The Wall Street Journal
By: Jon Hilsenrath
December 8, 2010
The Federal Reserve is likely to leave monetary policy unchanged next week at its final meeting this year as it assesses the impact of its bond-buying program and the unfolding tax debate in Washington.
The central bank has been buffeted by criticism of its plan to buy $600 billion of Treasury bonds since unveiling it in early November. Internal and external critics say the program, aimed at keeping long-term interest rates low, could spur inflation or another asset bubble, stirring doubts about the Fed's commitment to the program and likely muting its impact.
But top Fed officials haven't expressed any inclination to veer from their course or to alter significantly their message to the public about the plan. Though the prospects of business and worker tax cuts and slightly stronger economic growth might reduce the Fed's incentive to add to the program later, persistently high unemployment and low inflation give the central bank little incentive to pull back now.
Fed Chairman Ben Bernanke is leaving his options open. "This is not something that we've set into automatic motion going forward," he said in an interview last week with the CBS program 60 Minutes. "We want to continue to think about it--whether it needs to be changed, whether it needs to be increased or decreased or modified."
Despite the widespread criticism, Mr. Bernanke has maintained his commitment to the purchases. "The balance of risks is in favor of this policy," he said last week.
Several factors will play into Fed officials' thinking when they gather for their monetary-policy meeting Dec. 14:
Slightly Improved Growth Outlook The economy could be gaining some steam, but not enough that officials believe it no longer needs the Fed's support. Despite a disappointing November jobs report, other indicators including retail sales, unemployment filings, factory reports and anecdotal evidence gathered by the Fed's 12 regional banks point to slightly firmer growth.
Output has been growing at an annual rate of just over 2% for more than six months, barely at what Mr. Bernanke has described as the "escape velocity" needed to ensure sustained economic expansion. The economy has to speed up to an annualized growth rate of between 3% and 3.6% next year just to meet Fed officials' modest expectations.
"We are in something of a soft patch," Richmond Fed President Jeffrey Lacker said in a speech Monday, adding that he is more optimistic than most private forecasters about a 2011 pickup. Still, even with better growth, few officials expect much progress on unemployment.
Fiscal Policy in Flux Mr. Bernanke got only part of what he wanted in the Obama administration's deal with congressional Republicans to extend Bush-era tax cuts and include new economic boosters such as a payroll-tax holiday. Mr. Bernanke wants steps to spur growth in the short term, but he also wants a longer-run plan to reduce the federal budget deficit, which hasn't materialized.
The tax cuts could boost the U.S. economic growth rate by a half percentage point or more in 2011, but they also widen the budget deficit. The Fed would welcome the growth but doesn't want to be seen as facilitating deep long-run deficits with its bond-buying plans.
Uncertainty about the budget outlook gives the Fed added incentive to keep monetary policy steady for now. Ultimately, if tax cuts boost growth, worsen deficit worries or stir new inflation worries, the Fed could decide not to push the bond plan beyond $600 billion, or even pull it back. But it isn't there yet.
Assessing the Bond-Buying Plan The bond purchases have failed to push long-term rates lower as hoped. Yields on 10-year Treasury notes have risen to 3.2% from 2.5% since Mr. Bernanke broached the bond-buying idea in late August. But top officials have argued that on the margin, the program has eased broader financial conditions.
Stock prices are up 14% since late August. Moreover, some officials say long-term interest rates would be even higher without the program. Other factors have driven rates recently, including improved economic data and the administration's tax plans. Europe's woes also have strengthened the dollar, which officials hadn't expected.
Communication strategy is part of the Fed's ongoing discussions. Officials considered in October and November tying the bond program more clearly to inflation. One idea was to signal continued bond buying until its forecast for inflation, now around 1%, moved toward 2%.
Some worried that approach could be confusing and others felt the Fed shouldn't tie policy just to inflation when it also has a mandate to bring unemployment down.
If inflation continues to slow, the Fed could revisit this issue.
It could also consider whether to strengthen its commitment to keeping short-term interest rates near zero if markets begin to price in a premature Fed tightening. Fed funds futures markets indicate the Fed is expected to raise the fed funds rate to 0.5% by early 2012. Though the Fed's forecast shows officials expect inflation to remain below their 2% goal and unemployment to remain high through 2012, officials aren't inclined to push against market expectations now.
Write to Jon Hilsenrath at firstname.lastname@example.org