October 15, 2010
If investors had any doubt that the Federal Reserve will take some policy action next month to try to stimulate the sluggish U.S. economic growth, Fed Chairman Ben S. Bernanke removed it on Friday.
In a speech in Boston, Bernanke said Fed officials expect unemployment to remain higher and inflation lower than they want them to be for a prolonged period. Under these circumstances, officials are "prepared to provide additional accommodation if needed to support the economic recovery and to return inflation over time to levels consistent with our mandate," he said.
Bernanke didn't spell out what action the Fed's policy making group, the Federal Open Market Committee, would take at its next meeting on Nov. 2 and 3, but it was clear that the most likely step would be a resumption of purchases of large amounts of longer-term securities. Previous purchases of $1.7 trillion worth of Treasury and mortgage-backed securities were "successful in bringing down longer-term interest rates and thereby supporting the economic recovery," Bernanke said.
All these issues were discussed at the last FOMC meeting on Sept. 21, according to minutes released this week. "Several members noted that unless the pace of economic recovery strengthened or underlying inflation moved back toward a level consistent with the committee's mandate, they would consider it appropriate to take action soon," the minutes stated.
Some Fed officials probably will oppose buying more assets, and one, Thomas M. Hoenig, president of the Kansas City Federal Reserve Bank, is likely to dissent, as he has at each regular FOMC meeting this year over the wording in the committee's statement that it plans to keep its target for overnight interest rates close to zero "for an extended period."
Bernanke's description today of the current state of the economy and the outlook showed that in his view, there was no evidence of either stronger growth or a pickup in inflation. The Labor Department reported today that consumer prices rose only 0.1 percent last month and 1.1 percent over the past 12 months. Fed officials generally would like to see an inflation rate of about 1.7 percent to 2 percent, partly to be sure some sort of shock didn't cause the overall level of prices to decline, a condition known as deflation.
Most Fed officials believe unemployment, which is currently 9.6 percent, could fall to below 5.5 percent without causing inflation to accelerate.
Some monetary policy experts say that the sort of additional efforts to help the economy the Fed is considering would be a serious mistake. At a conference in New York this week organized by the Shadow Open Market Committee — a group created more than 30 years ago to offer monetarist critiques of Fed policy — Gregory D. Hess of Claremont McKenna College said large scale asset purchases would be "unduly aggressive, risky, unproven and misguided."
Hess argued that economic growth is not so slow or inflation so low that action is needed. If the Fed's balance sheet is expanded by added purchases, the central bank could have difficult shrinking it when policy needs to be tightened in the future, Hess said.
However, Marvin Goodfriend of Carnegie Mellon University, a former research director at the Richmond Federal Reserve Bank, said action such as what the Fed is considering would be useful under some circumstances.
Measures of inflation have declined and "the likelihood that labor markets will remain weak for some time suggest that inflation could fall further," Goodfriend said. "The risk is that inflation expectations are dragged down, raising real interest rates and tightening interest rate policy."
But that is not happening right now, he said. "With five-year market-based inflation expectations running near 1.5 percent, deflation does not yet present a clear and present danger," and until it does, the Fed should not begin to expand its balance sheet again, Goodfriend argued.
Yet another thread of disagreement with further Fed attempts to lower interest rates emerged at the annual meeting last weekend of the Institute of International Finance, an organization of private bankers from around the world.
Charles Dallara, IIF managing director, said at a press conference that Fed efforts to reduce interest rates would put downward pressure on the value of the dollar, encourage large new flows of capital to emerging market countries and drive up the value of their currencies. Government officials in several such countries, particularly in Asia, have been complaining for months about such an impact of Fed policy on them. Some officials in Europe have also expressed their unhappiness with the rise in the value of the euro, which has made their exports more costly to buy.