By Steven K. Beckner

(Continued)

Such a communication change is hardly a done deal. There are many
challenges to reaching a consensus for pursuing such a strategy.

Some officials warn that setting a data trigger for tightening
could expose the Fed to a loss of credibility if it were to reach a
certain data point, say a certain level of inflation or unemployment,
only to decide not to begin the tightening process.

At his June 22 post-FOMC press conference, MNI asked Bernanke: “Do
you have a trigger of unemployment or inflation at which you would begin
the exit process and if you do would it make sense to announce it? If
not, why not?”

Bernanke replied, “It’s impossible to create a statistical trigger
because we have currently 17 independent members of the FOMC, each
having his or her view on the outlook of the efficacy of monetary policy
and on the risks to inflation and unemployment. So we don’t have any
such formula.”

“We have staff producing various scenarios which give an indication
of, given their projections of where the most likely points for
beginning of an exit would be,” Bernanke continued. “But as I said
earlier, when I was asked about my own projections those are tentative,
depending on a lot happening and depending on the forecast evolving as
expected, and certainly it’s subject to change as new information comes
in.”

But there has evidently been a change of heart since June, making
the adoption of some kind of data triggers an option at least worth
considering.

“I would say that there’s been, at least on my part, an increased
appreciation of the value of trying to be as clear as possible to the
public and markets to reduce any tendency to misinterpretation of what
the path of policy is likely to be,” said Lockhart, “and perhaps some
concern, on my part at least, that a date-specific forward guidance
statement is sort of a depleting accommodative posture as the date
approaches.”

“So in my mind you would get more flexibility out of trying to make
it state dependent or describe states,” he added.

There appears to be little sympathy on the Committee for another
communications tactic recommended by Harvard Professor and former
International Monetary Fund chief economist Kenneth Rogoff — to
consciously permit inflation to run well above target for several years.

Evans, a current FOMC voter, recently said he does “not think that
a temporary period of inflation above 2% is something to regard with
horror.” But a temporary aberration is not the same thing as a
deliberate policy of higher inflation.

Richmond Fed President Jeffrey Lacker, who will be an FOMC voter
next year, looked strongly askance at the Rogoff scheme in a recent
interview with MNI. “It’s certainly the case that raising inflation for
a time can work well in a model to stimulate growth, but between those
models and the real world I see a lot of complications in being able to
engineer a temporary increase in inflation and be able to credibly
reduce inflation later,” he said.

“Being willing to tolerate inflation for a time is a dangerous path
to go down,” Lacker went on. “It leads to volatility, uncertainty and
real problems for central banks.”

A cut in the interest rate paid on excess reserves (IOER) is one
policy alternative which Bernanke has mentioned on a number of
occasions. But while it has not been totally discarded as an option,
there is mounting concern that an IOER cut would not only have little
positive impact, but could have negative consequences for the
money markets. There is a feeling that it could do more harm than good.

With “twist” being a one-shot deal, with communications gimmicks
holding out only modest and uncertain promise and with an IOER cut being
viewed increasingly dubiously, that leaves QE3 as the most potent weapon
remaining in the Fed’s arsenal.

And QE3 could conceivably take the form of MBS, not just Treasury
purchases, even though that would go against the FOMC’s stated desire to
eventually get back to an all-Treasury portfolio.

Beyond purchases of Treasuries, agencies and agency-backed MBS, the
Fed has legal authority to do other things as well — things that it
would prefer not to do in normal circumstances. But it has in the past
shown a willingness to go to extraordinary lengths in “unusual and
exigent” situations.

The Fed can, for instance, buy state and municipal bonds. And it
can buy foreign government debt instruments.

Although it cannot directly buy corporate debt, or for that matter
equities, the Fed can extend credit, against a wide range of collateral,
indirectly to business through special facilities. And it has done so,
for example through the now-defunct Term Asset-Backed Securities Loan
Facility (TALF). Aided by capital from the U.S. Treasury, drawn from the
Troubled Assets Relief Program (TARP), the New York Fed lent to holders
of asset backed securities backed by consumer and small business loans.

Another monetary tool that has fallen somewhat into disuse, but
could be enhanced and used more aggressively, is the discount window.

Alternatively, given the stigma attached to discount window loans,
the Fed could revive the Term Auction Facility (TAF), under which
depository institutions could bid for 28- or 84-day credit at regular
Fed auctions.

At its next meeting, the FOMC will be updating the outlook for GDP
growth, unemployment and inflation from the forecasts made in late June.
Since then, as Bernanke and others have readily acknowledged, the
outlook has worsened and downside risks have increased significantly.

With new forecasts in hand, and taking into account fast-breaking
events in Europe and elsewhere, the FOMC will have the difficult task in
coming weeks and months of deciding how much more of its dwindling
ammunition it can constructively use in the knowledge that, as Bernanke
has said, monetary policy is no “panacea.”

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