Stocks soar after Federal Reserve's move to bolster U.S. economy

Nov. 4 (Bloomberg) -- Richard Clarida, global strategic adviser at Pacific Investment Management Co., talks about the performance of the Federal Reserve and the outlook for more quantitative easing measures. Clarida, speaking with Scarlet Fu on Bloomberg Television's "InBusiness," also discusses investment strategy and the global economy. (Source: Bloomberg)
Washington Post Staff Writers
Friday, November 5, 2010; 12:37 AM

The Federal Reserve's aggressive action this week to boost the economy sent stocks soaring Thursday to their highest level in two years as investors expressed renewed confidence that someone in Washington was finally giving the sluggish recovery a lift.

The Dow Jones industrial average was up nearly 2 percent, erasing the last of the breathtaking losses that followed the failure of the investment bank Lehman Brothers in September 2008 and the resulting panic over a possible collapse of the global financial system. Other major U.S. stock indexes were also up sharply.

The Fed's decision to pump $600 billion into the economy through a massive program of Treasury bond purchases was a dramatic move at a time when the White House and Congress have been unable to muster a coherent policy for fueling the recovery and reducing a stubbornly high jobless rate.

Although voters in national elections Tuesday told pollsters that the economy was their biggest worry, the outcome of those contests left Congress less likely to adopt temporary tax breaks or spending increases to energize economic growth. With Republicans taking control of the House and Democrats retaining a slim majority in the Senate, a legislative stalemate over fiscal policy looms.

Republican leaders object to a round of stimulus spending and instead have vowed to slash more than $100 billion a year from the federal budget. That leaves the Fed and its chairman, Ben S. Bernanke, on their own in trying to jolt the economy and possibly puts them at odds with Republicans who have already accused the central bank of overreaching.

The Fed's task, which it plans to pursue with bond purchases over the next eight months, already carries significant risks for the economy, including the possibility of significantly greater inflation. Bernanke's job could become even more difficult - and unemployment even more intractable - if Congress tightens the national purse strings while the economy is still weak.

The Fed's action in effect grants Congress carte blanche to cut taxes or raise spending significantly without worrying about the impact of higher budget deficits on the economy. Deficit spending requires the government to borrow heavily, which in turn puts pressure on a broad range of interest rates. The central bank's bond purchases are designed specifically to lower interest rates, giving lawmakers the leeway they would need for fiscal stimulus.

A hard line on spending

If the Fed is offering Congress a credit card, however, Congress appears to be turning it down.

On Thursday, Senate Minority Leader Mitch McConnell (R-Ky.) repeated his party's opposition to additional government spending aimed at creating jobs. "We will loudly oppose future stimulus bills that only stimulate the deficit," he said.

He expressed an openness to cooperating with the Obama administration on additional tax cuts for businesses. "If [President Obama] wants to address spending, debt and private-sector job creation, he'll find a willing partner in House and Senate Republicans," McConnell said.

But neither party has shown any interest in Obama's first foray down that path, a September proposal to make permanent an existing tax credit for domestic research and development and to allow businesses to deduct their expenses more quickly. Nor has there been support for an idea embraced by many economists to grant employers and employees a payroll tax holiday through a temporary elimination of Social Security and Medicare taxes.

If lawmakers don't reach agreement on tax cuts, Congress is more likely to make things worse than better. About $400 billion worth of tax breaks enacted during the George W. Bush administration and part of Obama's stimulus package are set to expire Dec. 31. And it is not clear whether lawmakers will extend emergency jobless benefits past a Nov. 30 expiration date.

Bernanke has been calling on others in the government, both publicly and privately, to share his urgent concern about the economy and stressed that action by the Fed is no cure-all.

"The Federal Reserve cannot solve all the economy's problems on its own," Bernanke said in an opinion article published in Thursday's Washington Post. "That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector."

Tough spot for Fed

If Congress remains on the sidelines, the Fed would be left in a precarious position. Acting alone, it could be showered with blame if the economic recovery continues to flag. "The Fed cannot do everything," said John Silvia, chief economist at Wells Fargo. "For the Fed to do enough to get the economy going completely on its own would require such aggressive intervention that it would cause a lot of distortions and risks."

The election Tuesday ushered into Congress dozens of tea party conservatives whose supporters are more inclined to overhaul or abolish the Fed than to applaud its works, according to polls of self-identified tea party voters.

Republican leadership aides in the House and Senate said they foresee no effort to challenge the Fed's decisions. But Rep. Tom Price (R-Ga.), chairman of the Republican Study Committee, issued a statement calling the Fed's actions "a fancy way of saying that the money in Americans' pockets is about to buy a lot fewer groceries, clothes, and gasoline." And tea party favorite Rand Paul, the Republican senator-elect from Kentucky who has blamed the Fed for the financial crisis, repeated his call for closer scrutiny of this "secretive organization."

"The Fed continues to not learn from its mistakes," Paul spokesman Jesse Benton said Thursday. "This situation also shows once again why we need a full audit of the Fed and the trillions of dollars they have put on their books or printed in the past few years."

Meanwhile, Rep. Ron Paul (R-Tex.), Rand Paul''s father and the incoming head of a House subcommittee on monetary policy, told Reuters on Thursday that the Fed is "way too independent" and "totally out of control." He condemned the Fed's program of bond purchases as "central economic planning at its worst."

While the economy was the dominant issue on voters' minds, with 62 percent calling it the country's most important issue, there was no clear message about what they wanted the government to do about it, according to an exit poll. About four in 10 voters said they wanted the next Congress to focus on slashing the budget deficit. A similar proportion said more spending to create jobs should be the top priority. Roughly four in 10 said they want to see the Bush-era tax cuts extended for all taxpayers, and four in 10 want them continued only for families with annual incomes under $250,000.

Even without any action by Congress, the Fed's strategy for pumping money through the economy, known as quantitative easing, can work. It is meant to lower long-term interest rates, which should give businesses greater incentive to invest and strengthen the housing market by lowering mortgage rates. But those effects rely on business people and potential home buyers responding to lower rates.

In other words, the Fed may be making $600 billion, but for it to have an effect, somebody has to spend it. If businesses, consumers and the government all refrain, the effects could be minimal.

Polling director Jon Cohen contributed to this report.

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