Federal Reserve renews program to spur growth amid concerns about economy
By Zachary A. Goldfarb and Peter Whoriskey,
The Federal Reserve said Wednesday that the economy was slowing significantly but took only modest action to stimulate growth, underscoring how little is being done across Washington to address the nation’s unemployment crisis.
In response to a spate of bad economic data, the Fed said it would renew a bond-buying program designed to spur economic activity by encouraging borrowing by consumers and businesses.
The Fed said it expects the economy to grow between 1.9 percent and 2.4 percent this year — a dramatic half-percentage-point downgrade from just two months ago — and projected that unemployment would probably remain at 8.2 percent for much of this year and perhaps still be as high as 8 percent at the end of 2013.
“We’ve taken a step today which is a substantive step,” Fed Chairman Ben S. Bernanke said. “Moreover, we have stated that we’re prepared to take further steps, if necessary, to promote sustainable growth and recovery in the labor market.”
But the Fed’s decision to extend the program known as “Operation Twist” for six months highlights how the central bank, the Obama administration and Congress are struggling to make a major dent in unemployment, three years after the economy officially started growing again.
The first round of the Fed program, which aimed to reduce interest rates on loans, is estimated by outside economists to have trimmed borrowing costs by only 15 or 20 cents for every $100 borrowed, a fairly modest impact. (That amounts to a yearly savings of $600 on a $300,000 mortgage.) The next round may have even less punch.
Likewise, other recent federal efforts to pump fuel into the economy have failed to have a major effect.
For instance, President Obama and Congress agreed in 2011 and 2012 to cuts in workers’ payroll taxes, giving people more money to spend. But a succession of unexpected developments has largely offset that stimulus. The list of setbacks includes the disruptive earthquake in Japan, spikes in gasoline and food prices, and a decline in foreign demand for U.S. goods and services as a result of the European financial crisis and a slowdown in emerging markets such as China and Brazil.
Obama, Congress and the Fed have also struggled to address the weakened housing market, which continues to weigh on the wider economy.
A key way that Fed policies work is by reducing interest rates on mortgages, which encourages people to buy new homes and frees up money for existing homeowners who refinance their homes at lower rates.
Yet this has not been happening as much as officials had hoped. In many cases, homeowners are underwater, meaning they owe more than their loans are worth, and are unable to refinance, while banks are reluctant to lend to new borrowers whose credit records have been hit hard in the past few years.
Meanwhile, Obama is touting a number of short-term measures to gin up growth — for example, additional tax cuts to spur business hiring and a plan to provide more funding to state and local governments. But Congress is unlikely to take up either. Republicans argue that cutting government spending and scaling back regulations is a better way to energize the economy.
Rather than helping the economy, U.S. policymakers have done quite a bit to hurt it. In particular, economists say a series of tax hikes and spending cuts scheduled to take place at year’s end is already causing anxiety at companies, slowing hiring and raising fears about another recession.
The Fed’s action was the minimum expected by investors in light of the threats facing the U.S. economy. As part of Operation Twist, the Fed will sell $267 billion worth of short-term Treasury bonds and buy longer-dated bonds.
By shifting purchases to longer-dated securities, the central bank is able to bring down stubborn long-term rates — for instance, those on corporate loans and mortgages — without printing more money. Printing money increases the chance of inflation, which invites political criticism.
“This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to [ease] broader financial conditions,” the Fed said.
But economists with varying ideologies said the economic impact of Operation Twist would be small.
“The Fed has really shot all of its big guns already,” said Stephen D. Oliner, a resident scholar at the American Enterprise Institute and a former associate director at the Fed. “The real problems in the economy are beyond the Fed’s control.”
Michael Mandel, chief economic strategist at the Progressive Policy Institute, said the impact would be minor. “What we have in the economy is real weakness on government and business investment,” he said, referring to public spending on infrastructure and education and the reluctance among corporations to bankroll hiring, equipment and plants. “What the Fed is doing is not going to have that much of an effect.”
Large companies are already “swimming in as much money as they need. They’re not making decisions based on a tenth of a percentage point,” he said. “Small business[es] are having trouble getting loans, no matter what the interest rate is.”
The Fed declined to take more aggressive efforts. One option would have been offering a firm commitment to keep interest rates ultra-low through 2014 or longer; the Fed says only that it expects to do so through 2014. A second initiative would have been printing hundreds of billions of dollars to purchase Treasury bonds and mortgage securities, increasing the amount of money invested by the Fed in the economy.
Republicans, including presumptive GOP presidential nominee Mitt Romney, have said that another round of asset purchases, known as “quantitative easing,” is unwarranted.
At its meeting Wednesday, the Fed also significantly reduced its estimate of economic growth, employment and inflation over the coming years, raising the odds of additional action to boost growth in coming months. Most senior officials at the Fed do not see any actions to withdraw support until at least late 2014.
By simply renewing Operation Twist, which was launched last year and was set to end this month, the Fed is sending the signal that it wants more time to see if the lull in hiring will abate.
“The Fed played it safe, taking out a little more insurance against downside growth risks, while positioning themselves to do more if Europe deteriorates or the labor market fails to pick up,” JPMorgan Chase chief U.S. economist Michael Feroli said in a research note.
The Fed is constrained because it has already engaged in several major rounds of stimulus to encourage economic growth, but with a frustratingly low level of success. Its strongest weapon — the federal funds rate, a benchmark for most lending — is near zero.
Other central banks have been acting aggressively lately. China’s central bank cut a key interest rate several weeks ago, spurring a rally. The Bank of England announced a measure last week to boost lending to British consumers and businesses.