|Page 2 of 2 <|
Federal Reserve's, Bernanke's credibility on line with new move to boost economy
"Phase one was to avoid a complete market meltdown and something akin to the Great Depression," said Mark Gertler, a New York University economist who has collaborated with Bernanke on academic research. "Phase two begins now and is in some ways trickier. . . . Once again we're in a situation where we have to use policies we haven't really experimented with."
The Fed is seeking to avoid the fate of Japan, where falling prices and weak economic growth over the past two decades have created a self-reinforcing economic stagnation. The hope is that by moving aggressively, such a cycle can be averted.
Fed watchers expect that the two days of meetings around a giant mahogany table will culminate this week in the announcement of around $500 billion in Treasury bond purchases and perhaps a statement indicating a willingness to make even more.
The intended benefits are already being felt. In anticipation of the Fed's action, investors have driven down mortgage rates, creating an extra incentive for people to buy a home. Expectations have also driven the stock market up, making Americans feel wealthier. And the dollar has fallen in value, making U.S. exporters more competitive, as currency investors reacted to an expected decline in U.S. interest rates.
But there's a danger that the bond purchases could work too well. For example, while a modest decline in the dollar could be good for the economy, a steep and disorderly drop could be disastrous.
And while Fed leaders want the inflation rate to be higher than it is now, if prices were to accelerate rapidly, that would be unwelcome.
There's also a risk that investors could view the Fed's program of buying Treasury bonds as a signal that the central bank essentially plans to fund U.S. budget deficits indefinitely by printing money. That could prompt interest rates to rise, stymieing the economic recovery.
Thomas M. Hoenig, president of the Kansas City Fed, appears likely to dissent from the Fed's decision this week. He said in October that such measures "could be a very dangerous gamble," given the risk of stoking asset bubbles, for instance in the stock market.
If, on the other hand, the efforts to jump-start growth fall flat, the Fed would be confronted with an even knottier quandary: take even bolder steps, such as a trillion-dollar round of bond purchases, or admit that these kinds of measures won't work and stand pat.
Ultimately, the question of whether the Fed can invigorate the economy depends on whether companies, individuals and even the government respond to lower interest rates by spending and investing.
Rates have been at exceptionally low levels for more than a year and corporate America is in sound shape financially, yet companies are holding back on hiring more employees and making new investments. Executives say they lack confidence that consumers will boost demand for products, because Americans are busy paying down debts.
Some economists argue that the volume of bond purchases needed to jar the economy into motion again is vastly larger than what the Fed has seriously considered. Larry Meyer, a former Fed governor now with Macroeconomic Advisers, estimated last week that it would take more than $5 trillion worth, 10 times what analysts are expecting. Fed leaders deem such gargantuan numbers too risky.
Either way, if the Fed overshoots or falls short, it could undermine the faith of the public and the financial markets in the ability of the government to address prolonged high unemployment and the risk of falling prices.
At a time when investors are already skittish about gridlock in Washington, such doubts could spook financial markets, creating a self-reinforcing downward cycle in the economy. (By contrast, the U.S. economy flourished from the mid-1980s until 2008 in part because investors and businesses were confident that the Fed would keep the nation on a steady growth path.)
A failed effort by the Fed could also prompt renewed calls to limit its authority and independence at a moment when popular discontent over its role in bailing out the financial system has already made the central bank a target for many in Congress.
But some partisans of the Fed are urging it take dramatic new steps even if there's a chance they don't work.
"I think the public understands that if unemployment remains high, monetary policy isn't going to be the reason," said Victor Li, a Villanova professor and former Fed economist. "No one is going to say the Fed isn't doing everything it can.