Facing fire from the left and the right, Federal Reserve Chairman Ben S. Bernanke on Wednesday mounted a spirited defense of the central bank’s wait-and-see approach to the economy, arguing that his detractors fail to grasp the damage that could be done if the Fed were to prematurely take any new actions.
After its third policymaking meeting of the year, the Fed left short-term interest rates near zero on Wednesday and said it planned to hold them there until at least late 2014. As it has all year, the Fed continued to say that the economy faced headwinds but would gradually improve. Economic projections from senior Fed officials suggested the economy would grow a bit faster than anticipated early this year and the unemployment rate would come down a bit more than earlier thought, perhaps ending the year around 8 percent.
But the Fed did not take any new actions — as it declined to do last month as well — and that has drawn stinging criticism from prominent commentators on the left and right. In a magazine article this week, Paul Krugman, Bernanke’s former Princeton colleague, attacked the Fed chairman for not doing “remotely enough” to help the jobless. In a magazine column, Sheila Bair, the former Federal Deposit Insurance Corp. chairman, chided him for keeping rates too low for too long, fostering a dangerous bubble in the bond markets.
Bernanke seemed to take most umbrage at Krugman’s critique, in the New York Times Magazine, which suggests that the Fed has refused to take action to help the out-the-work because it worries too much that such efforts can cause inflation. Economic theory holds that creating money to spur lending and drive economic growth — what the Fed does — tends to cause prices and wages to rise, but the Fed expects that inflation will come in at or below its target of 2 percent for the next few years.
“The question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate?” Bernanke said. “That would be very reckless.”
Bernanke said the Fed has spent three decades “building up credibility for low and stable inflation, which has proved extremely valuable” in taking actions to help the economy. He added: “To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.”
But while he defended the Fed’s decisions not to take new action, Bernanke also rejected calls for the Fed to withdraw support. In addition to keeping interest rates low, the Fed holds trillions of dollars in mortgages and Treasury bonds. These measures have pushed up the prices of bonds but kept interest rates on all sorts of loans low.
Writing in Fortune magazine, Bair urged that “the Fed should declare victory and not intervene if the market wants to push rates up a bit. Start deflating the bubble before it pops.” If the bond market were to pop, interest rates would spike rapidly.
“I think it’s a little premature to declare victory. I think that keeping interest rates low is still appropriate for our economy,” Bernanke responded Wednesday. Later, he said, “Here we are almost three years from the beginning of the expansion, and the unemployment rate is still over 8 percent.”
Earlier this year, Bernanke suggested that the Fed may take new actions to bring down unemployment if the recovery appeared weak. Since then, though, economic data have come in surprisingly strong, and Fed officials have revised their economic projections for 2012.
Fed officials said they expected the economy to grow by as much as 2.9 percent his year, compared to a maximum of 2.7 percent growth that was projected in January. They also projected that the unemployment rate would end the year between 7.8 and 8 percent, compared with an 8.2 to 8.5 percent projection released in January.
But while the Fed had a sunnier short-term outlook for the economy, the central bank also predicted that prices would rise faster than expected. Officials said the inflation rate this year was likely to be between 1.8 and 2 percent, compared with a January projection of 1.4 to 1.8 percent. Much of the increase was driven by rising oil and gas prices, an effect the Fed said would probably be temporary.
But it was clear that given the rosier projection for the economy and higher expectations for near-term inflation, the Fed was in no mood to take more steps to stimulate the economy. Indeed, some economists have expressed concern the Fed might decide to raise interest rates sooner than anticipated. While Bernanke made no such suggestion of that Wednesday, 13 of 17 Fed officials now favor raising rates in 2014 or sooner, while only 11 did in January.
The Fed slightly reduced its expectations for economic growth — to between 2.7 and 3.1 percent in 2013 and between 3.1 and 3.6 percent in 2014. But it also slightly reduced its projections for unemployment — to between 7.3 and 7.7 percent in 2013 and between 6.7 and 7.4 percent in 2014.
Should the economy suddenly deteriorate, Bernanke said the Fed is “entirely prepared to take” new steps to boost jobs.