This Week June 22-26

Fed Faces A Tough Balancing Act

Monday, June 22, 2009

What now, Mr. Bernanke?

The Federal Reserve's policymaking committee meets tomorrow and Wednesday and will grapple with a somewhat different situation than it faced at its last meeting, at the end of April. Since then, the financial system has continued to repair itself, and the economy, while very weak, continues to show signs of bottoming out later this year.

What has changed most since then is a steep rise in long-term interest rates, which is pushing up long-term borrowing rates, especially for mortgages. That could stand in the way of a nascent stabilization in the housing market.

It also creates a conundrum for Fed Chairman Ben S. Bernanke and his colleagues. They still view the economy to be in perilous shape and are inclined to do whatever they can to support it. That would suggest that they should expand their purchases of Treasury bonds and mortgage-backed securities to try to push long-term rates back down.

But not so fast. For one thing, Fed leaders view much of the rise in rates as reflecting the return of financial conditions to a more normal place. So that's a healthy thing -- and if the rise really does choke off growth excessively, rates will come back down in a self-regulating fashion.

More worrisome, part of the rise in rates may be caused by fears that the Fed will allow inflation to get out of control down the road and that it will print money to finance government deficits. To the degree that those fears are out there, expansion of the Fed programs could be counterproductive, sending rates up rather than down.

So, in the view of most Fed watchers, we're unlikely to see any major new action to bolster the economy out of the Fed's meeting, results of which will be released Wednesday.

Meanwhile, some major data are coming out this week -- figures for May durable-goods orders on Wednesday, May personal income and consumption on Friday, and the final revision of first-quarter gross domestic product data on Thursday.

-- Neil Irwin

NEIL IRWIN'S MUST-READS: In a piece for economist.com, White House economic adviser Christina Romer argues against a 1937-style economic complacency and explores whether the Federal Reserve should be a systemic risk regulator.

Tyler Cowen has some smart thoughts on the challenges and pitfalls of giving the Fed formal authority to fight risks to the financial system in a posting on MarginalRevolution.com.


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