Republicans take aim in battle to sink the Fed's QE2
Right-wingers on Capitol Hill want to end the US central bank's mandate to combat unemployment
Wednesday 17 November 2010
The Federal Reserve is facing calls to be stripped of its mandate to ensure full employment in the US and told to focus solely on price stability, in a backlash against its $600bn (£377bn) programme of quantitative easing.
Amid concern that the new, looser monetary policy may lead to inflationary pressures down the road, and with US trading partners complaining vociferously about the Fed's actions, Republicans on Capitol Hill seized the moment to propose reform of the central bank.
The Fed has also found itself on the back foot because of uncertainty about the potential effectiveness of its new round of quantitative easing – dubbed QE2, because it is the second time since the credit crisis that the Fed has printed money to buy up Treasuries and other bonds. The aim of the programme is to drive up the price of government bonds, thereby reducing their interest rates and making credit cheaper for businesses and homebuyers across the US.
However, rates have actually risen sharply since the Fed began buying Treasuries last week.
In a sign that they are concerned about misunderstandings and mischaracterisations of their policy, Fed officials fanned out to defend QE2 yesterday, but Republicans stepped up their attacks on the central bank. Bob Corker, a member of the Senate banking committee, said Congress should legislate to end the Fed's dual mandate, and tell it to focus solely on battling inflation. The Fed was first charged with ensuring "maximum employment" in 1946 in the aftermath of the Second World War and the Depression.
The dual mandate makes the Fed a "bipolar" institution and confuses financial markets, Senator Corker said. "Providing our central bank with a clear and explicit focus on keeping inflation low will serve America better than the broader mandate approach we have today."
Mr Bernanke has spoken repeatedly about the dangers of persistently high unemployment, which sits at 9.6 per cent in the US, which he says is dragging down overall demand in the economy. Interest-rate setters at the Fed say that inflation, at less than 1 per cent, is uncomfortably close to deflation and looks like being below the unofficial 2 per cent target for some time.
The right contends that printing money to buy government debt will debase the dollar and lead to rampant inflation. In other words, the Fed is recklessly risking price instability in an attempt to boost the economy enough to get unemployment down.
The former vice-presidential candidate Sarah Palin channelled conservative anger at the Fed at the weekend, calling on Ben Bernanke, chairman, to "cease and desist" with QE2. And on Monday night, House of Representatives member Mike Pence, a potential conservative challenger for the Republican presidential nomination in 2012, introduced legislation to end the dual mandate.
The move threatens to drag the role of the Fed to the centre of the economic debate on Capitol Hill, less than a year after the bank thought it had fought off political intervention in monetary policy. A bill that would have required an "audit" of the Fed's monetary policy did not garner support last year, after Mr Bernanke and his lieutenants warned that political intervention would unsettle markets and lead to higher interest rates.
Janet Yellen, the Fed's vice-chairman, said she was "not happy to see us caught up in a political debate", and said that doomsday predictions of soaring inflation were wide of the mark. "I'm having a hard time seeing where really robust growth can come from, and I see inflation lingering around current levels for a long time."
Ms Yellen, speaking to The Wall Street Journal, was one of several officials fanning out across the media in an attempt better to communicate the Fed's policy. Its Federal Open Market Committee decided on 3 November that it would pump the new money into credit markets in the next eight months, at a rate of $75bn per month. The purchases began last Friday and are continuing on a daily basis this week.
Interest rates on the benchmark 10-year Treasury have risen from 2.67 per cent on 3 November to 2.92 per cent yesterday, and some bond yields now sit at three-month highs. Critics say the Fed has failed to get rates down because the markets are now worrying about future inflation, and that QE2 is doomed to be counter-productive. Traders have said the Fed trailed the start of QE2 for so long that the downward move in rates came before, not after, the announcement. The snap-back has been the result of investors cashing in on their earlier bets, they say.
The Fed's Bill Dudley, president of the New York branch of the central bank, conceded yesterday that QE2 would not have a "huge, powerful" effect on the US economy, but instead characterised it as a "little bit of a nudge" that could create a virtuous circle of cheaper credit and improving demand.
Alan Blinder, a former Fed vice-chairman and a colleague of Mr Bernanke's at Princeton University, argued that the Fed would have a bigger effect on interest rates if it bought private-sector bonds, not government debt. That could be a more direct way to cut interest rates for companies, and would encourage the private sector to raise money for investment and job growth.
Despite disagreeing with the Fed's precise methods, Professor Blinder has become the the bank's most vociferous defender, dubbing domestic political critics as a modern day "Flat Earth Society".
Other economists also weighed in in support yesterday. "Criticisms of QE2 are beginning to border on the ludicrous," said John Lonski, chief US economist at Moody's Investors Service. "One widely quoted analyst stated that QE2 could doom the US to suffering the same fate as the Weimar Republic – but please don't feel compelled to run out and buy some Lederhosen. Moreover, it's unlikely that Americans soon will be exchanging their wallets for wheelbarrows. Hyperinflation does not impend. If anything, the Fed might have difficulty driving the annual rate of core inflation up to 1990's latest peak of 4.7 per cent, never mind reaching 1975's apex of 10.2 per cent."
Against economic easing
Niall Ferguson The historian is one of 23 signatories to an open letter to the Federal Reserve chairman Ben Bernanke saying QE2 risks "currency debasement and inflation" with no guarantee it will boost employment. "We disagree... that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero... will distort financial markets and greatly complicate future Fed efforts to normalise monetary policy."
Sarah Palin "What's the end game here?" the Republican asked. "Where will all this... take us? Do we have any guarantees that QE2 won't be followed by QE3, 4, and 5, until eventually – inevitably – no one will want to buy our debt anymore? When Germany, [which] knows a thing or two about the dangers of inflation, warns us to think again, maybe it's time for chairman Bernanke to cease and desist."
Zhou Xiachuan China's central bank chief said the US should focus on "reforming the international currency system" rather than taking unilateral action that amounts to a competitive devaluation. "If the domestic policy... is not an optimal policy for the world, it may bring a lot of negative impact," he said.
For economic easing
Alan Blinder "The anti-Keynesian revival has been disheartening enough. But now the economic equivalent of the Flat Earth Society is turning its fury on Ben Bernanke and the Federal Reserve," the Princeton economics professor and former Federal Reserve vice-chairman wrote in The Wall Street Journal. "It is not a shot in the dark, not a radical departure from conventional monetary policy, and certainly not a form of currency manipulation."
Barack Obama Amid criticism from across the G20, the US President weighed in to defend the Fed. "I will say that the Fed's mandate, my mandate, is to grow our economy. And that's not just good for the United States, that's good for the world as a whole. The worst thing that could happen to the world economy, not just ours, is if we end up being stuck with no growth or very limited growth."
William Dudley "What we're trying to do through our large-scale asset-purchase programs is to remove Treasuries from the market and force private investors into other assets," the president of the Fed's New York branch told CNBC yesterday. QE2 could lead to "a virtuous circle... a little bit more demand leads to more employment growth, higher income and rising confidence."
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