►Bernanke caution gives markets pause, as US dollar rebounds
Michael Hewson/ShareCast/Oct 18
For the last six weeks the US dollar has slid lower relentlessly on speculation that the Federal Reserve will embark on a further stimulus program to shore up the flagging US economy. Bernanke’s comments on Friday more or less confirmed the inevitability of such a move, and yet the US dollar index despite making new 8 month lows actually finished the day higher than when it started, which perfectly illustrates the dichotomy that can exist in currency markets between expectation and reality.
The fact is the Fed chairman’s comments about the difficulties in determining the pace, size and costs of any purchases are weighing on the FOMC committee with respect to how aggressive they should be at their November meeting. This has given the markets pause for thought and may give the US dollar some respite. Bernanke’s views on the prospects of the US economy are likely to be further analysed when he gives another speech on Tuesday night.

►Gold Declines for Second Day as Dollar’s Increase Curbs Investment Demand
Nicholas Larkin and Wendy Pugh/Bloomberg/Oct 18
Gold declined for a second day in London as a stronger dollar curbed demand for the precious metal as an alternative investment…
“The dollar looks set to provide further direction in the coming sessions as players speculate over the Fed’s quantitative easing measures,” said James Moore, an analyst at TheBullionDesk.com in London. Precious metals “would benefit from a period of consolidation, however gold should remain underpinned by dip-buying interest from the physical and investment sector.”
►When the weak are strong
Scott Sumner/The Money Illusion/Oct 17
How can we explain these perverse cases—weak economies and strong currencies? Perhaps the usual direction of causation was reversed. Perhaps the strong currency caused the weak economy, by causing deflation. Indeed, it’s now almost conventional wisdom that money was too tight in the US during 1929-33…
So it seems to me that the profession does have an answer to the mystery of strong currencies in weak economies. When this phenomenon occurs, the strong currency is itself the cause of the problem. It seems that deflation can severely damage a formerly quite productive economic machine…
Didn’t the US economy go down the toilet between July and November 2008? And didn’t the dollar not collapse, but rather soar in value against the euro during that 4 month period? So why do almost no economists consider tight money to have been the problem during that period? Why isn’t that like the US in the early 1930s, Argentina in the early 2000s, and Japan in the 1990s?
►China Uneasy with Quantitative Easing Prospect
Andrew Batson/WSJ Real Time Economics/Oct 18
Chinese commentators are starting to show unease at the increasingly likely prospect that the U.S. Federal Reserve will relaunch a program of buying bonds to push down interest rates. And no wonder: Even before it has actually started, such so-called quantitative easing is complicating the nation’s continued effort to manage its currency.
►Monetary Policy in a Low-Inflation Environment: Developing a State-Contingent Price-Level Target
Charles Evans/Chicago Fed/Oct 16
In my opinion, much more policy accommodation is appropriate today. In a speech two weeks ago,[2] I stated that I believe the U.S. economy is best described as being in a bona fide liquidity trap. This belief is not a new development for me; instead, it is a dawning realization. Risk-free short-term interest rates are essentially zero. Both households and businesses have an excess of savings relative to the new investment demands for these funds. With nominal interest rates at zero, market clearing at lower real interest rates is stymied.
In this setting, even a moderate expansion without a double dip will not lead to appropriate labor market improvement.[3] Accordingly, highly plausible projections are 1 percent for core Personal Consumption Expenditure Price Index (PCE) inflation at the end of 2012 and 8 percent for the unemployment rate. For me, the Fed’s dual mandate misses are too large to shrug off, and there is currently no policy conflict between improving employment and inflation outcomes. The economic theories that central bankers rely on for evaluating appropriate monetary policy suggest to me that we need lower short-term real interest rates than the current real federal funds rate of –1 percent. Indeed, if the federal funds rate were positive, I would advocate substantial nominal reductions. But we are effectively at zero…
If the Federal Reserve decided to increase the degree of policy accommodation today, two avenues could be: 1) additional large-scale asset purchases, and 2) a communication that policy rates will remain at zero for longer than “an extended period.”
A third and complementary policy tool would be to announce that, given the current liquidity trap conditions, monetary policy would seek to target a path for the price level. Simply stated, a price-level target is a path for the price level that the central bank should strive to hit within a reasonable period of time.
►Why Worry About Low Inflation?
Daniel Indiviglio/The Atlantic/Oct 16
On Friday, Federal Reserve Chairman Ben Bernanke all but promised that another round of monetary expansion is imminent. He emphasized that to take such a drastic measure, both aspects of the Fed’s mandate would have to be invoked. Obviously unemployment is too high, and lately inflation has also been lower than U.S. central bankers would prefer. It’s easy to understand why high unemployment is awful, but what’s so bad about low inflation?
In fact, a 1% inflation rate isn’t necessarily worse than a 2% inflation rate — it’s more about expectations. Since the market understands that the Fed targets an inflation rate of around 2%, when it sinks well below that, as it has recently, then the market may begin to change its expectation of the Fed’s ability and desire to hit that target. This risk becomes even greater when interest rates are already near zero, as the Fed would have to rely on alternative means to raise prices. So the market’s expectation could potentially lead to deflation — particularly in a time when the economy is very slow and firms might already be cutting prices to conjure up more consumer demand.
So the problem is more one of instability. The fear is that deflation could eventually result if inflation is allowed to decline below its target. Deflation is a particularly dangerous problem, because central banks don’t have strong tools to fight a deflationary spiral.