Monday, December 1, 2008

Bernanke’s State of the Economy Speech

Ben Bernanke gave a speech today before the Chamber of Commerce in Austin, Texas. It’s a bit dry but a good read. It paints a sober and sensible assessment of the financial crisis. He has given us some pretty misguided assessments in times past so this is a change.

The first section: “Federal Reserve Policies During the Crisis” is a recapitulation of major financial events since the collapse of Bear Stearns, and policy which has been formulated in reaction to them. It echoes most of the events reported on in this blog, telling things from the Fed’s perspective, and making some attempts to encapsulate the arguments pro and con to its actions. The only thing left out—that should have been included—is the recent expansion of base money supply.

The second section: “Economic Outlook” predicts the continuation of general economic downtrends at least for the short term, in housing, cars, and general retail, for example. In the long run, naturally he is optimistic about the U.S. economy. Around housing he specifically anticipates the “eventual stabilization in housing markets as the correction runs its course.” Finally, Ben has discovered the blogosphere!

The third and final section: “The Outlook for Policy” there were four points he spoke on: (1) Regarding the Federal Funds Rate that is now 1%, he admits the actual effective rate has been lower than that because Fannie Mae and Freddie Mac have been undercutting the Fed and lending their reserves overnight for less. Though he indicated the possibility they might go lower, at 1%, there isn’t much farther to go. (2) The Fed also offered the possibility to purchase GSE bonds, and Treasury Bonds to boost liquidity in the system. (3) The vast array of liquidity measures provided now can be broadened out and expanded further, he tells us—which would necessitate a expansion of the Fed’s balance sheet that would need to be contracted over time to prevent inflation. And (4) the Fed will continue to “preserve the viability” of failed financial institutions where it poses a systemic risk. He concludes by adding that foreign central banks are conducting similar extraordinary efforts. Again he leaves out the increase in base money by $650B (and counting).

Treasuries rallied on point (2) of the third section. Stocks fell sharply today.

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