Bloomberg News

Fed Monetary Course Hard to Undo for Bernanke Successor: Economy

June 24, 2013

Fed Monetary Course Hard to Undo for Bernanke Successor

Federal Reserve Board Chairman Ben Bernanke on Capitol Hill in Washington, DC. Photographer: Alex Wong/Getty Images

The Federal Reserve under Chairman Ben S. Bernanke has committed itself to a monetary strategy for this year and beyond that will be difficult to undo under a new chairman.

Under Bernanke’s leadership, the Fed has set out clear markers for the conditions that need to be met to moderate and eventually end its asset-purchase program and then begin increasing interest rates. As a consequence, the identity of the chairman next year is unlikely to matter as much as in the past.

“Usually, the Fed chairman comes in with a clean slate to do whatever they want,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York and a former researcher with the central bank. “Whoever comes in this time is going to inherit a pretty rigid structure.”

Bernanke’s second four-year term as chairman ends on Jan. 31. While neither he nor the White House has said definitively that he’ll step down, President Barack Obama suggested just that in a television interview last week, saying the Fed chief had stayed in his post “longer than he wanted.”

Bernanke has tried to make the policy-making Federal Open Market Committee more transparent and democratic. By de-emphasizing the role of the chairman in the committee’s deliberations, he has made it harder for his successor to change the course of policy, said Roberto Perli, a former Fed official who is now a partner at Cornerstone Macro LP in Washington.

Policy Commitments

“The FOMC under a potential new chair would be largely the same as the current one, and it is unlikely that FOMC members would relinquish their authority or renege on their own policy commitments simply because a new chair may have different views,” Perli wrote in a June 19 note to clients.

Assuming Bernanke is leaving the Fed, Obama probably will want to name someone whose views are not all that different. In a television interview with Charlie Rose, the president said the Fed chairman has done “an outstanding job.”

“I’d be quite surprised if the president nominated a chairman who wasn’t broadly in agreement with the policies that the current chairman has led on the committee -- an emphasis on getting the unemployment rate down and having economic activity be stronger, an emphasis on communication and transparency,” former Fed Vice Chairman Donald Kohn said in an interview in Bloomberg’s Washington bureau.

One of the leading contenders to replace Bernanke is the current vice chairman, Janet Yellen, who led a subcommittee on the FOMC that focused on devising the central bank’s communications strategy. Since Yellen helped forge the policies, she’d probably be inclined to continue them, said Joseph LaVorgna, chief U.S. economist for Deutsche Bank Securities Inc. in New York.

‘Very Comfortable’

“My guess is the next person is Janet Yellen, and she seems to be very comfortable going along with the policies to date,” said LaVorgna, a former economist at the New York Fed. “I imagine the transition, whoever it is, but likely her, being very seamless.”

Economists in a June 19-20 Bloomberg survey assigned Yellen a 65 percent probability of taking over the top job once Bernanke’s term ends. Timothy F. Geithner, a former Treasury secretary and former New York Fed president who worked closely with Bernanke in both those posts, was seen as the second most-likely successor, with odds of 10 percent.

The next Fed chairman will be “inheriting the last vestiges of the current policy regime,” said Eric Green, the global head of rates, foreign exchange, and commodities research at TD Securities Inc. in New York. “Basically they’re not going to have a lot to do that first year.”

Ensuing Regime

That will change after asset purchases end and the Fed prepares to start raising its benchmark interest rate, said Green, another former economist at the New York Fed. Then, the FOMC “will have an opportunity to completely define the ensuing regime -- the rate tightening regime.”

The Fed has tried to spell out how it will adjust policy in the future partly out of necessity. With short-term interest rates already effectively at zero, it can’t lower them further to promote growth. Instead the Fed has used asset purchases and more open communication -- promising, in effect, to keep short-term rates lower for longer -- to try to achieve that goal.

“Particularly when you’re in unconventional policy mode, talking about the future and how the Fed might react under certain circumstances is critical,” said Kohn, who is now a senior fellow at the Brookings Institution in Washington.

“One of the main thrusts of the Bernanke chairmanship is to help explain as best as the Federal Reserve could what their reaction function is,” he added.

Stocks Retreat

U.S. stocks retreated, sending the Standard & Poor’s 500 Index to a nine-week low, as Chinese equities entered a bear market amid concern a cash crunch will hurt the world’s second-largest economy and speculation increased that the U.S. will begin curbing stimulus.

The S&P 500 fell 1.7 percent to 1,565.07 at 10:01 a.m. in New York, the lowest level on a closing basis since April 22. The 10-year Treasury note yield rose to 2.61 percent at 10:09 a.m. in New York, after reaching 2.66 percent, a level unseen since August 2011.

The CSI 300 Index of China’s biggest companies tumbled 6.3 percent, the most since August 2009 and taking its decline from this year’s peak to more than 20 percent.

European bonds extended declines from last week, sending Germany’s 10-year yield to a 14-month high, as concern the Fed will begin curbing its stimulus plan this year damped demand for fixed-income assets.

Italian two-year note yields jumped to the most in six months, while Spain’s 10-year yield climbed above 5 percent for the first time in almost 12 weeks.

Dialing Down

Bernanke told a news conference on June 19 that the central bank may start dialing down its unprecedented bond-buying program this year and end it entirely in mid-2014, provided that growth quickens and inflation moves up closer to the Fed’s 2 percent target. The central bank currently is purchasing $85 billion of assets per month, comprising $40 billion of mortgage-backed securities and $45 billion of longer-term Treasury debt.

Policy makers forecast that growth will pick up to 3 percent to 3.5 percent next year, from 2.3 percent to 2.6 percent this year, according to their central tendency estimates, which exclude the three highest and three lowest projections. Inflation -- as measured by the personal consumption expenditure price index -- will speed up to 1.4 percent to 2 percent, from 0.8 percent to 1.2 percent this year.

Zero Rates

Bernanke said the FOMC expects a “considerable interval” between the ending of asset purchases and the first interest-rate increase. He reiterated that the central bank intends to keep short-term rates near zero at least as long as unemployment remains above 6.5 percent and the outlook for inflation doesn’t exceed 2.5 percent. Joblessness was 7.6 percent in May, and inflation was 0.7 percent in April.

A “very strong majority of FOMC participants still expect rates to be quite low at the end of 2015,” Bernanke said.

A strong majority also doesn’t expect the committee to sell any of the mortgage-backed securities it has on its balance sheet, he added.

Once a policy has been spelled out, it’s always harder to change course, said Robert Eisenbeis, a former director of research at the Atlanta Fed.

“It’s still a committee, and what one chairman can do depends on their ability to manage the committee,” added Eisenbeis, now vice chairman and chief monetary economist at Cumberland Advisors Inc. in Sarasota, Florida. “It’s like trying to move a glacier. It’s very hard for someone to come in and change course unless they’re a very skillful politician.”

To contact the reporters on this story: Rich Miller in Washington at rmiller28@bloomberg.net; Joshua Zumbrun in Washington at jzumbrun@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net


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