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Fd chair blames long term rates on world savings glut { March 20 2006 } Original Source Link: (May no longer be active)
http://www.nytimes.com/2006/03/20/business/20cnd-fed.htmlhttp://www.nytimes.com/2006/03/20/business/20cnd-fed.html
March 20, 2006
Fed Chief Sees Need to Include Global Factors in Setting Rates
By EDUARDO PORTER
Ben S. Bernanke, the newly installed Federal Reserve chairman, suggested this evening that the central bank would need to pay more attention to global financial conditions in setting interest rates, moving beyond its usual focus on domestic economic forces.
In his prepared remarks to the Economic Club of New York, Mr. Bernanke told the group gathered at the Grand Hyatt Hotel in midtown Manhattan that to understand the reasons behind movements in American bond yields, "an explanation less centered on the United States might be required."
In only his third speech since being sworn in as Fed chairman last month, Mr. Bernanke was also skeptical about the argument that the economy will slow in the near future.
Mr. Bernanke built his speech around one of the most pressing puzzles in financial markets today: Why do long-term bond yields remain so low despite steadily rising short-term interest rates?
Historically, long-term rates have fallen because investors were anticipating a slowdown in the economy or a significant decline in inflationary pressures. But Mr. Bernanke argued that other factors —including a worldwide imbalance between abundant savings and less robust investment — may be a more powerful explanation for the current phenomenon.
Over time, however, the challenge will come in determining whether the new global forces are likely to push interest rates lower than otherwise — or higher. The answer, Mr. Bernanke said, will be increasingly crucial to the conduct of monetary policy.
If long-term yields are low primarily because investors are buying more long-term bonds — be it Chinese central bankers trying to manage the yuan's exchange rate or global investors more comfortable with long-term securities because of a decline of economic volatility — they would be adding an extra lift to consumer spending and business investment. That would tend to push the Fed to raise its key short-term interest rate a little more than it might otherwise have considered appropriate.
"If spending depends on long-term interest rates, special factors that lower the spread between short-term and long-term rates will stimulate aggregate demand," Mr. Bernanke said. Other things being equal, he added, this "argues for greater monetary policy restraint" and higher short-term interest rates.
On the other hand, if the low bond yields are indicating that investors expect an economic slowdown, it might require the Fed to take an entirely different tack.
The behavior of long-term bond yields has perplexed financial investors for many months. Starting in June 2004, the Fed has raised its benchmark federal funds rate on overnight bank loans to 4.5 percent from 1 percent in quarter-point increments. Yet the 10-year Treasury bond yield has only inched ahead slightly and it is now only about a quarter of a percentage point higher, creating a pattern known as a flat yield curve.
Financial investors awaited Mr. Bernanke's speech in hopes of combing it for signs of when the Fed might end the long string of interest rate increases. The Fed is widely expected to raise its key rate another quarter of a percentage point at its meeting next week, but analysts are more divided over whether it will echo that rate increase again in May.
Yet beyond discarding the notion of an economic slowdown, Mr. Bernanke refrained from providing any precise indication of what should be expected of short-term interest rates. "The implications for monetary policy of the recent behavior of long term yields are not at all clear-cut," he said.
Mr. Bernanke agreed that domestic factors are still very important, pointing out that the drag on consumer spending from higher-priced energy and expectations that the housing market will cool might be keeping longer-term interest rates low even as short-term rates rise.
But he threw a new element into the mix: the possibility that what he has referred to as a "global savings glut" — an excess in global savings over global investment — might also be weighing on long-term rates, with ambiguous implications for American monetary policy.
Mr. Bernanke first articulated this thesis about a year ago, when he was a governor at the Federal Reserve. He posited that cash reserves have been accumulating quickly among oil exporters, East Asian nations pursuing export-oriented growth strategies and other developing countries.
As these countries have amassed savings, global investment has remained subdued partly because of spending restraint among the developing countries that were burnt during the financial crises of the late 1990's, and partly because of sluggish growth in the work force of the aging industrial world.
Considering all these elements left Mr. Bernanke perched on the fence. To the extent that lower long-term yields merely reflect investors increased appetite for long-term debt, he said, "the policy rate associated with a given degree of financial stimulus will be higher than usual."
But, he said, "to the extent that long-term rates have been influenced by macroeconomic conditions, including such factors as trends in global savings and investment, the required policy rate will be lower."
Copyright 2006 The New York Times Company
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