Posted on Tuesday, November 2, 2010
WASHINGTON — The Federal Reserve is all but certain to move to spur the nation’s sputtering recovery this Wednesday, but most economists say it is unlikely to have a big impact on employment and growth.
Overruling objections from a handful of inflation-fearing dissidents, the Fed’s policy-setting committee, which begins a two-day meeting on Tuesday, is expected to resume quantitative easing, a strategy of buying Treasury securities to put downward pressure on long-term interest rates. The hope is that new action by the Fed will make a deflationary spiral of falling prices less likely, and make it somewhat easier for consumers and businesses to borrow and spend.
In theory, the Fed could print trillions of dollars to achieve its aim, but it is far more likely to start with a smaller amount — perhaps a few hundred billion — and gradually buy more bonds as conditions warrant.
That open-ended, conditional approach would be a departure from the Fed’s first, $1.7 trillion round of debt purchases, which lasted about 15 months and ended in March.
The Fed’s chairman, Ben S. Bernanke, seems to be under no illusion about the potency of the new purchases, having declared in August that “central bankers alone cannot solve the world’s economic problems.”
With inflation well below the Fed’s unofficial target of 2 percent, unemployment stuck at nearly 10 percent, and gross domestic product growing at a lethargic rate, Mr. Bernanke has evidently concluded that doing nothing is not an option.
Mr. Bernanke has long argued that a central bank, having lowered short-term rates to zero, as the Fed did in December 2008, still has tools to prevent an economy from slipping into deflation; he is now following that advice.
But economists seem to be in broad agreement that no matter the magnitude of the Fed’s actions this week, the economy will remain challenged for some time.
“There is a substantial chance that the U.S. economy is headed into a lost decade, similar to what Japan has experienced in the past 15 years, possibly with zero inflation instead of actual deflation,” said Robert J. Gordon, of Northwestern University, who serves on the committee that determines the start and end dates of recessions.
“But the consequences for the U.S. population will be much more severe than in Japan,” he added, “because of our higher unemployment rate, our lack of a social safety net, our system that ties medical insurance to employment instead of making it a right of citizenship, our greater inequality and our higher level of poverty.”
Guillermo A. Calvo, of the School of International and Public Affairs at Columbia University, gave a similar assessment.
“The central problem in the U.S. is the breakdown of the credit channel, especially credit for small firms and for working capital,” he said. “Buying long-term Treasury bonds amounts to directing credit toward a sector that has no need for it.”
The Fed’s actions, Mr. Calvo said, will mostly be felt abroad. Quantitative easing is likely to push down the value of the dollar and send even more money flowing into the faster-growing economies of Asia and Latin America, where interest rates are higher and inflation is a greater worry than in the sluggish economies of North America and Western Europe.
Mr. Calvo said the result could be heightened tensions over currency and trade and pressure on emerging-market countries to curb the flow of capital into their economies.
The Fed has clearly taken steps to address both sources of anxiety, domestic and foreign, and to fully prepare the markets for its next move.
On Aug. 10, the Fed took a baby step toward additional monetary expansion, deciding to use proceeds from its portfolio of mortgage-backed securities to buy two- to 10-year Treasury securities. In an Aug. 27 speech in Jackson Hole, Wyo., Mr. Bernanke emphasized the need to analyze both the costs and the benefits of action, but made it clear he was prepared to move if needed.
At the Fed’s most recent policy meeting, on Sept. 21, the committee said it was “prepared to provide additional accommodation if needed,” and in a speech in Boston on Oct. 15, Mr. Bernanke said “there would appear — all else being equal — to be a case for further action.”
The actions have already had an effect. Since Aug. 10, long-term interest rates have fallen, stock prices have risen and expectations of inflation have crept upward.
At a closed-door gathering of central bankers from the Group of 20 economic powers in Gyeongju, South Korea, on Oct. 22 and 23, Mr. Bernanke tried to reassure his peers, some of whom expressed alarm about the effect of Fed action on the dollar.
In response, Mr. Bernanke cited the imperative of supporting domestic growth and the role American consumer demand plays in sustaining the worldwide recovery, according to people who attended the meeting.
What the chairman has not managed — or necessarily tried — to do, however, is to quell the dissenting voices within the Fed who say additional action is a grave mistake.
The most prominent dissenter, Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City, has argued that new quantitative easing could lead to imbalances and volatility, undermine the Fed’s independence and unmoor inflation expectations. In his most pointed language to date, he recently called the plan a “dangerous gamble” and a “bargain with the devil.”
Other regional Fed presidents — Charles I. Plosser of Philadelphia, Richard W. Fisher of Dallas and Jeffrey M. Lacker of Richmond — also oppose additional bond purchases. But there is substantial support for more monetary stimulus from William C. Dudley of New York, Eric S. Rosengren of Boston, Charles L. Evans of Chicago and, recently, Dennis P. Lockhart of Atlanta.
Speculation about “hawks” (whose priority is fighting inflation) and “doves” (who put relatively greater emphasis on reducing unemployment) is a well-established game among Fed watchers.
But it is Mr. Bernanke’s opinion that ultimately matters. He has studiously avoided wading into fiscal controversies, but it seems clear that the gridlock over taxes and spending, and the virulence of the rhetoric going into the Tuesday elections, has deprived the central bank of the support fiscal policy can play in bolstering the recovery.
“Fiscal measures would accomplish something; they directly support spending and therefore G.D.P.,” said James K. Galbraith, an economist at the Lyndon B. Johnson School of Public Affairs at the University of Texas, Austin. “Quantitative easing will accomplish nothing beyond flooding the banks with cash which they will use, if at all, for speculating rather than lending.”
But Scott E. Pardee, an economist at Middlebury College, said Mr. Bernanke was correct to do all he could. “As long as unemployment is so high, and the housing market is not standing on its own two feet yet, the Fed has no other choice,” he said. By SEWELL CHAN Huffington Post