When it comes to achieving his mandate for full employment, Ben S. Bernanke’s willingness to undertake more bond buying shows yet again that he’s the most aggressive and experimental Federal Reserve chairman in history.
Unemployment that’s stalled above 8 percent for 43 consecutive months has prompted Bernanke to make the case for adding to his record monetary stimulus because it would provide a benefit, even if small, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. Bernanke defended his use of unorthodox policies in Jackson Hole, Wyoming, last month, and signaled a third round of so-called quantitative easing might be needed to lower joblessness.
“He wants to do whatever it takes,” said Feroli, a former Fed economist. Bernanke’s message was “let’s get away from the squabbling” over the pros and cons of different strategies and “remember that we’ve got a huge problem here, so let’s do something.”
The policy-setting Federal Open Market Committee will weigh additional accommodation at its Sept. 12-13 meeting. Economists doubt a third round of bond buying would have much impact: Decision Economics Inc. and IHS Global Insight forecast $600 billion in purchases will boost growth in 2013 from less than 0.1 percentage point to no more than 0.4 point.
“Even if Bernanke felt the numbers were small, he would still feel a need to act because he is not meeting the dual mandate on either side,” said Paul Edelstein, director of financial economics at IHS Global Insight in Lexington, Massachusetts. “We are below 2 percent inflation,” the Fed’s target, and “we are far from full employment.”
The personal-consumption-expenditures price index climbed 1.3 percent in the 12 months through July.
Bernanke’s changes to the size and composition of the balance sheet are unique in the Fed’s nearly 100-year history, said Allan Meltzer, a professor at Carnegie Mellon University’s Tepper School of Business in Pittsburgh. “Nothing like this has ever occurred in the past,” said Meltzer, who has published a two-volume history of the central bank.
The Fed chairman’s Jackson Hole speech echoed the tone of a 1999 paper in which Bernanke, a Great Depression scholar, dubbed Japan’s struggling economy “a case of self-induced paralysis” and urged aggressive action from the Bank of Japan to jumpstart growth, Feroli said.
“As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation,” Bernanke said Aug. 31. “The stagnation of the labor market in particular is a grave concern.”
Widespread weakness in the August employment report, released Sept. 7 by the Labor Department, bolstered Bernanke’s case for further easing. Employers added 96,000 jobs, missing the 130,000 forecast by economists in a Bloomberg survey and falling below July’s 141,000 total, which was revised down by 22,000. Average hourly earnings were little changed, and the unemployment rate unexpectedly declined to 8.1 percent from 8.3 percent as 368,000 Americans left the workforce.
Even though additional easing probably wouldn’t significantly alter the U.S. economy’s trajectory, Fed policy makers may view such measures as a worthwhile effort to offset possible drags from a deepening slump in Europe and U.S. fiscal restraint in 2013, according to Antulio Bomfim, senior managing director at St. Louis-based Macroeconomic Advisers.
Last year’s deficit-reduction agreement between President Barack Obama and congressional Republicans helped create a $607 billion “fiscal cliff” of spending cuts and tax increases that will start in January unless Congress acts to stop them. The Congressional Budget Office predicted the changes will trigger another recession if legislators do nothing.
The Fed is partly “motivated by the notion of risk management,” Bomfim said. “You don’t wait until you see those risks materialize. But, more important, the chairman seems to think that quantitative easing is very effective at promoting growth.”
Economic data since policy makers last met July 31-Aug. 1 largely have shown the U.S. on a downward path. Manufacturing shrank for a third month in August, the longest decline since the 18-month recession ended in 2009, according to the Institute for Supply Management. FedEx Corp., operator of the world’s largest cargo airline, said Sept. 4 that earnings for the quarter ended Aug. 31 will be short of its forecast after a weak global economy damped revenue.
Still, consumers are showing more optimism and resilience as almost four years of record-low interest rates allow Americans to reduce debt and home prices show signs of rebounding. Household spending rose in July for the first time in three months, and consumer confidence climbed to a three month high in August, according to the Thomson Reuters/University of Michigan final sentiment index.
Feroli predicts central bankers will extend their plan this week to keep interest rates at record lows beyond the current “at least through late 2014” date and will announce a third round of asset purchases. The first two helped swell the Fed’s balance sheet to a record of almost $3 trillion.
At least four government bond dealers predict Bernanke will abandon a limited plan and opt for open-ended buying. Economists at Goldman Sachs Group Inc., Barclays Plc, BNP Paribas and Deutsche Bank Securities in New York say the Fed will tie the purchases to economic performance, not a sum and end-date.
Another $600 billion in bond purchases -- the same size as the program announced in November 2010 -- wouldn’t change Feroli’s forecast for 8.2 percent unemployment at year-end, he said, adding that it might “marginally” lower his estimate of 8 percent joblessness in December 2013 by 0.1 percentage point.
“It’s beneficial, but it’s probably not going to be, on its own, enough to take us back into a Goldilocks economy,” Feroli said, referring to growth that’s neither too fast nor too slow.
John Lonski, chief economist at Moody’s Capital Markets Group in New York, is more sanguine about the economic boost. He said such purchases may lower yields on 10-year Treasuries to between 1 percent and 1.5 percent, which would support the housing market and help consumer confidence. The benchmark note yielded 1.65 percent on Sept. 10.
“The benefits of QE3 will be demonstrable,” said Lonski, who assigns greater than 50 percent odds the Fed will announce bond buying this week. “It’s a mistake to assume that a further reduction by the 10-year Treasury yield would be without material effect.”
Inflation expectations have climbed since Bernanke’s Aug. 31 speech signaled more stimulus may be imminent. The break-even rate for five-year Treasury Inflation Protected Securities was 2.05 percentage points on Sept. 10, up from 1.92 points on Aug. 30. The rate, a yield difference between the inflation-linked debt and comparable maturity Treasuries, is a measure of the outlook for consumer prices over the life of the securities.
Bernanke said Aug. 31 that a Fed study reported their large-scale asset purchases may have raised the level of economic output by “almost 3 percent” and boosted private payroll employment by more than 2 million jobs. The U.S. economy expanded 2.4 percent in 2010 after contractions of 0.3 percent in 2008 and 3.1 percent in 2009.
The study may be overly optimistic, according to Bomfim. Macroeconomic Advisers estimates $675 billion of quantitative easing would produce 0.2 percentage point of growth next year, reduce unemployment by 0.2 percentage point and have a negligible effect on inflation.
“The chairman did express some measured confidence that the macroeconomic effects are there,” Bomfim said in an interview from his Washington office. The firm predicts the Fed will ease monetary policy as soon as this week, either with another round of quantitative easing or with a change in the guidance for how long it will keep the federal funds rate close to zero, where it has remained since December 2008.
The main reason QE3 will have a “virtually imperceptible” impact on growth is because consumers have limited access to credit, according to IHS Global Insight’s Edelstein. That means lower risk-free interest rates aren’t going to translate into big cuts in borrowing costs for households with poor credit ratings or businesses with risky balance sheets, he said.
Only about $2 billion out of $790 billion in total mortgage originations were classified as subprime in the first six months of 2012, according to Inside Mortgage Finance, a Bethesda, Maryland, company that provides data and research on residential lending. That trend has held for the past 18 months, as such lending totaled $6 billion or just 0.28 percent of all originations.
Even though QE3 may provide only “relatively modest” benefits, the weakness in employment will prompt the Fed to announce additional asset purchases this week, according to Dean Maki, chief U.S. economist at Barclays in New York. Policy makers also will push out their interest-rate guidance, he predicted.
“The Fed is growing more impatient with the state of the labor market,” Maki said. Proponents of more bond buying think it “helps a little bit, and therefore they should do more.”