Unemployment is stuck above 9 percent, and recent jobs reports have been increasingly ominous. With the legislative branch mired in what can charitably be called cataclysmic paralysis, the Federal Reserve stands as one of the few Washington institutions that can help goose the economy and stimulate employment.
In November, the Fed began a second round of quantitative easing, in which it bought up $600 billion worth of long-term US Treasury bonds in order to lower interest rates and stimulate growth. That program ended on June 30.
On Capitol Hill this week, Fed chairman Ben Bernanke faced an onslaught of questions in both the House and Senate about the possibility of a third round of quantitative easing given the still-dire employment situation. Republicans, who deeply oppose such a move, seemed nervous that Bernanke would undertake QE3. Democrats generally seemed nervous that he wouldn’t. Bernanke’s scattershot testimony managed to alternately satisfy and frustrate both sides—perhaps indicated that the Federal Reserve is as divided as the Congress.
On Wednesday, appearing before the House Financial Services Committee, Bernanke said “the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support.” Media reports proclaimed the Fed was prepared to undertake QE3, and the stock market rallied.
The next day, appearing before the Senate Banking Committee, Bernanke dialed back those expectations. “We’re not proposing anything today,” Bernanke said. “The main message I want to leave is that this is a serious situation. It involves a significant loss of human and economic potential.” Stocks fell on the news.
How should Bernanke’s comments be interpreted—will the Fed try to help the address the jobs crisis? It’s somewhat odd that he sent mixed signals, given that the Fed chairman’s words and actions are parsed so closely that investors can find themselves examining the size of his briefcase on a particular day.
One possibility is that Bernanke is walking a tightrope because the Fed itself is divided on QE3. “I think that he’s trying to manage dissent at the Fed,” said Dean Baker, co-director of the Center for Economic and Policy Research. “I don’t have any inside knowledge, but it is pretty clear that many members of the [Federal Open Market Committee, a part of the Fed] wants him to be fighting inflation. I suspect the deal was a wait and see approach and he may have been worried that he looked like he was jumping the gun yesterday.”
Inflation is a byproduct of quantitative easing, and is often used as the counter-argument to taking action. But inflation is low, unemployment is high, and progressive economists advocate aggressive action. Baker echoed an argument from Paul Krugman, who noted that at Princeton, Bernanke advocated a Japanese response to their fiscal crisis that involved targeting a high inflation rate—around 3 to 4 percent. “That would lower real interest rates and reduce debt burdens,” said Baker. “That probably is not politically feasible, but it would be good policy.”
As for what is feasible, Baker suggested targeting a longer-term interest rate, perhaps a 1 percent target for the five-year rate through 2012.
Either way, it’s clear that Bernanke is not yet ready to take action. Perhaps there’s solace in the fact he even floated the idea—that passes for progress in Washington these days.