Forecast for Fed: No change
By Neil Irwin,
Next week, leaders of the Federal Reserve will spend two days behind closed doors discussing the economy, to be capped off with Chairman Ben S. Bernanke’s first quarterly news conference.
The likely result of all that talking: nothing.
The controversial program of buying $600 billion of Treasury bonds announced in November is all but certain to end in June, as was the original schedule, and no new such program is in the works. The Fed is committed to keeping its interest rate target near zero, where it has been for more than two years. Unlike the European Central Bank, the Fed sees little need to raise rates to try to combat rising food and energy prices.
In other words, Fed leaders don’t plan to make monetary policy either looser or tighter any time soon, but rather are expecting to keep the current strategy of easy money — near-zero interest rates and vast sums of bonds held on its books — in place.
The recent rises in energy prices, Fed Vice Chairman Janet Yellen said in a speech last week, seems “unlikely to have persistent effects on consumer inflation or to derail the economic recovery and hence do not, in my view, warrant any substantial shift in the stance of monetary policy.”
The stuck-in-neutral policy stance comes as the economic picture in the United States has become more mixed. The year began with high expectations for growth; many private forecasters upgraded their projections for the year, as did Fed leaders. In January top Fed officials projected that the economy would grow 3.4 to 3.9 percent in 2011.
But since then, there have been a series of economic disappointments, including higher oil prices, bad January weather and weak trade data. Private forecasters now say the economy grew at a weak 1.5 percent or so rate in the first quarter and have marked down their expectations for growth over the course of the year, and the Fed will likely do the same in new projections to be released next week.
The Fed’s approach has its critics. Internally, several Fed officials have argued that interest rates should rise sooner rather than later, lest inflation take off and financial bubbles develop. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, said last week that the Fed’s target interest rate should be raised to 1 percent.
And some other economists, including Nobel laureate and columnist Paul Krugman, have argued for the Fed to undertake even more aggressive expansion of the money supply to try to drive down unemployment.
Fed officials view the poor first-quarter economic performance as more an anomaly than a trend, and see the economic expansion as being well-entrenched, even if it’s not particularly strong.
“We must not be overly optimistic about the growth outlook,” William C. Dudley, president of the Federal Reserve Bank of New York, said in a recent speech. “The coast is not completely clear — the healing process in the aftermath of the crisis takes time and there are still several areas of vulnerability and weakness.”
And they view the current situation as fundamentally different from what they faced last summer, when they began making plans to buy $600 billion in bonds to try to prop up growth. That effort was often called QE2, because it was the second time the Fed used a strategy called “quantitative easing” to boost growth.
At the time, inflation was low and seemed to be heading lower, prompting fears that deflation, or a dangerous cycle of falling prices, could set in. And job growth was too weak to drive the unemployment rate down over time in any substantial way.
Although unemployment is high at 8.9 percent, Fed officials don’t see any such clear signals that new action such as another round of large-scale bond purchases would make sense. Inflation has been rising due to higher commodity prices, and there is little apparent risk of deflation. And the job market is steadily improving, adding about 200,000 jobs each of the last two months.
Moreover, many Fed officials say that the unorthodox strategy of quantitative easing has less marginal benefit the more it was undertaken. In other words, if they bought an additional $600 billion in bonds, it would help economic growth less than it did the last tranche.
Finally, the intense political blowback the Fed received to its earlier asset purchases may make some Fed officials wary about doing more.
“They won't mention it publicly, but the political backlash they received in November doesn’t make QE3 any more likely,” said Michael Feroli, chief U.S. economist at J.P. Morgan Chase.