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Backlash to bond-buying plan hampers Fed

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Nov. 15 (Bloomberg) -- Charles Calomiris, a professor at Columbia Business School, discusses his decision to sign an open letter to Federal Reserve Chairman Ben S. Bernanke criticizing the central bank's expansion of monetary stimulus. Calomiris speaks with Betty Liu on Bloomberg Television's "In the Loop." (Source: Bloomberg)

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By Neil Irwin
Washington Post Staff Writer
Monday, November 15, 2010; 7:39 PM

The political maelstrom that erupted after the Federal Reserve's decision two weeks ago to take expansive action to boost the economy has reduced the central bank's maneuvering room as it considers how to get growth on track.

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The intensity of the criticism of their plan to pump $600 billion into the ailing U.S. economy has come as a surprise to Fed officials, even though they discussed many of the risks that critics have raised.

Fed officials, who prize their independence, are wary of finding themselves at the center of a partisan fight. Republicans are attacking the central bank's bond-buying plan, while President Obama and key Democrats are defending the steps as helpful for creating jobs.

This week, a group of conservative economists began a campaign attacking the move as tempting inflation and the debasement of the dollar. Last week, there was a round of sharp criticism from foreign leaders, who described the action as a form of currency manipulation because it could lead to a weaker dollar.

These attacks may not be enough to get the Fed to reconsider its plans in the near term but strengthen the arguments of Fed officials who have argued that the costs of the bond-buying plan outweigh the benefits. As a result, it's now less likely that the Fed will further expand the program, as it had seemed in the immediate aftermath of the move.

The backlash may already be making the Fed's program less effective. For example, the policy is meant to drive long-term interest rates down, yet 10-year Treasury yields are actually up by nearly 0.4 percentage points since the Fed's announcement, including a dramatic spike Monday to 2.95 percent. The rise appears to reflect, at least in part, investors' perceptions that the sharp criticism has made it less likely that the Fed will extend its program of buying Treasury bonds to boost the economy.

Fed Chairman Ben S. Bernanke is also finding himself with less latitude. Although Bernanke as a practice tries not to make detailed pronouncements about fiscal policy, he has called for near-term tax cuts or spending increases to boost growth in the short run, coupled with policies to bring the budget deficit down over the next several years.

Recently, Bernanke has been weighing whether to make that case more forcefully and publicly, bearing in mind that this effort could be seen as politicizing the Fed. The criticism of the Fed's measures make it even riskier for him to become more assertive in pushing his preferred fiscal policy.

While Fed officials view their independence from politics as crucial, the central bank has often faced vociferous criticism and found itself caught in the political fray. Last year, Bernanke was pilloried for the Fed's role in bailing out banks and failing to prevent the financial crisis. And many past Fed chairmen have been roundly criticized for keeping interest rates too high, contributing to unemployment.

But Bernanke is facing a very different critique than his predecessors: that he is doing too much to try to strengthen the job market, and that the unconventional steps he has taken could cause inflation or a much weaker dollar in the longer run. One leading Republican on Monday even suggested eliminating the Fed's legal mandate to worry about both employment and inflation.

"I think we ought to get the Fed back in the business of focusing on price stability and preventing inflation, and not also on this dual mandate of full employment for the country," Rep. Mike Pence (R-Ind.), said in an interview on CNBC.

The risk of the Fed again finding itself at the center of a political maw underscores some of the concerns raised by officials within the central bank at the policy meeting two weeks ago. The arguments offered by Kansas City Fed President Thomas Hoenig, along with the Richmond Fed President Jeffrey Lacker, Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher, are bolstered by the recent events.

They have worried in part that purchasing Treasury bonds could lead to investor perceptions that the central bank will "monetize the debt," or fund large U.S. budget deficits.

"The blow back strengthens the internal hawks' arguments," said Diane Swonk, chief economist at Mesirow Financial.

There are a wide range of views among Fed policymakers as to what would justify an extension of the $600 billion bond purchase program beyond its expiration in June. If unemployment remains high and inflation remains very low, several Fed leaders are likely to be inclined to expand the purchases, though they may have a harder time carrying the day after the events of the last two weeks.

"It now looks like it's going to be hard for the Fed to do another round of aggressive policy because they know the criticism is going to undercut some of the confidence-building impacts," said Ethan Harris, chief economist of Bank of America-Merrill Lynch.


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