Ben Resuscitates QE, Downplays Risk & Cost
Last week, the Federal Reserve's quantitative easing was about to undergo some quantitative adjustment. At least that was the take-away from the minutes of the Jan. 29-30 meeting, suggesting that Fed policy makers were starting to view the costs of long-term asset purchases as outweighing the benefits.
Chairman Ben Bernanke disabused us of that notion this week when he delivered the Fed's semiannual monetary policy report to Congress.
"We do not see the potential costs of the increased risk- taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation," Bernanke said in prepared testimony. The Fed will continue its $85-billion-a-month asset purchases, he said, "until it observes a substantial improvement in the outlook for the labor market in a context of price stability."
Bernanke did a good job of outlining, and downplaying, the risks of expanding the Fed's balance sheet, which, at $3.1 trillion, is almost four times its pre-crisis size. Along with the extended period of near-zero interest rates, large-scale asset purchases have the potential to increase the rate of inflation, encourage excessive risk-taking and financial instability, create market distortions, and, when interest rates rise, produce capital losses on the Fed's portfolio of long-term securities.
I would add one more risk to his list: a loss of credibility as the Fed appears more willing to tolerate higher inflation in the short run in exchange for lower unemployment.
The Fed chief emphasized the substantial costs of persistently high unemployment, to both the individual and society at large. What he didn't do was explain how more of the same is going to achieve a different result.
The unemployment rate has exceeded 7 percent for 50 consecutive months. It has come down to 7.9 percent from 10 percent in October 2009, but this has been a grudging decline accompanied by a reduction in the percentage of the population in the labor force.
On the benefit side, Bernanke said that low long-term interest rates have helped spark a housing recovery, although it's not clear how credit for the revival should be apportioned among interest rates, time and a one-third collapse in nationwide home prices in the six years following the 2006 peak. To the extent that rock-bottom interest rates have goosed the stock market, consumers will feel better and spend more, Bernanke said.
Unfortunately, the "wealth effect" from equity markets doesn't seem to pack the same punch as that from housing, according to research by Credit Suisse economists Neal Soss and Henry Mo. Historically and for obvious reasons, housing wealth has been regarded as more permanent and less volatile than stock-market wealth. With housing values still depressed, the Fed will have to "engineer even larger bull markets in house prices and stock prices for any desired pick-up in economic growth," Soss and Mo wrote in the firm's Feb. 13 U.S. Economic Digest.
At this week's hearing, Senator Tom Coburn, a Republican from Oklahoma, asked Bernanke if there was a "diminishing return" on the Fed's efforts at quantitative easing. Bernanke acknowledged that it was a good question, cited the "substantial benefits" in 2009 when markets were chaotic, and concluded that there were "some positive benefits in terms of growth."
Fair enough. Still, I wonder if Bernanke isn't overconfident about the Fed's ability to unwind its stimulus in a timely fashion (we have the "tools"), identify potential risks to the financial system (we have enhanced supervision) and forecast the future (we have a model). Seven years after the air started to leak out of the housing bubble, the U.S. economy is still operating well below its potential. Housing seems to have bottomed, finally, and is just starting to make a noticeable contribution to economic growth. Under the circumstances, you would think avoiding a repeat of that whose name cannot be spoken -- asset bubble -- would be a top priority for the Fed.
In the three decades since inflation was tamed, the U.S. economy has been prone to periodic bouts of irrational exuberance in asset markets. Why? Both arise from the same source, which is excess money and credit creation. Why isn't the Fed more concerned about how credit is allocated, or misallocated as the case may be?
Senator Bob Corker, a Republican from Tennessee, accused Bernanke of being a "dove" for his implementation of expansionary policies. Bernanke responded by boasting of his record on inflation. He said it was "the best of any Federal Reserve Chairman in the postwar period -- at least one of the best, about 2 percent average inflation."
Alan Greenspan, Bernanke's predecessor, could say the same. With two bubbles -- one in Internet stocks, the other in housing -- under his watch, he's not exactly going to be remembered for his track record on inflation.
(Caroline Baum, author of "Just What I Said," is a Bloomberg View columnist. The opinions expressed are her own.)