Federal Reserve Chairman Ben S. Bernanke pulled out all the stops to avert a depression last year. Now he and his colleagues must decide how to respond to the risk of a growth recession in 2011.
The possibility of a sub-par expansion poses a dilemma for the central bank’s policy-making Federal Open Market Committee when it meets tomorrow. While the economy isn’t so weak that it’s clearly in need of more monetary stimulus, it may not be strong enough to keep unemployment from increasing.
Twenty seven of 58 economists polled by Bloomberg News this month see growth in 2011 below the 2.5 percent to 2.8 percent pace Fed policy makers peg as the long-term trend. Twenty eight see the jobless rate rising above last month’s 9.6 percent sometime in the next nine months. That combination would constitute a growth recession.
“When you’re in a crisis, your mandate’s a little different and you’re not debating things,” said Diane Swonk, chief economist at Chicago-based Mesirow Financial Inc., who attended the Fed’s annual gathering in Jackson Hole, Wyoming, last month. “When you’re in the no-man’s-land” of a “post-crisis economy, it’s a lot harder.”
The Fed’s difficulties are compounded by the fact that it has already cut the overnight interbank interest rate to near zero and FOMC members are divided about the costs and benefits of further easing through unconventional policies such as buying more bonds and increasing its $2.3 trillion balance sheet.
The Fed “is more split than I can ever remember,” said Laurence Meyer, a Fed governor from 1996 to 2002 who is now senior managing director of St. Louis-based Macroeconomic Advisers.
While policy makers aren’t likely to adopt any new initiatives at their meeting tomorrow, they probably will announce a major asset-buying program in January, said Ethan Harris, head of developed-markets economic research at BofA Merrill Lynch Global Research in New York.
That would push the yield on 10-year Treasury notes below 2 percent in the first quarter of 2011, he said. It stood at 2.74 percent at 4:41 p.m. on Sept. 17 in New York, according to BGCantor Market Data.
Lower yields would make investments in shares of companies that pay dividends more attractive, said Jerry Webman, chief economist and senior investment officer at OppenheimerFunds in New York, which manages more than $155 billion.
“One of the things we’ve been doing is encouraging investors in this environment to look at stocks with rising dividends,” he said.
He pointed to Cisco Systems Inc., which said on Sept. 14 that it plans its first shareholder payout this fiscal year. The San Jose, California-based company is the world’s largest maker of computer-networking equipment.
The late Solomon Fabricant, a professor of economics at New York University, coined the term growth recession to describe an economy that isn’t expanding fast enough to keep unemployment from rising. The minutes of the Fed’s last meeting, on August 10, suggested the central-bank staff didn’t see that happening next year. While lowering its forecast for the balance of 2010, the staff foresaw “a moderate strengthening of the expansion in 2011” that would reduce the jobless rate. Fed officials will present an updated forecast at tomorrow’s meeting.
The recession ended in June 2009, the National Bureau of Economic Research said in a statement today. Growth has slowed this year though, to an annualized 1.6 percent in the second quarter from 3.7 percent in the first and 5 percent in the fourth quarter of 2009, according to the Commerce Department in Washington.
The pace of the expansion “recently appears somewhat less vigorous than we expected,” Bernanke said in an Aug. 27 speech at Jackson Hole. “Although output growth should be stronger next year, resource slack and unemployment seem likely to decline only slowly.”
Continued high joblessness -- the unemployment rate has been at or above 9.5 percent for more than a year -- is taking a toll on the economy and consumer spending.
“Our customer remains challenged,” William Simon, president and chief executive officer of Wal-Mart Stores Inc., the world’s largest retailer, told a Goldman Sachs global retailing conference in New York on Sept. 15. The Bentonville, Arkansas-based company has “to figure out how to deal with what is an ever-increasing amount of transactions being paid for with government assistance.
“You need not go farther than one of our stores on midnight at the end of the month,” Simon said. “About 11 p.m. customers start to come in and shop, fill their grocery basket with basic items -- baby formula, milk, bread, eggs -- and continue to shop and mill about the store until midnight when government electronic benefits cards get activated, and then the checkout starts.”
Some Fed policy makers have voiced doubts about how much the central bank can do to spur growth and lower unemployment. Minneapolis Fed President Narayana Kocherlakota blamed much of the joblessness on “mismatch problems,” with many Americans lacking the skills to fill jobs that are available.
Such problems “do not strike me as readily amenable to the kinds of monetary-policy tools currently available to the Fed,” he said in a Sept. 8 speech in Missoula, Montana.
Dallas Fed President Richard Fisher said that he would be reluctant to ease policy further because the economy is constrained by fiscal and regulatory uncertainty. “Further accommodation might be pushing on a string,” he said in a speech on Sept. 1 in Houston.
Bernanke has said the Fed does have the ability to aid the economy, if that’s what’s needed.
“We have the tools to help support economic activity and guard against disinflation,” he told fellow central bankers at Jackson Hole.
The last time the U.S. confronted a growth recession was in 2002-2003, as it struggled to recover from the 2001 contraction. After climbing at a 3.5 percent annual pace in the first quarter of 2002, the economy slowed throughout the year, rising just 0.1 percent in the fourth quarter. The jobless rate rose to 6 percent in December from 5.7 percent in January.
The Fed responded by cutting its target for the federal funds rate by a half percentage point in November and by a further quarter point in June of the following year. That left the rate banks charge each other for overnight loans at 1 percent.
With the rate now near zero, the focus of policy has shifted to the balance sheet and the possibility the Fed might add to its holdings of securities, particularly Treasuries.
Such purchases “would be effective in further easing financial conditions,” Bernanke said in Jackson Hole, adding that the extent of the impact isn’t clear.
“Lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings,” he said.
The central bank’s purchases of securities in 2008 and 2009 may have lowered the yield on 10-year Treasury notes by as much as a half percentage point, based on research by the New York Fed. The effect on the mortgage-backed securities rate was larger, according to the research. In all, the Fed bought $1.75 trillion of securities, including $300 billion in Treasuries.
Future purchases may have less influence on rates, said Lyle Gramley, a former Fed governor who is now a senior economic adviser for the Potomac Research Group in Washington. That’s because such buying seems to have a greater impact at times of heightened stress in financial markets, such as in 2008 and 2009, he said.
While Japan’s asset-buying program from 2001 to 2006 -- so-called quantitative easing -- had a “limited” effect in boosting the economy, it did help dispel concerns about the finances of the country’s banks, according to a July 2006 paper by Bank of Japan official Hiroshi Ugai. Unemployment fell to 4 percent in December 2006 from 4.8 percent in January 2001 after rising as high as 5.5 percent during the six years.
The Fed doesn’t have the research to “be confident about the effects” of asset purchases on the economy, said David Resler, chief economist at Nomura Securities in New York. Still, with growth slowing, he predicts it will announce a program tomorrow.