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Fed’s Next Move: What Will Boost the Economy?

October 15, 2010 at 3:54 PM EST
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Fed chairman Ben Bernanke signaled Friday that his agency is prepared to make new moves to boost the economy. But what would help the most? Jeffrey Brown asks economists.
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JEFFREY BROWN: The Federal Reserve stands ready to act further to pump up the economy. That was the signal from Chairman Ben Bernanke today. But he stopped short of exact details, and said the risks of future moves are still being weighed.

Speaking at a conference in Boston this morning, Ben Bernanke cited concerns the economy isn’t improving fast enough.

BEN BERNANKE, chairman, Federal Reserve: With growth in private final demand having so far proved relatively modest, overall economic growth has been proceeding at a pace that is less vigorous than we would like. Given the committee’s objectives, there would appear, all else being equal, to be a case for further action.

JEFFREY BROWN: Chairman Bernanke suggested the Fed could expand its purchases of government debt in order to lower long-term interest rates, a tool known as quantitative easing. But he admitted the policy comes with some risks and uncertainties.

BEN BERNANKE: We have much less experience in judging the economic effects of this policy instrument.

JEFFREY BROWN: Another concern cited by Bernanke was inflation, but not the familiar problem. Indeed, the Labor Department today announced the consumer price index had risen just 0.1 percent in September, and, overall, only 1.1 percent in the past year.

This morning, Chairman Bernanke said, that is too low.

BEN BERNANKE: In effect, inflation is running at rates that are too low relative to the level that the committee judges to be more — most consistent with the Federal Reserve’s dual mandate in the longer run. And the risk of deflation is higher than desirable.

JEFFREY BROWN: Fed policy-makers are expected to announce their new actions at their next meeting in early November.

Two prominent economists who attended today’s Fed conference join us now, Alan Blinder of Princeton — he’s a former vice chair of the Fed and economic adviser to President Clinton. And John Taylor of Stanford and the Hoover Institution, he served in the Treasury Department of President George W. Bush.

Alan Blinder, I will start with you. By Federal — Federal Reserve standards, this was a pretty clear message, right?

ALAN BLINDER, former vice chairman, Federal Reserve: Yes, that’s right. You put the right modifier on it.

(LAUGHTER)

ALAN BLINDER: They are not usually that clear. It was a pretty clear message. And it said, more quantitative easing is coming soon, which everybody presumes, including myself, to mean at the very next meeting of the Federal Open Market Committee.

JEFFREY BROWN: Explain what — explain a little bit more this idea of quantitative easing. What is it intended to do?

ALAN BLINDER: Well, the idea is, once you get the interest rate, the federal funds rate, they call it, as low as it can go — and they are about there — if you still want to expand the economy, there are a variety of things you can do.

One of them is to create money and buy more assets. And that’s what is called quantitative easing. And, in particular, that’s what Chairman Bernanke was, let’s say, hinting very strongly the Fed is on the verge of doing, presumably in pretty large magnitude.

JEFFREY BROWN: Now, John Taylor, at the same time, Bernanke also talked of the uncertainties and risks of doing that. What are those?

JOHN TAYLOR, senior fellow, Hoover Institution: Well, he did emphasize the cost and the benefits and illustrated the cost. One is how you undo all this at the right time.

Remember, the Fed already did a big dose of quantitative easing a year ago. And that’s expanded their balance sheet in ways that people worry about. That means increase in money, which has to be pulled out. And how that is going to be done is uncertain. That could cause another jolt to the economy.

And the benefits of this, I think, are also quite small, in my view. Again, we saw a big dose of quantitative easing already, and I don’t think it did much good, and I don’t think this one will do much good either. So, I think it’s important to look at both the cost and benefits. In fact, the chairman indicated that quite clearly in his speech today.

JEFFREY BROWN: Well, Alan Blinder, how — as we sit here today, how prescribed is the Fed right now? What options do they have?

ALAN BLINDER: Well, they don’t have the option they would love to have, which is to drive the interest rate down to negative territory. That is their conventional policy, go through zero, and come out the other side. That is not an option.

One thing they could do is buy other sorts of assets, private assets, as opposed to Treasury assets. Another thing they could do is try to manipulate market expectations by their words. As you know, the Fed has been saying, we’re going to hold the interest rate at zero, essentially, for — quote — “an extended period.”

You could change that terminology to make it sound even longer, you know, like a hyper-extended period or something. Or, my favorite idea, what you could do is, the Fed is now paying money to banks, about a quarter of a percent, on the accounts they hold at the Fed. These are called their reserves.

It is like the checking accounts that each bank has at the Federal Reserve. It’s earning a quarter of a percent. The Fed could lower that to zero. It could even go negative, that is, to start charging banks in order to kind of sandblast that money out of the banks, and in — in some sense, to the economy.

JEFFREY BROWN: John Taylor, what’s your answer to this? How prescribed is the Fed first? And what options do you see?

JOHN TAYLOR: Well, right now, I think there’s tremendous uncertainty about policy in general, fiscal and monetary policy.

And, for monetary policy the Fed’s responsibility, I think they could do a good job of outlining the strategy for the future. Right now, this idea is thrown out. Alan just mentioned a couple of them that are being discussed. But there is no strategy of where things are going. And I think that creates uncertainty.

I think a big stimulus to the economy would be to outline a strategy, ultimately, when the economy gets moving, how will the exit take place, in the meantime, a description of what their plans are for the reserves in the banks or the balance sheet, whether they are going to change the interest payments.

But, right now, it’s kind of a list of tools and a list of ideas. And I think that kind of shakes up the market. You have seen lots of volatility. The dollar has fallen a lot since these discussions have taken place. And those — that volatility concerns me. It’s a reflection, I think, of the uncertainty.

JEFFREY BROWN: And what — Alan Blinder, what is Chairman Bernanke telling us when he says inflation is too low? We’re not used to hearing that.

ALAN BLINDER: Right.

JEFFREY BROWN: We’re used to worrying about it on the upside. So what is he saying?

ALAN BLINDER: The Fed has a mandate from Congress, if you read the Federal Reserve Act, to pursue — quote — “stable prices.”

There’s no number put on that by Congress. And the Fed has shied away from putting on a number. But, in recent years, the Fed has come close, sort of right up to the edge of putting on a number. And that number is in the 1.5 percent to 2 percent range. So, you could think of it as 1.75 percent, plus or minus something.

Now inflation is running under 1 percent. And Bernanke is pointing out that, according to their working definition of price stability, what they need to achieve to follow the instructions Congress gave them, is above where inflation is. And that means you want to push inflation up, which, as you say, is an unusual thing to hear out of a Central Banker.

JEFFREY BROWN: But I guess, John Taylor, the other side is, you — do people worry about pushing it up, still worry about pushing it up too much or too fast?

JOHN TAYLOR: Oh, ultimately, definitely. That is a concern, not right now, because we have this terrible unemployment situation. But, absolutely, down the road there is a concern, and it could come faster than you think.

And, as the chairman indicated today, he looked at a number — 1.1 percent, I think, is the number he gave for inflation. So that’s really not too far away from their target. So I think they’re concerned about actually deflation at this point, and having to come down.

I personally don’t think that’s a concern. But, in the meantime, the inflation rate is not abnormally low. It is something that — I think it is close to the range. So, again, that’s one of the reasons why I wouldn’t use that as an argument for additional quantitative easing.

Also, I might add the quantitative easing that they had earlier sometimes called QE1 — this is — this would be QE2 — QE1 was — was motivated for the emergency situation, which we were in during the panic period of this crisis. And so this is a completely different rationale for quantitative easing.

And it’s an example of sort of there’s not a strategy out there outlining the problem and how they’re going to deal with it.

JEFFREY BROWN: All right, we will leave it there and watch. Alan Blinder, John Taylor, thank you both very much.

JOHN TAYLOR: Thank you.

ALAN BLINDER: Thank you.