on. “For those who worry that fiscal stimulus
always comes too late and goes too far, there would be the central
bank’s commitment to revert to a policy of active control of aggregate
demand through monetary policy once the nominal GDP target path is
reached.”

Monetary-fiscal coordination may not be easy, he says, but the BOE
program is “at least a demonstration that coordination can occur.”

(3 of 3)

** MNI **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]

Continued

By Steven K. Beckner

Woodford questions the effectiveness of the kind of conditional
forward guidance the FOMC has engaged in since the financial crisis —
“that avoids actually making any promises about how future policy
decisions will be made, and in particular without giving listeners any
reason to suppose that future decisions will be made on anything but a
purely forward-looking basis.”

It may even backfire by signalling that the Fed expects a longer
period of economic weakness, he warns.

“It is unclear why announcements of this form should have the
desired effect, and on at least some occasions they seem to have little
effect,” he writes. “Moreover, simply presenting a forecast that the
policy rate will remain lower for longer than had previously been
expected, in the absence of any reason to believe that future policy
decisions will be made in a different way, runs the risk of being
interpreted as simply an announcement that the future is likely to
involve lower real income growth and/or lower inflation than had
previously been anticipated — information that, if believed, should
have a contractionary rather than an expansionary effect.”

Woodford goes on to suggest that the Fed undermines the
effectiveness of its forward guidance by hewing too closely to its 2%
inflation target.

The Fed’s assurances that its easing policies “should in no way
suggest that there will be any relaxation of the FOMC’s vigilance when
it comes to preventing any increase in inflation … tend to contradict
precisely the kind of signals that one would want such policies to send
in order for them to be effective in providing people a reason to spend
more,” he writes.

“They imply that simultaneous forecasts of low nominal interest
rates for a longer time must indeed reflect pessimism about the speed of
the economy’s recovery rather than any change in the criterion that will
be used to determine the appropriate timing of the interest rate
‘lift-off’; and they work to reduce the extent to which asset purchases
can affect the economy through either the ‘signalling channel’ or the
‘inflation risk channel,” he adds.

Better than a conditional calendar date for starting to raise rates
would be a “reaction function” of the type advocated by Evans and
others, he suggests.

“A more useful form of forward guidance, I believe, would be one
that emphasizes the target criterion that will be used to determine when
it is appropriate to raise the federal funds rate target above its
current level, rather than estimates of the ‘lift-off’ date,” Woodford
writes.

“If such an explicit criterion made it clear that short-term
interest rates will not immediately be increased as soon as a Taylor
rule descriptive of past FOMC behavior would justify a funds rate above
25 basis points, this would provide a reason for market participants to
expect easier future monetary and financial conditions than they may
currently be anticipating, and that should both ease current financial
conditions and provide an incentive for increased spending.”

Seemingly anticipating Woodford’s paper, minutes of the July
31-Aug. 1 Federal Open Market Committee meeting, show that the FOMC
discussed ways of strengthening the “forward guidance” if it ultimately
decides to extend the period of zero rates past “late 2014.”

“It was noted that such an extension might be particularly
effective if done in conjunction with a statement indicating that a
highly accommodative stance of monetary policy was likely to be
maintained even as the recovery progressed,” the minutes say.

“Given the uncertainty attending the economic outlook, a few
participants questioned whether the conditionality of the forward
guidance was sufficiently clear, and they suggested that the Committee
should consider replacing the calendar date with guidance that was
linked more directly to the economic factors that the Committee would
consider in deciding to raise its target for the federal funds rate, or
omit the forward guidance language entirely,” the minutes add.

Woodford recommends that the Fed make a commitment to return
nominal GDP to the trend path that it had been on up until the fall of
2008.

He argues that “this would both make it clear that policy will have
to remain looser in the near term than a purely forward-looking Taylor
rule would imply, and at the same time provide assurance that the
unusually stimulative current policy stance does not imply any intention
to tolerate continuing inflation above the Fed’s declared long-run
inflation target — that in fact, it will not lead to a future level of
nominal income any higher than what people had reason to anticipate at
the time that they acquired their existing nominal assets and undertook
their existing nominal obligations.”

-more- (2 of 3)

** MNI **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]

By Steven K. Beckner

JACKSON HOLE, Wyo. (MNI) – Although the Federal Reserve has gone to
extraordinary lengths to stimulate the economy, it’s gone about it in
the wrong way, or at least has limited the effectiveness of the tools it
has used.

That is the conclusion reached by Columbia University professor
Michael Woodford in a paper prepared for presentation at the Kansas City
Federal Reserve Bank’s annual symposium here Friday.

Woodford, a respected monetary economist who has made presentations
to the prestigious gathering of central bankers in previous years,
contends that “forward guidance” about the future path of the federal
funds rate will be ineffective, non-credible and perhaps even
counterproductive if it is left conditional.

Only a firm committment to keep the funds rate near zero longer
than the Fed otherwise would will work to stimulate economic activity,
he argues. He lends support to a proposal by Chicago Federal Reserve
Bank President Charles Evans to keep the funds rate near zero so long as
unemployment is above 7% and inflation is below 3%.

Woodford also questions the effectiveness of large-scale asset
purchases — so-called “quantitative easing” — but says purchases of
mortgage-backed securities is apt to be more helpful than buying
Treasury securities. And he said QE can help reinforce the Fed’s effort
to signal that it intends to keep rates low.

Woodford also commends the Bank of England’s subsidized lending
program to the Fed’s consideration, but says it would only work if done
in coordination with the Treasury.

Since December 2008, the Fed has held the federal funds rate in a
zero to 25 basis point target range, with the effective funds rate
trading eight to 13 basis points below the rate it pays banks on excess
reserves (IOER).

After the funds rate reached the “zero lower bound” (ZLB), the Fed
bought a total of $2.35 trillion of Treasuries and MBS through the
creation of new bank reserves. It has financed additional long-term bond
purchases through the sale of short-term securities, which does not
cause a net expansion of reserves on the Fed’s balance sheet.

What’s more, the Fed’s policymaking Federal Open Market Committee
has resorted to the communication tool of stating, conditionally, that
it expects to keep the funds rate near zero for a long period. Since
January of this year, the FOMC has said it “anticipates that economic
conditions — including low rates of resource utilization and a subdued
outlook for inflation over the medium run–are likely to warrant
exceptionally low levels for the federal funds rate at least through
late 2014.”

Yet, to the Fed’s frustration, despite all its efforts, the economy
has grown too slowly to reduce the unemployment rate as rapidly as in
previous recoveries.

Woodford examines both forward guidance and quantitative easing, as
practiced by the Fed, and finds them wanting but acknowledges that Fed
policymakers may not want to go in the direction he suggests.

Woodford says the Fed is engaged in “wishful thinking” if it
believes it can provide additional monetary stimulus without committing
itself to future low rate policies and without getting involved in
targeted easing efforts that could involve it in “credit allocation.”

Forward guidance to affect expectations about future short-term
interest rates and thereby encourage near-term spending and investment
can’t work, he maintains, if market participants don’t believe the Fed
will hold rates down over an extended period, even after the economy has
begun to accelerate and/or inflation has begun to rise. To be credible,
a less conditional commitment needs to be made, he says.

“In practice, the most logical way to make such commitment
achievable and credible is by publicly stating the commitment, in a way
that is sufficiently unambiguous to make it embarrassing for
policymakers to simply ignore the existence of the commitment when
making decisions at a later time,” Woodword writes.

Mere words are not enough, he says.

“It does not make sense to suppose that merely expressing the view
of the economy’s future path make them believe it,” he writes. “If
speech were enough, without any demonstrable intention to act
differently as well, this would be magic indeed — for it would allow
the central bank to stimulate greater spending while constrained by the
interest-rate lower bound, by telling people that they should expect
expansionary policy later, and then also fully achieve its subsequent
stabilization objectives, by behaving in a way that is appropriate to
conditions at the time and paying no attention to past forecasts.”

“But there would be no reason for people believe central-bank
speech offered in that spirit,” Woodford continues. “Hence it is
important, under such an approach to policy, that the central bank not
merely give thought to the future course of conduct that it would like
for people to anticipate, and offer this is as a forecast that it would
like them to believe. It must also think about how it intends to
approach policy decisions in the future, so that the policy that it
wants people to anticipate will actually be put into effect.”

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** MNI **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]

Did he, or didn’t he, that’s the question.

• Will give them 24 hours to digest the plan before Thursday’s council meeting
• No preferred option on bond plan yet

Better get crackin’ kids, the clock is ticking.