By Jon Hilsenrath | WSJ | Jun. 6, 2012
Disappointing U.S. economic data, new strains in financial markets and deepening worries about Europe's fiscal crisis have prompted a shift at the Federal Reserve, putting back on the table the possibility of action to spur the recovery.
Such action seemed highly unlikely at the central bank's April meeting, when forecasts for growth and employment were brightening. At their policy meeting this month, Fed officials will weigh whether the U.S. economic outlook is deteriorating enough to justify new measures to boost growth, according to interviews and Fed speeches.
The Fed's next meeting, June 19 and 20, could be too soon for conclusive decisions. Fed policy makers have many unanswered questions and have had trouble forming consensus in the past. Top Fed officials have said that they would support new measures if they became convinced the U.S. wasn't making progress on bringing down unemployment. Recent disappointing employment reports have raised this possibility, but the data might be a temporary blip. Moreover, the Fed's options for more easing are sure to stir internal resistance at the central bank if they are considered.
Their options include doing nothing and continuing to assess the economic outlook—or more strongly signaling a willingness to act later if the outlook more clearly worsens. Fed policy makers could take a small precautionary measure, like extending for a short period its "Operation Twist" program, in which the Fed is selling short-term securities and using the proceeds to buy long-term securities. Or, policy makers could take bolder action such as launching another large round of bond purchases if they become convinced of a significant slowdown.
The landscape for the Fed is complicated by the presidential election. Mindful of his own legacy and the Fed's independence, Chairman Ben Bernanke seems unlikely to allow the political calendar to sway his decisions. He appears especially immune from politics now, with just 18 months left in his term as chairman and little indication that he wants another. Still, some investors speculate the Fed has an incentive to decide quickly to avoid shifting policies close to the November vote.
This week, Mr. Bernanke and Fed Vice Chairwoman Janet Yellen will explain where they stand on the economy and policy. Mr. Bernanke will testify Thursday before the Joint Economic Committee of Congress. Ms. Yellen will deliver a speech in Boston Wednesday evening.
When Fed policy makers meet, one critical issue will be whether they downgrade their forecasts much. In April, they predicted the economy would grow between 2.4% and 2.9% this year, and the jobless rate would fall to between 7.8% and 8.0%. That was a slightly better outlook than in January. They also nudged down their unemployment forecasts for 2013. But last week the government reported that the economy expanded at just a 1.9% annual rate in the first quarter and the unemployment rate in May was 8.2%. After falling in late 2011, the jobless rate has moved little in the past few months.
There is little worry at the Fed of a new recession. But central-bank policy makers might act if their growth forecasts decline enough to raise doubts about the economy's capacity to keep lowering unemployment.
The employment data are hard to read now. Some of the recent slowdown in job gains might be a temporary payback after a hiring spurt in January and February partially related to warm weather. Fed officials also worry that data might be skewed by seasonal adjustments that statisticians use to smooth normal monthly swings in the data. These adjustments are based on past movements in the economy and might have been thrown off by large swings during the financial crisis.
Mr. Bernanke suggested in March that he anticipated some slowdown in job growth because the economy wasn't expanding fast enough to support continued large unemployment declines.
A number of officials aren't yet convinced the outlook has significantly darkened. James Bullard, president of the St. Louis Fed, said the weak May jobs report was disappointing, but not enough to substantially alter his expectation for "sluggish growth modestly improving over the coming year." Speaking in St. Louis, he also said new Fed policies wouldn't ease Europe's financial woes.
In an interview Friday, Cleveland Fed President Sandra Pianalto said she wasn't yet convinced that the outlook had significantly darkened.
There are other new economic concerns at the Fed. Financial conditions appear to have worsened in the past few weeks, with stock prices falling, the dollar strengthening and high-risk debt—such as corporate and mortgage bonds—becoming more costly relative to low-risk debt, such as Treasury bonds.
The Fed has said it would keep short-term interest rates near zero through at least late 2014. The latest spate of bad data is likely to cement the conviction of top officials to stick with that plan.
Mr. Bernanke faces tactical decisions as he plots a strategy for another potential summer economic swoon. The $400 billion Operation Twist program is set to end this month. Like other bond-buying programs, it is meant to push long-term interest rates lower and drive investors into riskier assets. An immediate question is whether to let it end.
Mr. Bernanke must decide whether to let the program end. The Fed has enough short-term securities left to extend it for a few months as a precaution while it watches how the economy develops. If officials become more convinced about a growth slowdown they could expand the Twist program or launch another round of securities purchases—an approach known as quantitative easing—to try to boost growth.
Mr. Bernanke will confront a divided Fed when officials meet. Some doubt the effectiveness of buying more bonds when interest rates are already very low. Moreover, some officials have become frustrated that low rates aren't helping many segments of the economy because of banks' unwillingness to lend. And some officials worry that the Fed is risking higher inflation or another financial bubble down the road if it keeps expanding its $2.8 trillion portfolio of securities and loans. Others, however, believe the Fed should be doing much more to spur growth, especially at a time when inflation looks to be planted near the Fed's 2% objective. They also argue that the bond purchases, though an imperfect tool, have helped to drive long-term interest rates down and stock prices higher, which they say has spurred spending and investment.
Officials in the Fed's activist wing are speaking out for more action. "We should be providing more accommodation," Charles Evans, president of the Chicago Fed, said in a speech Tuesday evening. Mr. Evans has long called on the Fed to provide an assurance it won't raise interest rates until unemployment falls below 7%, or unless inflation rises above 3%. Mr. Evans told reporters after his comments he expected to shave his growth forecast and worried employment progress could stall.
Tuesday he also said, "steady progress toward stronger growth is essential, and I would be willing to buy mortgage-backed securities to do so."
On the other hand, the Fed's wing of policy skeptics came out against further action Tuesday.
"During the next few weeks as I contemplate the future course of monetary policy, I will be asking myself what good would it do to buy more mortgage-backed securities or more Treasurys when we have so much money sitting on the sidelines," Richard Fisher, president of the Dallas Fed, said in a speech Tuesday at St. Andrews University in Scotland. "I believe that were we to go down the path to further accommodation at this juncture, we would not simply be pushing on a string but would be viewed as an accomplice to the mischief that has become synonymous with Washington."
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