Dec. 12, 2012 at 12:45 PM ET
The Federal Reserve is keeping its foot hard on the economy’s accelerator amid persistent high unemployment that may be sapping the confidence of consumers and businesses.
But critics of the policy are beginning to voice concerns that the short-term boost to growth may be creating much bigger problems down the road.
The nation's central bank announced Thursday that it would continue buying bonds at an aggressive pace to keep interest rates low and spur job growth. The policy extends the Fed’s four-year strategy of flooding the financial system with cash by piling more debt onto the nearly $2.8 trillion in Treasury and mortgage bonds already stashed in its vaults.
Critics of the policy are beginning to voice concerns that the short-term boost to growth may be creating much bigger problems down the road. The fear is that the Fed's policy could spark a round of damaging inflation, and that the eventual unwinding of that debt pile would force rates higher again, dampening economic growth.
At a news conference following the central bank’s policy decision, Fed chairman Ben Bernanke acknowledged that, as the Fed’s holdings swell, “there’s a greater cost that might be associated with that.”
But Bernanke and supporters of the Fed’s current policy argue that a prolonged period of high unemployment creates a greater risk of long-term damage to the U.S. economy. The longer workers remain out of a job, Bernanke has said, the less likely they are to find new jobs that pay as well as the ones they lost.
“If we could wave a magic wand and get unemployment down to 5 percent tomorrow, obviously we would do that,” Bernanke told reporters.
On Wednesday, Fed policymakers voted to continue buying some $45 billion worth of Treasury bonds every month, extending a program that was to have expired this month. In a surprise shift, the central bankers set a specific target for holding interest rates at historic lows near zero percent. So long as inflation remains contained, the Fed pledged to continue buying bonds until the unemployment rate, now at around 7.9 percent, falls below 6.5 percent.
"Although the unemployment rate has declined somewhat since the summer, it remains elevated," the Fed said in a statement released after a two-day meeting of its policy setting Federal Open Market Committee.
The renewed bond buying followed several rounds of unprecedented – and untested – policies the central bank has adopted in the years following the worst financial meltdown since the Great Depression.
The latest, known as “Operation Twist,” involved selling short-term debt and buying long-term bonds. The effect was to create more demand for those bonds, driving down interest rates on long-term borrowing, like mortgage loans while draining cash out of the system with the sale of short-term debt.
But the program exhausted the Fed’s supply of short-term debt holdings. With the job market still weak, the central bank decided to continue buying longer-term bonds to keep interest rates low indefinitely. Record low mortgage rates have helped revive the housing market and lowered monthly payments for millions of homeowners, freeing up more money for consumers to spend.
The Fed’s historic bond buying binge has left it holding a huge pile of debt. Since the global financial system melted down in September 2008, the Fed has more than tripled its holdings of Treasury debt and mortgage bonds to more than $2.8 trillion.
Critics argue that the Fed may be going too far by continuing to expand its holdings because the infusion of cash used to buy those bonds raises the risk of higher inflation. They also worry that, as those bonds are eventually sold off, those sales typically have the reverse impact of raising interest rates, which would tend to slow economic growth.
Wall Street rallied on the Fed's announcement, however, on the theory that a fresh infusion of tens of billions in cash will help prop up stock prices. But not all investors were encouraged by the Fed’s latest policy decision.
“It's remarkably dangerous for the FOMC to continue to expand its balance sheet without any assistance on fiscal policy from The Hill,” said Todd M. Schoenberger, a managing partner at LandColt Capital. “It may take generations to unwind these accommodative monetary policy moves.”
The Fed’s critics include one of its own policy makers, Richmond Fed president Jeffrey Lacker, who cast a lone dissenting vote on the bond buying plan Wednesday, as he has at all seven Fed policy meetings this year.
Lacker has argued that the job market is improving in spite of the policy, which he thinks risks sparking a nasty bout of inflation. The longer the Fed keeps adding to the pile of bonds accumulating in its vaults, the harder it will be to unwind those holdings, he told an economic conference last month in Charleston, W.Va.
“We are in uncharted territory, and that will make it difficult to get the timing just right,” he said. “The larger our balance sheet when the time comes to withdraw monetary stimulus, the more difficult and risky that process will be.”
But the rest of the policy committee believes there’s a greater risk in backing away from its current strategy. Though the pace of hiring has improved this year, the economy is much weaker than during any recovery from recession in the past half century.
After showing signs of life this summer, growth appears to be slowing again. Consumers and businesses have turned gloomy as Congress and the White House remained deadlocked on a budget deal. Until a compromise is reached by year-end, a half trillion-dollar package of tax hikes and spending cut will kick in, producing a major drag on economic growth.
The mood of American consumers – who account for more than two thirds of economic activity – turned markedly sour this month, according to a survey released last week. The Thomson Reuters/University of Michigan's preliminary reading of its index of consumer sentiment plunged to the lowest level since August.
Small business managers are also feeling downbeat. .Sentiment tumbled to its lowest level in more than 2-1/2 years in November, according to the National Federation of Independent Business. The group’s monthly optimism index plummeted to its weakest reading since March, 2010.