Feb. 7 (Bloomberg) - Last week’s encouraging news on jobs hasn’t much changed the Federal Reserve’s sobering assessment of the U.S. economy. That was Chairman Ben Bernanke’s message to Congress today.
Bernanke is right. One month’s numbers do not make a recovery, and the economy still faces severe difficulties. Recent indicators have been mixed. It’s good that employers added 243,000 jobs last month, and that the unemployment rate fell to 8.3 percent. Manufacturing growth picked up in January, too. But consumer confidence slipped. The housing market is still on its back. The Fed has lowered its forecast for growth this year and still thinks downside risks outweigh the upside.
We’ve said it before, but it bears repeating: Further monetary easing is needed and abrupt fiscal tightening should be put on hold. The alternative would be to risk another round of one step forward, two steps back.
The Fed, you could argue, is doing all it can. Last week the central bank said it expected to keep interest rates close to zero for almost three years, a newly extended timeframe that amounts to a subtle loosening of monetary conditions. Bernanke then went even further.
The central bank has an inflation target of 2 percent, he said -- a firmer statement than before and an upward tweaking of the Fed’s inflation goal (previously, 2 percent was the top end of an implicit target range). Bernanke tweaked it again by saying the Fed’s dual mandate to maintain full employment as well as price stability implied patience in bringing inflation back down when the economy is very weak.
Whether these smoke signals amount to a substantial easing of policy is debatable. From a market psychology point of view, the Fed’s gloom roughly cancels out the comparatively timid steps it is taking to loosen its policy. To be effective, the Fed must be bolder.
It ought to do two things. Much as we have written about the dangers of unleashing inflation, it should affirm that, under exceptional circumstances, it would permit a period of higher-than-target inflation. Last week, under questioning by House Budget Committee Chairman Paul Ryan, Bernanke felt compelled to walk back from previous comments on this. “We will not tolerate higher inflation,” the Fed chairman said firmly. The real question, he said, is how quickly above-target inflation should be brought back down. We sympathize with Bernanke in his dealings with Congress, but this is an invisibly fine distinction, and it leaves investors unsure of Fed policy.
When unemployment is high, short-term interest rates near zero and inflationary pressures diminishing, a rise in expected inflation -- so long as it is carefully controlled -- is not a problem to be avoided but a necessary part of the solution. Under those conditions, showing patience in bringing inflation back down to the target would have the effect of raising inflation expectations. So be it. Last week, Bernanke hinted he’d be patient, but the Fed needs to explain this logic without equivocating, and Congress needs to let it.
Second, the Fed should embark on another round of bond buying, known as quantitative easing, to put more cash into the economy. Together these steps would provide effective monetary easing -- though not necessarily, one should note, lower nominal bond yields. Indeed, if nominal long-term interest rates keep falling, inflation expectations are subsiding and the policy isn’t working.
In reading Bernanke’s work as a scholar, and between the lines of his statements and testimony, there is little doubt he agrees. But the political hazards of moving openly in this direction are clear. The Republican-controlled Congress would erupt. It doesn’t help that the Fed’s board is split on these questions. As a practical matter, the next round of QE might have to wait for an alarming economic setback. If so, that’s a pity, and the economy will suffer needlessly.
Support the Recovery
This puts extra weight on another of the chairman’s favorite themes -- and here we agree without reservation. Fiscal policy needs to better support the recovery. Again, this comes in two familiar and inseparable parts: First, avoid premature fiscal tightening; second, make credible commitments to stabilize public borrowing in the medium term.
As with monetary policy, the problem is politics. The Republican-controlled House is itching to cut government spending immediately, making adequate short-term stimulus impossible. The president and his Democratic allies are fine with postponing talk of longer-term budget retrenchment. In an election year, it’s a task they’d rather not take up.
Scope remains for smaller measures that will help. No question, the payroll tax cut needs to be extended for the rest of the year -- and without offsetting cuts in spending that neutralize the fiscal effect.
We also urge Congress to take up the administration’s latest plan to help the housing market. The idea is to support mortgage refinancings at prevailing low interest rates, and not just for loans backed by Fannie Mae and Freddie Mac. Under previous plans, only home loans owned or guaranteed by the housing-finance companies were eligible. The administration says this would reach an additional 3.5 million households, costing as much as $10 billion. The administration wants to recoup this with a tax on banks. Congress seems likely to balk.
The plan deserves support. The idea is flawed only because, like earlier efforts, it’s still too timid. As we have previously argued, stabilizing the housing market will probably require reductions in mortgage principal as well as access to lower interest rates. The cost of an ambitious plan would run into the hundreds of billions. It would be money well spent, but we recognize it isn’t likely to happen.
Hemmed in by politics, monetary and fiscal policies aren’t doing what they could. Monetary policy is too cautious. Fiscal policy is overly stringent in the short-term and silent on what comes later. These problems are fixable. Let’s hope it doesn’t take another recession to fix them.
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