It came as no surprise on Tuesday when the Federal Reserve said that the economy was in a more precarious state than it had previously believed. It was refreshing that the Fed stopped blaming “transitory” factors like supply-chain disruptions from Japan and acknowledged, in effect, that this year’s rising joblessness and slowing growth are more than temporary setbacks.
The Fed announced that it expected to keep short-term interest rates at near zero for another two years “at least.” That is a sensible move because it gives markets and businesses a dose of certainty. The stock market, which had plummeted a day earlier, surged to a strong finish. But it’s doubtful that the Fed’s move will be enough to increase employment and growth.
It is particularly disturbing that three members of the Fed’s policy committee view inflation as a bigger threat than a weakening economy and opposed Tuesday’s decision to keep rates low into 2013. Judging from earlier statements, they stand prepared to oppose further measures to boost the faltering economy.
That could make it less likely that the Fed will use other effective tools at its disposal to spur demand and hiring. The committee said it was prepared to do more “as appropriate.” The danger is that as long as the stock market stays relatively stable, further loosening of monetary policy will never be deemed appropriate. Ben Bernanke, the Fed chairman, said at the Fed meeting in June that despite high unemployment, only a heightened risk of deflation would cause further easing by the Fed.
The focus on combating inflation at a time when the economy is clearly not overheating and when oil prices are retreating is akin to Washington’s fixation on spending cuts when the economy is weak. Both are a fundamental misreading of what the economy needs.
This misjudgment has led Congress and the Obama administration to pursue budget cuts without additional near-term stimulus, thus increasing the risk of prolonged stagnation or, worse, renewed recession. And it has led the Fed to deliver a grim economic outlook without doing enough to get growth back on track.
For starters, the Fed could take modest steps, like shifting its portfolio toward bonds with longer maturities, which would help to keep long-term rates low and nudge investors into riskier investments. It could reduce the interest it pays on the banks’ huge reserves or even tax the reserves to try to encourage more lending. It could also resume buying Treasuries or other securities to provide additional monetary stimulus. A more aggressive strategy would be letting inflation rise above the Fed’s comfort level of 2 percent or so to, say, 4 percent. That could help the economy by easing the repayment of debt.
In the absence of stimulative fiscal policy, even assertive moves by the Fed are unlikely to turn the ailing economy around. But they could help, if only the Fed would deploy them.
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