More Fed Bond Buying Won't Let 'Animal Spirits' out of the Cage

Markets will be hanging on every word in Federal Reserve Chairman Ben Bernanke's speech Friday morning in Jackson Hole, Wyo. That is because the minutes from the July 31-Aug. 1 meeting of the Federal Open Market Committee, released on Aug. 22, were widely interpreted as signaling some kind of further easing of monetary policy.

The minutes stated in part that "many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery." And yet, one day after the minutes were released, St. Louis Fed President James Bullard said they were "a bit stale." This turned market sentiment around, sending equity prices down.
So will he send a signal favorable to "additional monetary accommodation"? Or will he endorse Mr. Bullard's comments?
Looking ahead to its next meeting on Sept. 12 and 13, the FOMC could decide to initiate a new round of "quantitative easing" through purchases of Treasury bonds, mortgage-backed securities or other unconventional asset classes, which has been its strategy since the fall of 2008. It might also choose to extend beyond the end of 2014 the period in which it anticipates holding the federal-funds rate near zero. These aren't mutually exclusive possibilities.
But whatever path Mr. Bernanke points the FOMC toward, further "monetary accommodation" of the type being discussed will be futile at best or counterproductive at worst.

Bond purchases won't change any fundamental determinant of economic activity.

Consider the kind of policies implemented by the Fed since the crisis began. One variety consisted of credit allocation, whether by direct lending to targeted financial institutions or even nonfinancial firms such as auto makers. Fed purchases of mortgage-backed securities direct credit to favored firms and sectors rather than to the businesses that could make most productive use of it.

Read more: http://www.cato.org/publications/commentary/more-fed-bond-buying-wont-let-animal-spirits-out-cage