Markets Spike on Bernanke Talk of 'QE3'

Fed chairman's testimony sends stock markets upward.

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For the chairman of the Federal Reserve, there are no "off-the-cuff" remarks. Today provided yet another example of how any utterance by Fed Chairman Ben Bernanke can send global markets spiking or spiraling. In an altogether measured assessment of the economic landscape and Federal Reserve policy, Bernanke suggested that the Fed could be open to a third round of quantitative easing. Shortly thereafter, the Dow Jones Industrial Average shot skyward.

In his Semiannual Monetary Policy Report to Congress, Bernanke told members of the House Financial Services Committee, "Even with the federal funds rate close to zero, we have a number of ways in which we could act to ease financial conditions further." Though he went on to discuss a number of possible strategies, the mention of possible "additional stimulus" sent the financial world buzzing, causing bumps in stocks and gold prices.

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In "quantitative easing," a central bank attempts to stimulate the economy by purchasing securities and thereby increasing the money supply. For this reason, the practice has earned the nickname of "printing money." It is not a common tactic, however, and is usually used when other monetary moves, like lowering interest rates, prove ineffective. This would appear to be the case; the federal funds rate—the interest rate at which banks can borrow from other banks with excess reserves—has been near zero for over two years, and economic growth remains sluggish.

Greg Daco, principal U.S. economist at economics forecasting firm IHS Global Insight, says that Bernanke's report went "pretty much as expected," with the chair repeating parts of the latest minutes of the Federal Open Market Committee, the Fed panel that determines interest rates and money supply. But mention of a third round of quantitative easing, which some call "QE3," is new to the Fed's line. On Tuesday, the FOMC released the minutes of its June meeting, at which board members opened up the possibility of "additional monetary policy stimulus."

"I think it was surprising the degree to which the chairman emphasized the possibility of the use of additional extraordinary measures by the Fed," says John Lonski, chief economist at Moody's Capital Markets Group.

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Even though Bernanke only talked of the possibility of further easing, Lonski says that the chair knew the power that his testimony could have. "Through his testimony, Bernanke was trying to ease fears of a pronounced slowdown if only by reassuring markets that the Fed will do all in its power to stave off a double-dip recession," he says, adding that that reassurance may itself help markets. "To the degree that the mere indication of the Fed's willingness to employ extraordinary measures, boost financial markets, that perhaps might actually lessen the need for such extraordinary action."

Whether further easing is actually likely remains to be seen. Though the Fed predicts moderate economic growth in the coming years, with GDP growth potentially inching up past 4 percent in 2013, unforeseen threats could easily knock the economy off track. Daco also points out that the Federal Open Market Committee is divided over the possibility of further monetary stimulus.

The chief argument against quantitative easing is that it can drive inflation upward. However, Daco says that the current labor situation may prevent that from happening. "Currently, there's a lot of slack in the labor market, and wages have not been growing at a fast clip, so if wages aren't growing very fast, there is very little risk for inflation to spike out of control."

The chairman's testimony may reflect the Federal Reserve's broader push for transparency. The Fed has been moving toward more openness in recent months, giving its first press conference ever in April, followed by another in June. Even the Fed's communications strategy can help to stabilize the economy, says Daco. "Transparency is generally a good thing for an economy. It helps investors, helps consumers know where they're going," he says. The effects of the Fed's words may be unquantifiable, but in the current climate, the economy needs any boost it can get.