When Federal Reserve Chairman Ben Bernanke has his first-ever press conference after a regular Fed policy making committee meeting Wednesday, he’s likely to get a lot of questions – about interest rates, inflation and his expectations for fiscal policy.
Anything Bernanke says will make news and could move markets.
But he won't address the details of the fierce budget debate wracking Congress. He and his colleagues still have many issues to grapple with.
- The possibility of a tough deficit reduction package and its economic impact.
- The scheduled end on June 30 of the Fed's purchases of Treasury securities, known as quantitative easing.
- An increase in interest rates somewhere down the road.
The Fed needs to consider fiscal policy changes as they make the economic forecasts on which they base their monetary policy decisions. As the government moves to reduce deficits in the months and years ahead by cutting spending and increasing taxes, that tighter fiscal policy means an increase in interest rates is not likely anytime soon.
“This time the range of possible outcomes seems greater, but it’s a pretty good bet that fiscal policy will be tighter,” said former Fed Vice Chairman Donald L. Kohn, who is now at the Brookings Institution. "If fiscal policy is tighter, that could well argue for a later tightening of monetary policy."
In the past, significant fiscal policy tightening led the Fed to cut interest rates. But the central bank’s target rate is already effectively at zero, which is why the Fed embarked on a series of extraordinary policies, such as buying large quantities of longer-term Treasury securities and mortgage-backed assets. Bernanke maintains the purchases have kept longer-term rates lower than they otherwise would have been. Other economists argue the program has had little impact.
keep four eyes going — two on
inflation and two on what the effects
of budget austerity are going to be.”
Extending the program might be politically difficult, but it is one of the few things the Fed could do if it chose to try to offset any of the impact of a major tightening of fiscal policy, which in the short run would effectively reduce what households and businesses have to spend and constrain economic activity. In the long-run it might work the other way around, at least that's the goal.
Charles L. Schultze of the Brookings Institution, a former White House economist and budget director, said Fed officials “are going to have to keep four eyes going — two on inflation and two on what the effects of budget austerity are going to be.”
The spending cuts called for in the recent deal between congressional Republicans and Obama are not large enough “to disrupt the continuing recovery but they may slow it down a tad,” Schultze said. “One thing all this talk about budget cuts might do is to give Bernanke another argument not to move immediately to start to fight inflation.”
Even though unemployment is still high at 8.8 percent, a small minority of the 17 FOMC participants — there is one vacancy on the Fed Board — worries about rising inflation and wants to pull back from the extraordinary efforts the Fed has made to counter the financial crisis and stimulate the economic recovery. However, the majority, led by Chairman Ben S. Bernanke and Vice Chairman Janet L. Yellen think differently.
In a recent speech, Yellen acknowledged that inflation has increased as gasoline, food and other commodity prices have climbed sharply. But she argues that has been the result of rising global demand and supply disruptions, not Fed policy.
“An accommodative monetary policy continues to be appropriate because unemployment remains elevated. Even now, measures of underlying inflation are somewhat below the levels that FOMC participants judge to be consistent, over the longer run, with our statutory mandate to promote maximum employment and price stability,” Yellen said.
The committee's latest statement will be released at 12:30 p.m. Wednesday and Bernanke will meet the press at 2:15 p.m.
On Thursday, the Commerce Department will release its first estimate of first quarter economic growth, which many forecasters expect to be at a 2 percent annual rate or less. Economists at Goldman Sachs expect that to rebound to around 4 percent for the current quarter. Beyond that, “We see a number of downside risks to our forecast that the economy will grow above potential in the second half of 2011 and in 2012,” the Goldman economists said. “These include high oil prices and the potential for more aggressive federal budget cuts.”
Fiscal policy changes often are difficult for the Fed to deal with because of the uncertainty over what Congress will do. “But it very important to them and they have people who do nothing but follow fiscal policy,” said Joseph Gagnon, a former Fed staff official now at the Peterson Institute for International Economic Policy. (The Peterson Institute is partly funded by Peter G. Peterson, who also funds The Fiscal Times.) “This time it is bigger and more uncertain than ever before.”
Gagnon, who argued strongly for the large scale asset purchases as a supplement to regular policies once rates got close to what is known as the zero lower bound, doesn’t expect the Fed to tighten monetary policy soon given the state of the economy. “I think they are on a very long leash,” he said, adding, “There will be tighter fiscal policy, either just tight or incredibly tight … It’s more likely they would raise rates in 2013 than 2012.”
Of course, should surging commodity prices begin to affect core inflation, which excludes volatile food and energy prices, all bets could be off. As Yellen explained in her speech, the key is whether expectations of future inflation begin to rise. If that were to happen, then consumers and businesses would begin to try to protect themselves by raising their selling prices and demanding higher wages.
So far that hasn’t happened in a significant way, particularly on the wage front. “If a continued run-up in commodity prices appeared to be sparking a wage-price spiral, then underlying inflation could begin trending upward at an unacceptable pace,” Yellen said. And the Fed would have to respond.
Stimulus by the Fed is Disappointing, Economists Say (New York Times)
Why Bernanke’s Press Conference Matters (NPR)
How FOMC Meetings Affect the Stock Market (FuturesMag.com)