By Rich Miller
March 16 (Bloomberg) -- Ben S. Bernanke may have something to learn from his former Massachusetts Institute of Technology colleague Mervyn King.
By buying government securities to increase the supply of money, Bank of England Governor King is taking a step that Federal Reserve Chairman Bernanke has only talked about. Early results have been encouraging: Yields on 10-year U.K. government bonds fell to 2.94 percent March 13, at least a 20-year low, from 3.64 percent before King announced the policy March 5.
“The BOE is providing an actual experiment in answering some of the concerns that the Fed has about the effectiveness” of using the strategy to effectively print more money, says former Fed Governor Laurence Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers LLC.
Bernanke and his colleagues on the Federal Open Market Committee start a two-day meeting tomorrow to discuss the deteriorating economic outlook and what they can do to turn it around. After their last meeting ended on Jan. 28, policy makers said they were “prepared to purchase longer-term Treasury securities” if it became clear the policy would be “particularly effective” in getting credit flowing again.
Since then, the stock market has fallen, with the Standard & Poor’s 500 index down 13 percent in a month and a half, even after last week’s 11 percent gain. Unemployment hit a 25-year high of 8.1 percent in February, and the number of Americans drawing jobless benefits reached a record 5.3 million.
Flooding the System
“The economy is in a free-fall,” says Tim Duy, an assistant professor at the University of Oregon in Eugene who writes on Fed policy. “They need to flood the financial system with money.”
Bernanke first raised the possibility of Treasury purchases in a speech on Dec. 1. The central bank subsequently put the idea on the back burner to focus on this month’s start of the Term Asset-Backed Securities Loan Facility, a $1 trillion credit program for consumers and small-business owners.
“At this point in time, the Fed has judged that buying long-term Treasuries is not the most efficient means of easing financial conditions,” Federal Reserve Bank of New York President William Dudley said after a March 6 speech in New York.
Treasuries have lost 2.85 percent this year, according to an index compiled by Merrill Lynch & Co., sending yields higher.
Dudley and other Fed policy makers argue that they get more punch for their purchases by concentrating on specific credit markets rather than buying Treasuries. The average interest charge on a 30-year fixed-rate mortgage has fallen to about 5 percent from more than 6 percent since the Fed announced plans to purchase $500 billion of mortgage-backed securities last November.
‘Credit Easing’
Bernanke, 55, has described the Fed’s approach as “credit easing” to distinguish it from the “quantitative easing” policy the Bank of Japan adopted from 2001 to 2006. The strategies differ in how they pump money into the economy. The BOJ’s focus was on increasing reserves in the banking system to encourage more lending. The Fed is trying to lower the cost of credit for specific types of borrowers, such as home buyers.
King -- whose office adjoined Bernanke’s when the two were visiting professors at MIT in Cambridge, Massachusetts, during the 1980s -- is pursuing both approaches.
Gilt Purchases
He is aiming to expand reserves in the financial system through purchases of U.K. government bonds, known as gilts -- a strategy he describes as “conventional unconventional” monetary policy. He will also buy private-sector assets as Bernanke is doing -- an approach the Bank of England chief calls “unconventional unconventional.”
The U.K. Treasury authorized the BOE to spend 150 billion pounds ($210 billion) for asset purchases, mostly of gilts. In the first stage, it will spend 75 billion pounds during the next three months.
King, 60, who has faced criticism for moving too slowly as the economic crisis gathered steam, was able to put his plan into action quickly because it involves the government-debt market, where the BOE already operates regularly. The central bank held its first auction to buy gilts on March 11, just six days after it unveiled the program.
In contrast, it has taken the Fed four months to launch the TALF, as it tweaked the terms of the program to make it more attractive for private lenders to participate.
Favorable Response
The U.K. bond market responded favorably to the moves by King. Corporate bonds in pounds rose, driving down borrowing costs. The Markit iBoxx sterling nonfinancial corporate bond index has gained 4.7 percent since March 4. The benchmark index includes 260 bonds issued by companies including confectionary maker Cadbury Plc, Vodafone Plc and supermarket chain Tesco Plc.
“Given that it was a groundbreaking operation, it went pretty well,” says John Wraith, head of sterling interest-rate strategy at RBC Capital Markets in London.
The Fed and the BOE, like other central banks, are struggling to find fresh ways to rescue their economies as they run out of room to cut interest rates further. King cut the BOE’s benchmark rate to 0.5 percent March 5, and the Fed’s overnight lending-rate target has been between zero and 0.25 percent since Dec. 16. Both are record lows.
The Bank of Japan is focusing on measures to improve corporate finance, rather than on boosting the money supply. Governor Masaaki Shirakawa, 59, argues that quantitative easing had only a limited effect on improving the economy when the BOJ tried it earlier this decade, although it did help stabilize the financial system.
Shirakawa’s Intentions
“Shirakawa doesn’t seem to have any intention of reviving quantitative easing by using a reserve target,” says Izuru Kato, chief market economist at Totan Research Co. in Tokyo.
The BOJ, which reduced its benchmark interest rate to 0.1 percent in December, is buying commercial paper and corporate bonds and has resumed purchases of shares from financial institutions. Shirakawa, though, is resisting pressure from politicians to increase the BOJ’s purchases of government bonds to help finance a stimulus package.
The Swiss National Bank is taking a different tack. After cutting its main lending rate to 0.25 percent March 12, the central bank started selling Swiss francs in the foreign- exchange market. The flood of new francs drove the Swiss currency down 3.4 percent against the euro March 12 and 13.
Exchange Rates
When central banks fail to align their nontraditional policies, “that can be hugely destructive” for exchange rates, says Richard Portes, professor of economics at the London Business School. After King unveiled his plans March 5, the pound fell 3.4 percent against the euro through March 13.
European Central Bank President Jean-Claude Trichet has been reluctant to emulate the policies of some of his fellow central bankers. The ECB’s key rate, at 1.5 percent, is the highest among major central banks in the industrial world. Trichet, 66, said March 5 that while the ECB is examining “nonstandard measures,” it hasn’t made any decisions on their use.
Bernanke and the Fed led the way last year in taking unconventional steps to aid the economy by supporting the commercial-paper market and moving to buy mortgage-related debt, says David Jones, president of Denver-based DMJ Advisors.
“Now he’s got to decide whether it goes all the way and buys Treasuries,” says Jones, author of four books on the Fed. “At some point,” he predicts, the central bank will.
To contact the reporter on this story: Rich Miller in Washington rmiller28@bloomberg.net
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