by Jon Hilsenrath
Friday’s grim jobs report will no doubt have many Federal Reserve officials wondering what, if anything, they can do to support an economy that appears to be badly stumbling. Fed Chairman Ben Bernanke laid out his thinking in his June press conference.
Despite the bad jobs numbers, it appears unlikely that the Fed will choose to do anything soon.
As Mr. Bernanke explained in his press conference, “the current outlook is significantly different than what we were facing in August of last year.” Back then, the Fed was worried that consumer prices were going to start falling, sending the U.S. into a Japan-style bout of deflation. So it decided to buy $600 billion in Treasury securities to boost markets and hold long-term interest rates down. “We no longer have a deflation risk,” Mr. Bernanke said in June. “Inflation is above — at the moment — is above target.” Moreover, Fed officials are forecasting a turnaround in the second half of the year.
If Fed officials see signs that inflation is slowing again, or if the turnaround doesn’t materialize, the picture may change. Indeed, commodities prices have retreated in recent weeks. But Mr. Bernanke signaled in June that he wanted to take some time to watch the economy before deciding on next steps. It’s not obvious that the jobs number, as bad as it was, will be enough to shift his thinking.
If the Fed were to do more, Mr. Bernanke laid out four steps it could take:
–QE3: Officials believe that the first round of securities purchases, known as quantitative easing, worked well to stabilize markets, reduce interest rates and promote recovery and that the second round staved off deflation worries and boosted markets. But they worry that both rounds came with costs, including a bloated balance sheet that someday will need to be unwound and severe political backlash. Many investors are going to start screaming for “QE3.” But given the costs, there’s reason to believe it wouldn’t be the Fed’s first choice unless inflation really started to slow.
–PROMISES, PROMISES: Another potentially more promising intermediate step laid out by Mr. Bernanke was a change in communications strategy. The Fed has given an assurance to the public that it expects to keep short-term interest rates near zero for “an extended period.” This is meant to encourage risk-taking, spending and investment. The Fed could set parameters around the “extended period” language. For instance, it could say, as the Bank of Japan has in the past, that it won’t raise rates unless certain conditions are met, like a move of its inflation projections above the Fed’s 2% goal. An added benefit of this approach is that it is a step toward a more explicit inflation target, which Mr. Bernanke supports, as do many inflation hawks on the Federal Open Market Committee. A drawback is that few investors see any chance of the Fed raising interest rates any time soon anyway. So it’s not clear the Fed will get much out of it. The Fed could also be more explicit about what an extended period means. The Bank of Canada during the crisis said rates wouldn’t rise for at least a year. Fed officials weren’t crazy about that approach, but they haven’t dismissed it.
While the Fed already gives investors some guidance on its plans for short-term interest rates, it has given no explicit guidance on how long it plans to hold on to its vast portfolio of Treasury securities and mortgage debt. Mr. Bernanke made clear that the Fed might change that and be more explicit about its plans for the portfolio. “It’s something we have on the table, something we’ve thought about,” he said. An assurance that it won’t sell them could help to hold long-term interest rates down and give investors more confidence. Mr. Bernanke seemed to suggest that he could move in this direction. “We’ve not yet chosen to make any particular commitment about the time frame,” he said at the press conference in response to a question from The Wall Street Journal. Note the word, “yet.”
–SHIFT THE PORTFOLIO: Fed officials believe that their securities purchases work in part because they induce risk-taking among investors by taking long-term securities — also known as “duration” — out of the market. Long-term securities are riskier than short-term securities because investors need to wait longer to get paid back. The thinking is that if there are few 10-year notes in the market, investors will go out and find other risky assets to invest in, like stocks or corporate bonds, thus pushing up stock prices and pushing down interest rates on other securities. The Fed could keep the overall size of its portfolio steady, but shift the makeup of the portfolio to have this impact. For instance, it could allow short-term holdings to mature and buy very long-term holdings in their place. Mr. Bernanke hinted at this in his press conference when he talked about structuring its portfolio in “different ways.” It’s hard to see the Fed generating very big confidence-inducing headlines from such a strategy. And it comes with costs — more long-term securities to sell one day when it’s time to exit. But it’s clearly on Mr. Bernanke’s list.
–NIBBLE AWAY AT SHORT-TERM RATES: The Fed now pays banks 0.25% for the money that they keep on reserve with the central bank. It could move this rate down a little further to give banks less incentive to park it in short-term markets and more incentive to lend it out. Because it is so close to zero, however, there’s not much more the Fed can do on this front. And lowering the rate comes with costs. If the Fed goes all the way to zero, it could hurt some important short-term lenders. The most obvious victims would be money-market mutual funds, which would be forced to find other ways to boost earnings on their piles of cash holdings. Right now, many U.S. money market funds have lent short-term funds to European banks. Does the Fed really want them taking more risk like that?
Taken together, the Fed is in a tough spot. The decision to purchase Treasurys last year was highly controversial internally for Fed officials. Doing it again, when inflation is moving up, would be even more so. And the policy tools don’t look terribly potent.
As Mr. Bernanke put it in his press conference: “We have an awful lot of uncertainty right now about how much of this slowdown is temporary, how much is permanent. So that would suggest, all else equal, that a little bit of time to see what’s going to happen is — it would be useful in making policy decisions. We’ll continue to look at the outlook and act, you know, as appropriately as the news comes in and the projections change.”
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