Why Ben Bernanke’s Plan Will Work | Chappaqua NY Real Estate

The FOMC delivered everything I expected – and more. This was a very strong move and I suspect many analysts are underestimating the potential positive impact on the economy.

However, as Fed Chairman said, monetary policy is “not a panacea”. I do think this will help, but this will not solve the unemployment problem.

Here are a few key points:

• Forward guidance is a critical part of Fed policy (see Michael Woodford’s paper presented at Jackson Hole). The FOMC didn’t go as far as targeting nominal GDP, but they took two key steps today: 1) they extended the forward guidance until mid-2015, and 2) the FOMC made it clear that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens“. “AFTER the economic recovery strengthens” is key.

• This easing was not based on new economic weakness. From the FOMC statement: “economic activity has continued to expand at a moderate pace in recent months”. This easing was intended to help increase the pace of recovery.

• Another key change was the FOMC tied this easing directly to the labor market: “If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

• I think this will be more effective than most analysts expect. As I noted last weekend, housing is usually a key transmission channel for monetary policy, and now that residential investment has started to recover – and house prices have stabilized, or even started to increase, this channel will probably become more effective.

I also liked that Bernanke addressed three concerns that have been raised about monetary policy. Note: The replay of the press conference is available here.

The first “concern” was that some people are confusing fiscal and monetary policy. Monetary policy is NOT spending (see Bernanke’s comments at 7:00).

The other two are legitimate concerns – that the Fed policies can hurt savers, and that there is a risk of inflation down the road. I agree with Bernanke that a stronger economy will lead to better returns for savers, and that inflation is not an immediate concern.