Fed may focus more on overseas factors


NEW YORK -- Ben S. Bernanke, the newly installed Federal Reserve chairman, suggested yesterday that the central bank will need to pay more attention to global financial conditions in setting interest rates, moving beyond its traditional focus on domestic economic forces.

In a speech to the Economic Club of New York at the Grand Hyatt Hotel in Manhattan, Bernanke said 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, Bernanke was also skeptical about the argument that the economy will slow in the near future, a view that many investors may take as a sign that the Fed is not quite near the end of its string of interest-rate increases.

Bernanke built the prepared text of 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?

Traditionally, long-term rates have fallen when investors have anticipated a slowdown in the economy or a decline in inflationary pressures. But 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 global forces are likely to push rates lower than otherwise might be the case - or higher. The answer, 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 they Chinese central bankers trying to manage the yuan's exchange rate or global investors more comfortable with long-term securities due to 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 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," 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 around the corner, it might require the Fed to take a different tack.

The behavior of long-term bond yields has perplexed financial investors for many months. Starting in June 2004, the Fed has raised short-term rates from 1 percent to 4.5 percent in quarter-point increments.

Yet the 10-year Treasury bond yield has only inched ahead slightly, and is now less than a quarter of a percentage point higher, creating a pattern known as a flat yield curve.

Financial investors awaited Bernanke's speech in hopes of combing it for signs of when the Fed might end its series of interest-rate increases. The Fed is widely expected to raise its key rate another quarter of a point at its meeting next week, but analysts are divided over whether it will echo that increase in May.

Yet beyond discarding the notion of an economic slowdown, Bernanke refrained from providing any precise indication of what to expect from the Fed.

Bernanke said domestic factors are still very important in determining long-term rates, noting that the drag on consumer spending from higher-priced energy and expectations that the housing market will cool might be keeping long-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" might also be weighing on long-term rates, with ambiguous implications for American monetary policy.

Considering all these elements left Bernanke perched on the fence. To the extent that lower long-term yields merely reflect investors' increased appetites for long-term debt, he said, "the policy rate associated with a given degree of financial stimulus will be higher than usual."

But "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."

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.