Fed likely to take action as US economy hits the brakes

25th July 2012

The Federal Reserve is prepared to take additional steps to spur activity and hiring in the US economy, according to a report by the Wall Street Journal on Wednesday. Officials at the central bank are growing impatient with the sluggish growth and high unemployment and are worried that the recovery from the recession that ended in the spring of 2009 is taking too long. Jon Hilesenrath, who wrote the report, said that conversations inside the Fed had turned toward how and when to move but did not find a consensus for what steps the Fed might take at its meeting next week.

The Fed's chairman, Ben Bernanke, told Congress last week that the options under consideration included a new round of asset purchases, or "quantitative easing," often described as QE3. As part of any such program, officials increasingly favour expanding the Fed's holdings of mortgage-backed securities for the first time since 2010.

The Fed also could take the smaller step of extending its forecast that short-term interest rates would remain near zero beyond late 2014, but many economists regard such a step as unlikely to provide a significant jolt to growth.

In the case of QE3, Sebastian Mallaby, a senior fellow at the Council on Foreign Relations and an FT contributing editor, writes in a column that unless the Fed can rekindle the shock value of the first round of quantitative easing, more QE is unlikely to work.

"Success depends on a whole range of actors deciding that the Fed is determined to accelerate recovery rather than repeat a tired trick that they have seen before. Banks, having sold Treasuries, must choose to reinvest the proceeds in riskier assets rather than just adding to their huge cash piles. Corporations, facing lower borrowing costs, must resolve that this is the moment to invest. Consumers, seeing rising stock and bond markets, must summon the confidence to spend.

"If the Fed won't take the risk of going beyond what it has tried already, private actors won't take risks either. Monetary policy is like faith healing. The patient must believe.

"Quantitative easing that fails to spark risk-taking could actually make things worse. A Fed that is both active and ineffectual is the worst thing for confidence, and indefinite purchases of Treasuries threaten to upset the way markets work."

Furthermore, Binyamin Appelbaum of The New York Times believes that a new round of bond-buying would be politically controversial so close to the November presidential election.

"During Mr. Bernanke's testimony last week, Democrats made clear they wanted the Fed to act and Republicans said it should proceed cautiously. The Fed chief has said repeatedly that the central bank will seek to do what is best for the economy, regardless of political pressure."

 

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