Federal Reserve's, Bernanke's credibility on line with new move to boost economy

Oct. 28 (Bloomberg) -- Rick Bensignor, chief market strategist at Execution Noble Ltd., talks about the possible impact of another round of Federal Reserve quantitative easing on the U.S. economy. Bensignor also discusses the outlook for U.S. stocks and offers his advice for investors. He talks with Pimm Fox on Bloomberg Television's "Taking Stock." (Source: Bloomberg)
By Neil Irwin
Washington Post Staff Writer
Monday, November 1, 2010; 12:48 AM

The Federal Reserve is preparing to put its credibility on the line as it rarely has before by taking dramatic new action this week to try jolting the economy out of its slumber.

If the efforts succeed, they could finally help bring down the stubbornly high jobless rate.

But should the Fed overshoot in its plan to pump hundreds of billions of dollars into the economy, it could produce the same kind of bubbles in the housing and stock markets that caused the slowdown. Or the efforts could fall short and fail to energize the economy, leaving a clear impression that the mighty Fed is out of bullets - thus adding even more anxiety to an already dire situation.

The meeting of Fed policymakers Tuesday and Wednesday is set to be a defining moment of Ben S. Bernanke''s second term as chairman of the central bank. Although he helped win the war against the great financial panic of 2008 and 2009, he now risks losing the peace if he fails to end the protracted economic downturn that followed.

Just two years after the world financial system nearly collapsed, it is again gut-check time for Bernanke.

"The greatest risk for the Fed in taking this action is that it could extend the economy's funk by giving a sense that either no one is in charge or that the people who are in charge can't get it right," said David Shulman, senior economist at the UCLA Anderson Forecast. "The whole psychology of that could leak back into the economy."

Jobs and prices

The Fed is charged by Congress with a twin mandate of maintaining maximum employment and stable prices, and it is failing on both counts.

The economy isn't in free fall. But as new data on gross domestic product affirmed Friday, the economy is mired in mediocre growth, too slow to bring down the unemployment rate. Inflation, meanwhile, is running about 1 percent, below the rate Fed officials view as optimal. When inflation is a little higher, it encourages consumers and businesses to spend money before it loses value.

"Viewed through the lens of the Federal Reserve's dual mandate," William C. Dudley, the New York Fed president, said in a speech early last month, ". . . the current situation is wholly unsatisfactory."

When Bernanke was confirmed earlier this year for a second four-year term, the widespread assumption was that his major task would be to decide when and how to move away from the unconventional measures taken during the crisis to boost growth.

In reducing its target for short-term interest rates to zero, the Fed had exhausted its normal tool for managing the economy. So the central bank pumped money into the economy by buying vast quantities of bonds - more than $1.7 trillion worth.

Now the Bernanke Fed is poised, if not to double down on that earlier bet, at least to up its wager.

CONTINUED     1        >

© 2010 The Washington Post Company