TOPICS > Economy

Bernanke: Fed Was ‘Too Optimistic’ About Recovery

June 20, 2012 at 12:00 AM EDT
The Federal Reserve extended a program to drive down interest rates after acknowledging the economic recovery may be more difficult than it anticipated. Jeffrey Brown speaks with Greg Ip, U.S. economics editor for The Economist magazine, about the Fed's "lowering of expectations" and its latest moves to prop up the economy.

JEFFREY BROWN: The nation’s economic outlook is worse now than just two months ago. The Federal Reserve issued a sobering new estimate today, in the face of a weak job market and trouble in Europe.

All eyes and markets looked to the Federal Reserve as it wrapped up its two-day policy meeting. When it was over, the Central Bank had lowered its estimate of growth this year by half-a-percentage point to 2.4 percent and said it expects the unemployment rate to remain at least 8 percent through 2012.

BEN BERNANKE, federal reserve chairman: The outlook has changed. Like many other forecasters, the Federal Reserve was too optimistic early in the recovery about the pace of recovery.

JEFFREY BROWN: Chairman Ben Bernanke said the Fed’s leaders understand the need to provide further assistance.

BEN BERNANKE: We are prepared to do what’s necessary. We are prepared to provide support for the economy.

JEFFREY BROWN: That support takes the form of extending Operation Twist through the end of the year.

Under the program, the Fed sells short-term Treasury bonds and buys long-term bonds to drive down interest rates. The effort has involved some $400 billion since last September. The extension will involve another $270 billion.

Bernanke left open the possibility of doing more if the job market worsens. The economy added just 69,000 jobs in May, and unemployment rose for the first time in 11 months.

BEN BERNANKE: I wouldn’t accept the proposition, though, that the Fed has no more ammunition. It’s our intention to do all we can to make sure that it doesn’t go on indefinitely. If we don’t see continued improvement in the labor market, we will be prepared to take additional steps if appropriate.

JEFFREY BROWN: The chairman also warned that Europe’s debt crisis is a worsening drag on the U.S. economy. And he appealed for action abroad.

BEN BERNANKE: We think that the policy-makers in Europe have very strong incentives to get this right. And we’re very hopeful that they will get it right. And we’re in close contact with them as they work on these issues. But, again, it’s also important for us to be prepared for any further problems that might emerge from Europe. And we have been doing that.

JEFFREY BROWN: That issue took center stage at this week’s annual Group of 20 meeting in Mexico. But the G-20 leaders stopped short of making any major decisions to remedy the situation.

Greg Ip, U.S. economics editor for The Economist magazine, was at Ben Bernanke’s press conference this afternoon and joins us now.

Well, Greg, the Fed doesn’t always speak so clearly, right? But in this case, there’s certainly a lowering of expectations for some time to come.

GREG IP, The Economist: Yes.

What is interesting is that, as recently as three or four weeks ago, there was no expectation or intention that the Fed would actually move this week. And so a lot happened in the last three or four weeks to really worry them and to lower expectations of how the economy is going to perform.

We had a couple very bad job numbers, employment growth of only 69,000 in May. We have had the situation in Europe worsen notably, where now Spain is in the crosshairs. There are real fears that Spain will need to be bailed out or it will end up defaulting on its debts, and more recently, people getting concerned about the fiscal cliff here in the United States, a combination of tax increases and spending cuts that could really well up the economy at year-end if nothing is done about it.

JEFFREY BROWN: So the one step that they talk, the firm step, extending the program, the so-called Operation Twist, tell us a little bit more about that. And is it still effective? What is it intended to do at this point?

GREG IP: Well, what Operation Twist does is basically the Fed has a balance sheet with roughly $2.5 trillion to $3 trillion worth of bonds. It’s a variety of bonds. Some mature in three years, some in five, some in 30 years. What they’re doing is they’re selling some of the shorter dated bonds, like one and three years, and buying longer–term bonds.

And the reason they’re doing that is that by purchasing long-term bonds, they push their prices up and their yields down and that affects all sorts of borrowers. If you get a mortgage, for example, you should benefit from that because as the Treasury bond yields come down, so should mortgage rates. And the idea is that, if they do enough of this, this will have a beneficial impact on the economy.

JEFFREY BROWN: Of course, long-term rates have been so low already, right? So the question is how much impact can something like this still have?

GREG IP: Well, it should have some impact.

Studies suggest that the previous rounds of programs similar to this have brought down long-term interest rates anywhere from 50 to 100 basis points. That’s a half to a full percentage point. but you raise a good question. A lot of the people who can take advantage of the low interest rates already have.

A real problem we have now is that so many people simply can’t because, for example, their houses are worth too little and they cannot refinance.

JEFFREY BROWN: Now, Ben Bernanke said repeatedly — I was watching the press conference that you were at — that the Fed is prepared to do more. And I saw you and others pushing.


JEFFREY BROWN: Why not more now? What exactly is he waiting for or looking at to decide on what further steps to take?

GREG IP: Well, I think there’s two possibilities.

The first is that things are still very muddy. I mean, the recent weakening of the economic data has been fairly sudden. And the Fed is still trying to figure out how much of that is real and how much of it might reflect things like the fact that there was a warm winter.

And also Europe, nobody really knows what’s going to happen with the crisis there, whether it will be resolved or whether it will get worse. I think the Fed would like more clarity on both those things before it decides that it has to do more. The second issue is, well, if they do more, how will they do it?

By the end of the year, they will have run out of short-term bonds to sell in some Operation Twist. They could then go a more radical step and do what they have done before, which is called quantitative easing. That’s where they go ahead and buy bonds and they pay for them by basically printing the money.

But what they worry about is that if they print too much money, it will be very hard to soak up the money later on when it’s no longer needed. So it’s a step that they would take only with great care.

JEFFREY BROWN: Well, we ran that clip of him saying, I wouldn’t accept the proposition that the Fed has no more ammunition. And this is exactly the point you’re speaking to, is a lot of people wonder, what is left to do? That’s a rather dramatic step.

GREG IP: It is.

But the point he’s making is that, yes, we have ammunition, but we’re afraid of it blowing up or doing other unintended consequences if we use it. The other problem is — he didn’t say this — but when the Fed has done quantitative easing in the past, they have gotten a lot of political flak, especially from Republicans in Congress and from countries overseas who think that the Fed is trying foist America’s problems on to other countries.


GREG IP: And that’s got to be a consideration when Fed officials think about the costs and benefits of any action that they take.

JEFFREY BROWN: Well, of course, and even more so in the midst of a political campaign, right? He’s taken some pressure from Republicans not to do steps like that. He’s taken some — he’s got some pressure from the other side to do something to stimulate the economy.

How — what — you said he didn’t say anything, but they’re aware of this, right?

GREG IP: They’re aware of this.

But, look, it’s not new that the Fed finds itself in the political crosshairs. Even in the old days, when they were not dealing with this unconventional tools, they would get beat up on both sides either about raising interest rates too much or cutting them too much depending on which side of the aisle people were coming from.

What makes it more difficult this time is that the tools they’re using are so much more unconventional. When they go out there and they do quantitative easing by buying bonds, they are accused of essentially trying to enable bigger government deficits.

JEFFREY BROWN: And just to keep it finally in the political context, there’s not much more for them to do before the election, right? Or when’s the next meeting? A couple more months?

GREG IP: They have another meeting I believe in a couple more months and they could act then if the economic outlook has deteriorated significantly.

But it’s interesting to note that with today’s announcement, their current plan runs until the end of the year, which is also exactly when the so-called fiscal cliff hits. Hopefully — whether it’s a coincidence, I don’t know, but the positive thing from their point is that if they need to take more action, then at least it will no longer be an election issue.

JEFFREY BROWN: All right, Greg Ip of The Economist, thanks so much.

GREG IP: Thank you.

JEFFREY BROWN: Online, we have several prominent economists, including more from Paul Krugman weighing in and debating Ben Bernanke’s moves to prop up the economy.