September 13, 2011
In many ways, Federal Reserve Board Chairman Ben Bernanke did more to prevent a modern- day Great Depression than either the Bush or Obama administrations. Bernanke used the central bank’s routine authority to cut interest rates, and when that wasn’t enough, he stretched the Fed’s legal authority to devise other ways to provide the needed funds to keep the nation’s financial system afloat. But now, with the economy almost flat-lining and unemployment stubbornly holding at 9.1 percent, a frustrated Bernanke finds himself hemmed in.
The central bank’s earlier successful sweeping actions and monetary maneuvers – including two rounds of massive bond purchases to pump more money into the system – are all but exhausted. The few remaining tricks at his disposal are relatively small bore. That grim reality, as well as nasty criticism from Texas Gov. Rick Perry and other Republican presidential candidates and resistence from other Fed policy makers, has Bernanke walking a fine line in his effort to provide further help to the economy, according to some familiar with Fed deliberations.
Is Bernanke becoming the incredible shrinking Fed Chairman, with little left to bring to the table in addressing one of the worst recessions of modern times, or will he find other ways to help revive the economy?
At next week’s two-day policy making session of the Federal Open Market Committee, the Bernanke led majority is likely to approve selling some of the shorter-term Treasury securities the Fed holds and use the cash to buy others that mature several years down the road. That could reduce rates on longer-term securities and rates linked to them –including those on home mortgages and private sector bonds.
However, with long-term rates already at their lowest level in decades the move would at best have a miniscule impact on the economy compared to the 5-percentage point cut the Fed made beginning in 2007 in its key target for interest on overnight deposits, which is now close to zero. Similarly, as Bernanke has said, financial markets are functioning smoothly now, so all the special financing mechanisms used at the height of the crisis have been wrapped up.
“What can the Fed do at this point?,” asks Mickey Levy, chief economist at Bank of America. “I think the tools are limited and Bernanke knows they are limited. They are in a box.”
“Financial markets have had the notion that the Fed can always pull a rabbit out of the hat,” Levy told the Fiscal Times. “Well, in this situation it can’t because the problems facing the economy aren’t necessarily amenable to quick monetary policy solutions.”
Bernanke has said repeatedly that there are still actions the Fed can take to give the economy a boost. However, in a speech at the recent Kansas City Federal Reserve Bank’s annual conference in Jackson Hole, Wyo., the Fed chairman acknowledged this has been an unusual, disappointing recovery. The normal economic processes that foster recoveries after recessions have been blunted, he said.
“Unfortunately, the recession, besides being extraordinarily severe as well as global in scope, was also unusual in being associated with both a very deep slump in the housing market and a historic financial crisis,” Bernanke said. “These two features of the downturn, individually and in combination, have acted to slow the natural recovery process.”
Even rock bottom mortgage rates—such as those on 30-year fixed-rate mortgages that averaged only 4.22 percent in the week ended Sept. have not led to a snap back in home construction because of the overhang of distressed and foreclosed properties, still falling home prices and tight credit conditions facing both builders and buyers, he said.
Fed policies have helped bring down mortgage rates, but monetary policy alone can’t do much about the other factors.
Nor can the central bank do anything about the hit to both consumer and business confidence this summer caused by the unnecessary political clash over increasing the federal debt limit. Republicans caused the rancorous debate with their effort to embarrass President Obama. And if uncertainty over future government policies is a factor in slowing economic growth and business hiring, as many Republicans claim, the debt limit fight only made matters worse.
Meanwhile, Bernanke has some in-house problems. At the last FOMC meeting on August 9, three Fed bank presidents dissented from the majority’s decision to try to lower intermediate-term rates by announcing that the Fed would keep its overnight rate target close to zero until mid-2013. Since many analysts and investors had been expecting the target to begin going up about a year from now, the announcement caused them to begin accepting lower yields on various investments maturing a year or so down the road.
The dissenters, Richard W. Fisher from Dallas, Narayana Kocerlakota of Minneapolis and Charles I. Plosser of Philadelphia, gave slightly different reasons for their actions. Essentially, they all felt the change carried some inflationary risk and was not really needed. Some other presidents not currently voting probably also disagreed with the majority view.
Charles Evans, their counterpart at the Chicago Fed, did not dissent . But in a recent speech in London, he made it plain he not only backed the mid-2013 commitment but wanted still more aggressive action to reduce unemployment.
“I think our dual mandate responsibilities and the strong impediments of the financial crisis argue for a more aggressive approach.” Evans said. One way to do that would be to have an open-ended commitment to keep the overnight rate target low rather than specifying a date such as mid-2013.
“This conditionality could be conveyed by stating that we would hold the federal funds rate at extraordinarily low levels until the unemployment rate falls substantially, say from its current level of 9.1% to 7.5% or even 7%, as long as medium-term inflation stayed below 3%,” Evans said.
For a committee that has historically operated on a consensus basis, this amount of public disagreement over policy is a problem for Bernanke and it probably limits the scope of further such actions to ease policy, knowledgeable Fed observers say. In very different fashion, the outspoken personal attacks on the Fed chairman from several candidates for the Republican presidential nomination make more aggressive Fed action difficult.
A few weeks ago, Gov. Perry claimed that some of Bernanke’s actions had been “treasonous.” At a recent GOP debate among the candidates in California, former House Speaker Newt Gingrich said of the chairman: “I would fire him tomorrow. I think he’s been the most inflationary, dangerous, and power-centered chairman of the Fed in the history of the Fed.”
With somewhat less vituperative language, former Massachusetts governor Mitt Romney said if he were president, “I’d be looking for somebody new. I think Ben Bernanke has over-inflated the amount of currency that he’s created.” Furthermore, he said, the purchase of $600 billion worth of longer-term Treasury securities, so-called quantitative easing, “did not work. It did not get Americans back to work. It did not get the economy going again.”
The complaints about inflation, which was a large part of what was behind Perry’s declaration, are groundless. Inflation has averaged just over 2 percent during Bernanke’s five and a half years as chairman, lower than that of any of his predecessors since the beginning of the 1970s. And the quantitative easing did help lower long-term rates and head off a potentially dangerous episode of broadly falling prices.
While Bernanke and the Fed don’t have the power by themselves to solve the nation’s terrible unemployment problems, the central bank could be called on again before long to be a lender of last resort as it was during the height of the financial crisis in 2008.
Many big European banks in the Eurozone are in trouble as a result of the sovereign debt crisis affecting Greece, Ireland, Portugal, Spain and Italy to varying degrees. If there is a default by one or more of those nations, some banks could be affected to the point they could no longer fund themselves. If those problems began to affect banks here and the U.S. financial market, the Fed could have to step in as it did so prominently in 2008 and 2009.
The politicians attacking the Fed ought to keep that in mind.