Markets still react to Bernanke

Okay, I'm going to briefly weigh in again where I probably shouldn't---the macro situation.

Apparently in response to Bernanke's speech in Jackson Hole today, the stock market and treasury bills rallied modestly, and the 10-year T-bill rate fell over 6 basis points.  I suppose one could argue this was due to something else, but I don't see anything other explanation in the news.

Paul Krugman summarized Bernake's speech as:
1. Things are really, really bad.
2. The damage is cumulative; the longer this goes on, the worse the prospects for the future.
3. The Fed has the power to do a lot to help the economy.
4. While you can argue that there are costs to action, the case for major costs is quite weak, and in particular much weaker than the case for major benefits.
5. Therefore, what we at the Fed will do is, um, sit on our hands some more, and think very seriously about maybe, someday, doing something.
While Krugman greatly supports the Fed trying to do more, he has also expressed skepticism that they can help much when the economy is at the zero lower bound.

But I'd just like to point out that the market still seems to respond to Bernanke's most demure suggestions.  I mean, how much news was there in his Jackson Hole speech?  We all more-or-less knew that the Fed was looking to do more imminently anyway, and now he's nudged another inch in that direction.

If we extrapolate from this, I think it suggests the Fed can do a lot more.  It could do this by changing market expectations, by replacing point 5 in Krugman's summary with a clear and firm commitment for the next X years.  That commitment could be to hold rates where they are for a longer period of time, to target a higher long-run inflation rate,  a commitment to hold rates low until unemployment falls to 6 percent, or a commitment to achieve trend nominal GDP.

I don't think it matters much which commitment they choose.  But I believe that if the Fed were to make a bold commitment of continued easing the economy would recover quickly. It's a shame they probably won't do that.

Update: Slight clarification: I expect the Fed will do something, but whatever they do will be relatively modest.  Perhaps there will be more asset purchases or something.  But I rather doubt we'll see a strong commitment to longer term policy.


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