The Federal Reserve Board's open market committee meeting this week likely presents the FOMC with its last opportunity to boost the economy before the end of the year. While the FOMC meets every six weeks, as a practical matter, the FOMC has historically been very reluctant to take major moves close to an election...
Even the 165,000-a-month average rate of job creation for the last five months is far too slow. With the economy needing roughly 100,000 new jobs a month just to keep pace with labor force growth, it would take us more than 12 years to make up our 10 million jobs deficit at this point.
If there is a clear need for more rapid growth, the data also show there is no downside risk of excessive inflation. The consumer price index fell 0.3% in May. It has risen by just 1.7% over the last year. (The core index rose 0.2% last month and is up 2.3% over the last year.)
Of course, many of us have argued that higher than normal inflation would be desirable, in any case. It would reduce real interest rates in a world where the Fed has already pushed the nominal federal funds rate as low as it possibly can. That would provide businesses with more incentive to invest. Higher inflation should also help to lift house prices, helping homeowners to rebuild equity.
However, even if the Fed is unwilling to accept the idea that it should promote higher inflation, as Chairman Ben Bernanke used to recommend back in his days as economics professor, it should at least be confident that the data show no reason to be concerned about inflation exceeding its target... There are two routes the Fed can go.
First, it could do yet another round of quantitative easing. This amounts to buying up more long-term debt, either treasury bonds or mortgage-backed securities, with the hope of driving down long-term rates further.
The Fed already owns close to $3tn in mostly long-term debt. It could buy another $1tn or so, in the hope of putting somewhat more downward pressure on long-term rates. In an optimistic scenario, perhaps this would lower the 10-year treasury rate by 15-20 basis points. That would allow for some additional mortgage refinancing, and perhaps be a modest spur to investment. It would also help to lower the value of the dollar, which would increase our net exports...
The alternative route would be to pick up an idea that Bernanke tossed out three years ago. He could target a longer-term rate. For example, he could announce that he would set a target of 1.2% for 10-year treasury bonds for the next year (compared to around 1.5% at present). This would mean that the Fed would buy as many Treasury bonds as necessary to bring yields down to this level.
This would have a similar, but likely, somewhat more powerful effect as another round of quantitative easing. In an optimistic scenario, it could lower 30-year mortgage rates by 20-30 basis points, allowing for a rather greater impact on mortgage refinancing and investment.
In neither case will the Fed action turn around the economy. The refinancing process itself will create jobs and provide some boost to the economy. In an optimistic scenario, Fed action could spur 5-10 million refinanced mortgages over the course of a year. If we assume an average saving of 1.5 percentage points on a $180,000 mortgage, this frees up $13.5bn to $27bn in mortgage payments to be spent on other items. That is between 0.1% and 0.2% of GDP. That might translate into 200,000 to 400,000 jobs. That's not getting us to full employment, but it is a step in the right direction.
There is one other important aspect to the Fed's actions that is almost never mentioned. The interest that the Fed earns on its assets is refunded to the Treasury. Last year, the Fed refunded almost $80bn in interest to the Treasury from the bonds and mortgage-backed securities it held.
If the Fed buys more assets, it will have more interest earnings to refund to the Treasury...
If we can stem the urge to cut funding for education or Medicaid by having the Fed buy a few hundred billion more in assets; that would be a pretty good reason to do it.
Tuesday, June 19, 2012
"What Bernanke Can Do..."