Relax until autumn

Wednesday morning, Deputy Prime Minister Ali Babacan gave an interview to a Turkish TV program and in the afternoon, US Federal Reserve (Fed) Chairman Ben Bernanke testified to the US Congress.
Bernanke seems successful in convincing markets Both of them tried to calm tensions that have appeared in the financial markets during the last weeks and to convince investors that, in fact, there was a terrible misunderstanding. Babacan, following the critical meeting at Dolmabahçe (see my article from Tuesday, July 15, “Plots out, common sense in”) that seems to have succeeded in convincing Prime Minister Recep Tayyip Erdoğan of the dangers of confronting market forces, clearly explained that for 10 years the Justice and Development Party (AK Party) government has played the game of an open market economy and it will continue to play the same game in the future. He also strongly reminded listeners that the central bank is an independent institution and thus free to set the monetary policy according to its mission. So, inside Turkey, tension declined to some extent, as evidenced by a slight appreciation of the Turkish lira and a buoying stock market. As for Bernanke, the stakes are even more important, since misunderstandings regarding the Fed's intentions are detrimental not only to the Turkish economy but for the world's economies. So, Bernanke's testimony to Congress aimed to clarify how the Fed evaluates the current situation of the US economy and more importantly, how it is setting benchmark conditions that will guide its monetary policy in the future. Let's start with Bernanke's mea culpa. The Fed chairman explained that at the June Federal Open Market Committee (FOMC) meeting, he and his colleagues anticipated real gross domestic product (GDP) growth beginning to increase during the second half of this year and eventually reaching 2.9, and 3.6 percent in 2015, and for the unemployment rate to decline to between 5.8 and 6.2 percent by the final quarter of 2015. Moreover, these forecasts have not been subject to external shocks like undesirable federal fiscal policy moves and the slowdown of economic growth in emerging markets. Bernanke specified that “in the interests of transparency, Committee participants agreed in June that it would be helpful to lay out more details about our thinking regarding the asset purchase program … as well as of the likely trajectory of the program if the economy evolves as projected.” Admittedly, markets had overreacted -- this is my interpretation -- to this desire for transparency. According to Bernanke, “With unemployment still high and declining only gradually and with inflation running below the Committee's long-run objective (2 percent), a highly accommodative monetary policy will remain appropriate for the foreseeable future.” First, the Fed will wait until it is sure of the strength of the ongoing recovery and when that is the case, it will start to reduce its asset purchasing. If the US economy has close to 6.5 percent unemployment and 2 percent inflation, the asset purchase program will be terminated as a tool of extraordinary times where the Fed policy interest rate is close to zero and cannot be turned into a negative rate. However, while this extraordinary tool will eventually be out of use, the Fed “… intends to maintain a high degree of monetary accommodation for a considerable time after the asset purchase program ends and the economic recovery strengthens.” This will be done by maintaining the federal funds rate at close to zero. In his testimony, Bernanke took care to add a new clarification regarding the guiding conditions of the monetary policy. He said, “The specific numbers for unemployment and inflation [6.5 percent and 2 percent] are thresholds, not triggers. Reaching one of the thresholds would not automatically result in an increase in the federal funds rate.” Then he explained that if, for example, unemployment reaches 6.5 percent, but not through a rise in employment but rather through a decline in the labor force, or if the unemployment threshold is reached, but not the threshold for inflation, the Fed will not be in a hurry to increase its federal funds rate. All those sophisticated and well-calibrated definitions and announcements are part of the difficult art of communication for central banks. One can assert that Chairman Bernanke gave a good example of this art form. I think that we can sleep soundly, at least until autumn. The risk of financial turbulence has been greatly minimized. Once autumn has passed, we will have to scrutinize very carefully the evolution of the US economy and track this evolution on the roadmap provided by Bernanke. In doing this, we cannot, of course, solve our structural problems, but we may at least avoid the surprises and the damage of high volatility in the markets.