To taper stimulus efforts? Examining the Fed’s role in the economic recovery

December 16, 2013 at 12:00 AM EST
Janet Yellen, Ben Bernake
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GWEN IFILL: Federal Reserve officials are facing a delicate dilemma once again this week: When is the right time to take a smaller role in an economic recovery that’s clearly under way, but one that still has left many Americans behind?

NewsHour economics correspondent Paul Solman has the story. It’s part of his ongoing coverage Making Sense of financial news.

PAUL SOLMAN: A candle, also known as a taper, a candle shrinking, also known as tapering, and thus we introduce the decision once again facing the Federal Reserve and its much-anticipated Open Market Committee meeting this week.

To taper or not to taper, that is the burning question for bond investors, for stock investors, for the economy as a whole. Since the crash of ’08, the Fed has created several trillion dollars of new money to buy Treasury and mortgage-backed bonds. Will that buying finally taper off?

We spoke with former Fed economist Catherine Mann.

CATHERINE MANN, Brandeis University International Business School: Paper means reduce the amount, the pace, so going from $45 billion to, say, $35 billion a month.

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PAUL SOLMAN: Billions of dollars that, ever since the crash, the Fed’s trading desk in New York has periodically injected into the economy by a process known as quantitative easing, creating great quantities of money to buy bonds, thus easing interest rates to boost the economy.

So what does Professor Mann think the Fed will do this week?

CATHERINE MANN: I don’t think the Fed’s going to do anything. This is Christmas season. This is not where you want to have coal in the stocking, so they are just going to not do anything. In fact, I don’t think they’re really going to do anything until later in the second quarter of 2014.

PAUL SOLMAN: And what are they going to do then?

CATHERINE MANN: I think there’s this nuance in the paper discussion that I think is important, tapering U.S. Treasury purchases, but perhaps not tapering or delaying the paper of mortgage-backed securities.

PAUL SOLMAN: In fact, the Fed has been buying these two very different kinds of bonds for two very different reasons.

The Treasury bond purchases were mainly meant to keep overall interest rates low, so people in businesses would borrow to spend, and thus grow the economy. The mortgage bond buying, however, was to revive the housing market. So how has it been going?

CATHERINE MANN: The banks have not done much in the way of lending.

PAUL SOLMAN: Because the economy hasn’t really recovered yet, says Mann.

CATHERINE MANN: So, if you are a bank and you make a loan today at a lower interest rate to a borrower, you know that that loan is not going to be worth it in a couple of years, when the interest rates in general are higher, even if you give that business a floating rate loan.

PAUL SOLMAN: Like a variable-rate loan.

CATHERINE MANN: Right.

So, as interest rates go up kind of generally, they will go up to that borrower too. Well, that borrower is now in a riskier situation then they were when you lent them at very low interest rates.

PAUL SOLMAN: They might not be able to pay you back.

CATHERINE MANN: Might not be able to pay you back.

PAUL SOLMAN: The Treasury purchases have, however, fueled a more controversial sort of growth, in the value of assets like stocks, says economist Robert Shiller, who just won a Nobel Prize for his work on markets.

ROBERT SHILLER, Yale University: That’s because investors don’t see the alternatives in the dead market as attractive. So they pile into the stock market and bid it up.

CATHERINE MANN: Stock equity markets, commodity prices and trading on foreign exchange, for example, those are collateral consequences of very cheap money that are starting to become more of a concern. So there’s been this question about whether or not the quantitative easing strategy has disproportionately benefited the upper end of the distribution, wealth distribution, who own stocks.

PAUL SOLMAN: So with a possible bubble in markets like stocks, and no real speed-up in business investment or consumer spending, the Fed may soon decide the Treasury bond purchases are doing more harm than good. Continuing to buy mortgage-backed securities, however, might still make sense.

CATHERINE MANN: For the middle class, the bulk of the their wealth is in their house. Those purchases aid the housing market. That really helps the middle class.

PAUL SOLMAN: And that’s because, if the Fed is buying mortgage-backed securities, it’s keeping housing interest rates low, makes it easier to buy a house, easier to build a house, more work for the construction industry.

CATHERINE MANN: And the third element, of course, is, it supports the housing market overall, which means everybody who currently has a house and has a mortgage, their house price goes up. And so they have wealth in their house, home equity.

PAUL SOLMAN: And then they might spend some of that wealth.

CATHERINE MANN: And they might spend some of that wealth.

PAUL SOLMAN: And so you mean that the Fed will be tapering off its buying of Treasury securities, but maybe not tapering off its buying of mortgage-backed securities, because it wants to continue to prop up the housing market?

CATHERINE MANN: I think that’s a definite possibility.

PAUL SOLMAN: And what would Robert Shiller do were he to have been named the new Fed chair , instead of Janet Yellen, married to one of his closest friends and collaborators, fellow Nobel laureate George Akerlof?

ROBERT SHILLER: I would have to think of some economic indicator that suggests that — that the economy is repairing itself. And the Fed has given a suggestion that they will keep interest rates near zero until the unemployment rate falls below 6.5 percent. And, see, that — that sounds like a rule of thumb. That sounds plausible.

PAUL SOLMAN: But with unemployment still at 7 percent and holiday spending yet to seriously heat up, few expect the Fed to taper or put out it’s not-so-brief candle as it struts and frets its hours upon the stage this week.

GWEN IFILL: The Fed’s decision will be announced Wednesday. That’s also when outgoing Chairman Ben Bernanke will hold what could be his last news conference on the matter.