The Federal Reserve appears to have succeeded where other central banks have failed — at least in convincing markets that it will be more dovish in the years ahead, said former Fed Chairman Ben Bernanke on Sunday. “As best we can tell, the Fed’s forward guidance — both in terms of its change in its framework and in terms of its commitments — have been fairly effective,” Bernanke said, during a discussion about economic policy during the coronavirus pandemic at the American Economics Association’s annual meeting.
Central banks often face the challenge of being credible about policy decisions that won’t be made for years, but the Fed seems to have accomplished this goal, Bernanke said. In August, the Fed announced a new policy framework, saying that it will attempt to overshoot its 2% inflation target, after years of undershooting that target. The Fed also said it would no longer preemptively hike its benchmark interest rate to ward off expected inflation, which had been standard Fed policy going back to the 1950s. Under the new commitment, the Fed won’t move until it actually sees rising inflation. Surveys of primary dealers conducted by the New York Fed indicate that market participants broadly believe the Fed has moved in a dovish direction and that inflation will be higher and unemployment will be lower when the Fed lifts its benchmark rate off zero, Bernanke noted. When the economy is slowly recovering from a deep recession, markets often look ahead and bond yields rise. But this spike in long-term bond yields can cause growth to stall out. This dynamic was a constant struggle for Bernake in the wake of the financial crisis in 2008. Market expectations today are much more dovish than after the 2008 financial crisis, Bernanke noted. “Financial markets don’t see rates being increased for something like four years,” he said. Bernanke said the Fed’s monetary policy has had beneficial effects since the pandemic started wreaking havoc on the economy in March. The economic recovery has proven to be faster than expected, he noted. In June, the Fed expected 2020 GDP growth would be minus-6.5% on a year-over-year basis. Now, the Fed expects it will be less than minus-2%. In addition, the sectors that are impacted by low interest rates have led the recovery. Bernanke said the Fed was also successful in restoring markets in the wake of the “short, sharp financial crisis” in early March when the economic impact of the coming pandemic became understood. Bernanke said the Fed’s Main Street lending facility was a notable exception and was less successful. The alternative “funding for lending” approach taken by many foreign central banks seemed more successful. Those plans provide very cheap funding to any marginal lending done by banks. “Those programs, particularly in Europe, have been extremely successful in getting money out the door,” he said.