As expected, Fed chair Ben Bernanke didn't introduce any new proposals during his speech in Jackson Hole. Real time economics provides highlights of his speech. Will the Fed introduce QE3 at some later date as some economists, such as Nouriel Roubini have suggested? Bernanke has emphasized that the his primary criteria that would lead him to implement another round of QE is fears of deflation (as was the case in late 2008 prior to QE1 and in 2011 prior to QE2). Given that most measures of inflation are close to the Fed's target, QE3 is unlikely any time soon. While some have criticized Bernanke, claiming that his policies will lead to high inflation, he continues to express the goal of keeping inflation at about 2% over time (a goal he first proposed in the 1990s). In fact, some economists have suggested that he raise his target for inflation to 4%; an idea rejected by Bernanke (so he gets criticized for possibly contributing to high inflation and for keeping it too low). Greg Mankiw provides a defense of Ben Bernanke. As he expressed today, Ben Bernanke recognizes the limits of monetary policy, that the Fed cannot ensure economic growth on its own, particularly sustained economic growth over time. At the same time, it plays a critical role in dealing with extreme financial distress or preventing deflation.
What about previous rounds of QE? Most economists strongly supported the first round of QE, which followed the approach suggested by Milton Friedman when an economy experiences a financial crisis. It accomplished its goal of stabilizing the financial system and preventing deflation (returning the economy back to normal would have been nice, but was not an expected outcome of the first round of QE). QE2 was more controversial. Virtually all of the new reserves introduced by the Fed remained in banks rather than circulating in the economy. Banks used it to build up excess reserves; the Fed's $600 billion in purchases of treasuries was accompanied by a little more than a $600 billion increase in excess reserves (see change in excess reserves from November to June). Thus, new money is not flooding the economy, meaning fears of very high inflation are unfounded (unless the Fed allows the reserves to flood the economy at some point in the future). However, when short-term interest rates are so low, many investors or speculators take on more risk in search of higher returns, leading to potential bubbles in some assets. Thus, though low interest rates are desirable in trying to stimulate economic growth, there are risks to such a policy if kept in place for too long.
There's been no more difficult time to implement monetary policy than today, given the after effects of the financial crisis, sovereign debt crises, ongoing economic weakness, etc. In addition, the heated political environment poses an additional challenge to being chair of the Fed, particularly if he has any interest in visiting Texas!
