The View From Bernanke's Perch at the Fed
Until recently, attacking Federal Reserve Chairman Ben Bernanke for being too passive sounded out of touch with reality. Indeed, he has been assailed for doing too much to bail out Wall Street and for risking the Fed's independence and inflation-fighting credibility by buying $1.5 trillion of mortgages and U.S. government bonds.
Yet the question lurking when Mr. Bernanke testifies in Congress this week is why the central bank isn't doing more now to rescue an economy that is losing momentum. After all, the Fed's forecast is for inflation below its informal target and persistently high unemployment for the next couple of years.
A key question ahead of Ben Bernanke's testimony to Congress today is why the Fed is not doing more to rescue an economy that is losing momentum. David Wessel, Neal Lipschutz and Kelly Evans discuss. Also, Nick Timiraos discusses why the housing sales are stalling again with inventories of unsold homes piling up and builders scaling back construction plans.
Here, more bluntly than Mr. Bernanke will put it if Congress ever gets around to asking, is what's going on.
The distressing economic outlook has deteriorated since the Fed's June 22-23 meeting. Mr. Bernanke would cut short-term interest rates if he could. But he can't; rates are already near zero. So the question is whether to pursue more-unconventional monetary policy.
The Fed, perhaps prematurely, ended its purchases of mortgages earlier this year. As the minutes of the June meeting note, Fed officials are at least talking about what would justify reopening the spigot.
There are a lot of little things the Fed could do to signal concern about the economy—and Mr. Bernanke may enumerate them if pressed. But the most likely to matter would be to buy more mortgages and Treasurys to push down long-term rates.
For now, Mr. Bernanke doesn't believe potential benefits of such a move outweigh potential costs. But he and his allies on the Fed's divided policy committee aren't saying never. Whether or not he explicitly says so, the Fed will consider buying more securities if the economy gets worse or credit markets show signs of severe distress, despite the eagerness of some Fed officials to move toward "the exit strategy."
The One Question Congress Needs to Ask Bernanke
1:23Ben Bernanke begins two days of testimony before Congress Wednesday. WSJ's David Wessel says if lawmakers can abandon their partisan politics, there's one big question they need to ask the Fed chairman.
Why wait? Put yourself in Mr. Bernanke's chair. When the Fed began buying mortgages, the gap between yields on mortgages and Treasurys was wide; now it isn't. Mortgage rates are very low and the housing sector is still moribund; it isn't clear pushing mortgage rates down another one-quarter percentage point would do much.
The Fed could buy more Treasurys, trying to push yields on 10-year Treasurys below the already low 3%. But that could backfire. With all the deficit angst around, a Fed move to buy Treasurys could provoke cries of "they're monetizing the debt" and push up long-term rates rather than lowering them.
As scary as this sounds, the Fed can't be sure of the net effect of buying more assets. It might not make things better. It would be, in short, a Hail Mary pass. And Mr. Bernanke isn't ready—yet—to throw it.
Mr. Bernanke's former Princeton University colleague, Nobel laureate Paul Krugman, has become the loudest critic of Mr. Bernanke's inaction, calling the Fed "feckless" (lacking in vitality, unthinking, irresponsible) in his New York Times column. In a prescient 1998 paper about Japan, Mr. Krugman warned that other countries might similarly confront the feared "liquidity trap," the circumstance at which the central bank has cut interest rates to zero and the economy remains very weak. His advice then: "Monetary policy will be effective…if the central bank can credibly promise to be irresponsible"—by promising to create inflation in the future.
The textbook point: Interest rates that matter are the inflation-adjusted ones. In recessions, the Fed effectively pushes inflation-adjusted rates below zero. But with nominal interest rates at zero, the only way to get inflation-adjusted rates lower is to get everyone believing that inflation will go up.
The practical point: This is easier to advise than to do safely. It would, at the very least, be hard to explain to a public already suspicious of the Fed. And it, too, could backfire. Manipulating inflation expectations is hard to calibrate. And the move would mean higher nominal (though lower inflation-adjusted) long-term interest rates. And outside of economic textbooks, higher nominal rates can hurt, pinching cash-strapped households for instance. It's risky.
Mr. Bernanke, in a widely re-read 2002 speech, argued that the Fed can create inflation and can thwart deflation. Mr. Krugman thinks deflation is around the corner; Mr. Bernanke isn't convinced.
If the Fed is truly out of good choices, then talk turns to fiscal policy. Both Mr. Bernanke and his deputy-designate, Janet Yellen of the Federal Reserve Bank of San Francisco, have been cautiously giving Congress advice on that. "If simultaneously Congress were to put in place meaningful measures that would phase in over time to address medium- and longer-term deficit issues…that would create greater scope in the shorter term for Congress to also contemplate…actions to address short-term weakness in the economy," Ms. Yellen said at a hearing last week, echoing similar advice from Mr. Bernanke.
In plain English, the Fed would welcome more fiscal stimulus if accompanied by a credible, specific commitment to reduce the deficit later. But the chances of Congress and the president executing that two-step maneuver are close to nil.
Which means, if things get worse, Mr. Bernanke may yet resort to the Hail Mary.
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