The Fed’s Second Act — Don’t Dare Call it Stimulus
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The Fiscal Times
November 1, 2010

The Federal Reserve has a dual legal mandate: to keep prices stable and to maximize sustainable employment. This week, the central bank is going to take a controversial step Fed officials hope will help eventually achieve both.

On Wednesday afternoon, at the end of a two-day meeting, the Fed's top policymaking group, the Federal Open Market Committee, is expected to announce resumption of purchases of longer-term Treasury securities, probably worth at least $1 trillion, according to estimates. The goal is to lower interest rates on private as well as government securities and in the process spur faster economic growth and reduce stubbornly high unemployment.

The long anticipated move, dubbed quantitative easing, or QE2, because it would be the second round of such purchases, is controversial for several reasons. Among other things, foreign officials are concerned about the effect on the value of the dollar and its impact on trade.

Since longer-term interest rates are already very low, even Fed Chairman Ben S. Bernanke isn’t sure how much difference the added large-scale purchases will make. The earlier round of Fed buying of about $1.7 trillion worth of Treasury and mortgage-backed securities that ended earlier this year did reduce rates, particularly those on home mortgages, but the lower rates led to only modest gains in the beleaguered housing market.

Opposition to QE2
Some members of the FOMC, particularly Thomas M. Hoenig, president of the Kansas City Federal Reserve Bank, oppose the move for fear it may lead to unacceptably high inflation and new asset price bubbles down the road. Other officials have expressed concern that such a large expansion of the Fed's $2.3 trillion balance sheet would make it more difficult for the central bank to pull back the extraordinary supply of cash in the banking system when economic conditions improve again.

"One disadvantage of asset purchases relative to conventional monetary policy is that we have much less experience in judging the economic effects of this policy instrument, which makes it challenging to determine the appropriate quantity and pace of purchases and to communicate this policy response to the public," Bernanke acknowledged in a mid-October speech.

And then there are the loud complaints from some foreign officials that Fed action to cut interest rates will unfairly devalue an already weak U.S. dollar, which would cheapen U.S. exports. The complaints are coming primarily from countries such as Germany, China, South Korea and Russia that have trade surpluses they want to keep.

According to Fed indexes of the dollar's value compared to groups of foreign currencies, the dollar last month was virtually the same as it was one, two and even three years ago. Super-low U.S. interest rates already have generated large flows of capital into some emerging market countries, driving up the local currency and hurting exports, officials say.

However, in the last few weeks, the dollar has dropped about 3 percent in response to the widespread expectation of Fed action. A weaker dollar could make U.S. exports more competitive on world markets, but that's not the primary purpose of what the Fed is doing.

Alessandro Giraudo, chief economist at Tradition Securities and Futures in Paris, said in an interview via email, "If the dollar goes down, this is only a secondary effect of a monetary policy decision meant at supporting a sliding economy." Besides, he added, "any recovery and possible strength of the U.S. economy may be very useful and helpful to support the world economy, for countries with and without trade surpluses."

Challenging Geithner
In short, the complaints about the dollar are not likely to influence the outcome of the FOMC meeting, and the foreign officials undoubtedly understand that. Most likely, their comments have been intended to challenge Treasury Secretary Timothy Geithner's efforts to persuade nations with large surpluses that they have an obligation to correct such imbalances just as much as nations, including the United States, which have large deficits.

Edwin M. "Ted" Truman, a former director of the Fed Board's Division of International Affairs who is a senior fellow at the Peterson Institute of International Economics*, said recently that the Chinese "have been able to use this criticism to some degree to deflect the currency debate into a debate about U.S. monetary policy." He added, however, that foreign criticism shouldn’t prevent the Fed from making the Treasury purchases, which he called "a reasonably sensible policy."

covered the Federal Reserve and the economy for 25 years at the Washington Post before joining Bloomberg News in 2004. In 2009 he began writing freelance pieces for, among others, Thomson Reuters, and is widely recognized for his ability to interpret the Fed.