Fed policy foggy as the economic picture clouds

Chairman Ben Bernanke faces pressure to make the Fed's message more lucid.
Chairman Ben Bernanke faces pressure to make the Fed's message more lucid. (Joshua Roberts)
By Neil Irwin
Washington Post Staff Writer
Thursday, August 26, 2010

With the housing market retreating, unemployment lingering and top officials at the Federal Reserve in open disagreement over what to do, Fed Chairman Ben S. Bernanke is under rising pressure to offer solutions in an address Friday that is likely to be his most important since the end of the financial crisis.

The central bank's policy intentions have been unusually muddled in the past two months, according to a widespread view among economists and people in the financial world. They say it is unclear how likely it is that the Fed will undertake major new efforts to try to support the economy, what economic conditions would trigger such actions and what form those actions would take.

Meanwhile, evidence mounts that the economic recovery is coming unglued. On Wednesday, the Commerce Department reported that sales of new homes in July hit an all-time low. Orders for durable goods, the kind of big-ticket spending that had been fueling economic growth, rose a bare fraction of what experts had predicted.

With statistics due out Friday that are expected to show the economy grew much less than estimated in the second quarter of the year, Fed-watchers are hoping Bernanke's comments later that day in Jackson Hole, Wyo., will instill confidence that he has a plan and can act decisively if the economy continues to deteriorate. They warn that recent conflicting signals from Fed insiders may even be contributing to economic weakness by spooking financial markets.

Some of the most vocal Fed policymakers have expressed diametrically opposite views on the economic outlook and their preferred course for policy, and Bernanke and his closest collaborators have been quiet in recent weeks.

"The chatter you're getting around policy right now is such a cacophony," said Ethan Harris, head of North American economics research at Bank of America-Merrill Lynch. "There's just a bunch of wildly different views being presented from both inside and outside of the Fed, and that is confusing markets."

The sense of confusion reflects the downside of Bernanke's leadership style. Bernanke is comfortable with other policymakers openly disagreeing with him and has led a more collaborative, consensus-driven Fed than his predecessor, Alan Greenspan. That approach paid dividends during the financial crisis.

Bernanke guided a complicated policy apparatus - which when fully staffed includes seven Washington-based governors and the presidents of 12 regional Fed banks across the country - to take aggressive, unconventional steps to combat the recession.

Policymakers with disparate views felt that their opinions were given serious consideration and thus were willing to follow the leader on unconventional policies, even when they had reservations.

But now, facing not an imminent financial collapse but a slow-moving problem of economic growth that is too slow to bring down joblessness, the costs of that management style are on display. In the past month, for example, Federal Reserve Bank of St. Louis President James Bullard published a paper asserting that the U.S. economy is at risk of a protracted period of falling prices and economic weakness known as deflation. The central bank should consider pumping hundreds of billions of dollars into the economy to preempt that risk, he argued. Bullard also appeared on CNBC to discuss that view at length.

Kansas City Fed President Thomas Hoenig has given speeches and interviews arguing the opposite problem. He sees the recovery as solid and has argued that the Fed's interest rate target should be increased so as to avoid stoking asset bubbles or inflation.

Neither man's arguments are within the mainstream of opinion on the Fed policy committee, where the majority view holds continued expansion as likely, deflation unlikely and rock-bottom interest rates to be justified for quite a while to come. But they and a handful of others, including Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher, have been more visible publicly than those who are closer to the center.

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