New Federal Reserve governor Jeremy Stein on Thursday entered the debate over the central bank’s recent actions to lift economic growth with a forceful defense of the decision to inject hundreds of billions of dollars into the economy.
In his first public remarks since joining the Fed in May, Stein, a 51-year-old Harvard economics professor, said he firmly supported the Fed’s announcement last month that it will buy $143 billion of mortgage bonds through the end of the year in an effort to reduce already record-low interest rates. He also supported the Fed’s decision to declare that it would continue to try to lift economic growth for as long as necessary to meaningfully reduce unemployment.
Bond purchases, known as quantitative easing, “have played a significant role in supporting economic activity,” Stein said in remarks at the Brookings Institution. Research, he said, shows that past asset purchases have brought down interest rates by up to 1.2 percentage points, leading to a drop in unemployment.
At the same time, Stein acknowledged the growing limitations on how much more the Fed can help the economy simply through bond purchases. “We could in principle push this tool to the point that the hurdle for additional usage would become very high,” he said.
The Fed has bought more than $1 trillion in bonds since 2008 with the goal of reducing interest rates on a wide range of assets, such as corporate bonds. It has also kept the nation’s benchmark interest rate near zero.
When interest rates are low, companies are more likely to borrow money to expand their businesses by investing in capital or hiring more workers. The basic problem in a weak economy, as Stein described, is that companies may simply see lower interest rates as an opportunity to refinance their existing debt rather than borrow more to expand.
“One might expect future rounds of [asset purchases] to have diminishing returns,” Stein said. “Issuance of both investment-grade and high-yield bonds have been robust. ... A large fraction of issuance has been devoted to refinancing.”
On the other hand, Stein said, the Fed has addressed that concern by telling the public that it will continue to support the economy by holding interest rates low even as the recovery strengthens. That pledge, Fed officials believe, should encourage businesses to go ahead and take advantage of low interest rates not just to refinance but also to spend and hire, because the Fed will be keeping interest rates low for years to come.
As a result, asset purchases may become even more powerful, he said.
Another worry, Stein said, is that by buying up more and more Treasury bonds, the Fed could make it harder for others in the market to have access to a safe asset at a time of global anxiety. “In a world where other sovereign debt has come into question, long-term Treasury securities are uniquely able to provide a money-like safe haven service,” he said. However, he added, “the costs of further [asset purchases] on this dimension are likely to be modest.”
Mortgage bonds are not considered safe haven assets and therefore aren’t drawing the influx of cash that investors have been pouring into Treasurys. So, the Fed’s mortgage bond purchases could more directly affect mortgage rates, helping to strengthen a critical area of the economy, Stein said.
“It is natural to focus on a sector that is more sensitive to financing costs. The housing market would seem to fit this bill,” he said.
In a question-and-answer question, Stein took issue with a number of prominent economists who have argued that the Fed should take measures to push the inflation rate significantly higher to heat up the economy.
He countered that it would be a mistake for the Fed to untether inflation expectations, after spending so many years proving that the central bank can keep prices stable. In addition, he said, he doesn’t “accept the proposition that actively seeking inflation would be effective,” since it might discourage investment and spending.