Why the Fed Deserves Credit for the Recovery
On 12-12-12, a day that already had numerologists buzzing, the Federal Reserve gave the markets a couple of new numbers to obsess over.
Fed Chairman Ben Bernanke and his fellow policy makers met investors' expectations by announcing a total of $85 billion in bond purchases per month. But they also added an unforeseen wrinkle by pledging to maintain the Fed's easy-money, zero-rate stance at least until the unemployment rate falls to 6.5% and expected inflation stays at or below 2.5%.
The setting of explicit targets has been discussed for some time and advocated by some within the Fed as a way to firmly anchor financial-market expectations and clearly convey central bank intentions.
Yet, these targets are mere guidelines, just the minimal prerequisites for the start of an eventual removal of the aggressive monetary stimulus the Fed has maintained. They are really just another way to convince investors and business decision makers that short-term rates will stay near zero and the Fed will stand ready to keep sluicing cash into the financial system until the labor market is unequivocally in better shape.
Indeed, the Fed's statement explicitly said it "views these thresholds as consistent with its earlier date-based guidance," which means the draining of liquidity from the system will not likely happen until mid-2015. In other words, until the reported unemployment rate falls by more than 1.2 percentage points from here, and the Fed's one- to two-year inflation forecast gets over 2.5%, don't even start to worry about rates rising from zero or the Fed shrinking its balance sheet.
The Fed's latest policy moves are not without its critics. The plan to buy $40 billion in mortgage securities and $45 billion in longer-term Treasuries per month adds another $1 trillion a year to the Fed's balance sheet, which already totals $3 trillion. For years, some analysts have been raising alarms that such voluminous money creation would surely uncork damaging inflation, which so far has not occurred. Others gripe that the Fed is essentially enabling the U.S. government's heavy deficits by absorbing so much Treasury debt.
A related complaint, offered here on Yahoo! by John Tamny of RealClear Markets, is that the production of all these reserves is hampering the economy by sapping the strength and reliability of the U.S. dollar.
Yet in the absence of immediate or even early indications of an upwelling of inflation, the Fed is clearly determined to focus maximum effort on the other leg of its "dual mandate," i.e. fostering full employment. So far, at least, the dollar has not collapsed and prices of everyday goods haven't soared. Even gold, which has doubled in price since the financial crisis, has not managed to hang near its 2011 highs even with such fears of dollar debasement being aired loudly.
Economists at Barclays call the latest moves a continuation of the Fed's "bold shift" which "further strengthen the Fed's commitment to generate a stronger recovery and substantially improve conditions in the labor market." Another objective is to join other central banks in working to "successfully contain large negative tail risks," or major market panic attacks.
It's pretty easy to snipe that the Fed's zero-rate policy and trillions in bond-buying pledges have done little to speed up the pace of this recovery and lower the stubbornly high unemployment rate.
Yet the U.S. recovery is among the soundest in the developed world since the Great Recession. Michael Darda, chief strategist at MKM Partners, points out that the Fed's policies "have been exactly enough to keep nominal GDP growing at a steady 4% rate" even with governments acting as a drag on growth in the past year or so.
That 4% nominal rate, which shakes out to a bit more than 2% real growth and just under 2% inflation, might not seem impressive by historical standards. But if it is sustained well into 2013, it would qualify as a victory for Fed policy makers and something of a surprise to financial markets still quick to spy a slowdown or worse around every corner.
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