Fed’s ‘Plan B’ for economy: Talking inflation up
Stop being so worried about economic apocalypse. Get out there and spend. And take some of your money out of the bank and invest in something that might actually produce a decent return.
If Federal Reserve officials could be completely honest, that’s how they’d explain what they want from many Americans under the policy shift they’re now debating.
In part, the new policy is more of the same old policy. The Fed isn’t anywhere close to raising short-term interest rates from the near-zero levels that have prevailed for nearly two years. Your bank savings will continue to pay next to nothing. Get used to disappointment there.
But the U.S. economy has slowed over the last nine months, and the Fed is fearful things could get worse. The economy shed more jobs than it created in September, the fourth straight monthly drop.
“There would appear, all else being equal, to be a case for further action,” Fed Chairman Ben S. Bernanke said in a speech Friday.
For Americans weary of — or terrified of — more intervention in the economy, Bernanke’s attempt to be supportive could backfire. But the Fed seems likely to be more worried about the risks of doing nothing in an economy that clearly has lost momentum.
The next phase of Fed help would involve creating more money out of thin air and trying to get it into the real economy. The first part is a snap for the Fed; the second part has become a lot harder since 2008.
Plan B (my term, not the Fed’s) also may involve something else: Getting inside your head. The Fed wants to convince us that inflation is too low and should rise. That’s a weird argument for a central bank to be making, and Bernanke knows it. The Fed is supposed to be an inflation fighter, not abettor.
But inflation is very low. The core consumer price index — prices excluding food and energy costs — was up just 0.8% in September from a year earlier, the smallest increase since 1961. Bernanke and his peers worry that low inflation could turn into deflation, meaning a sustained decline in prices and wages, if the economy weakens further.
If consumers believe they can get things cheaper if they wait to spend, deflation can become self-fulfilling. As Bernanke put it Friday, “The public’s expectations for inflation also importantly influence inflation dynamics.”
If, instead, the Fed can make you believe that prices will be rising faster in the next year or two, you should in theory be less inclined to hold back, and more likely to spend, if you’re able. That would apply to businesses as well as consumers. More spending could blunt deflationary pressures.
Plan B begins with one of the most eye-glazing terms in all of finance: quantitative easing, or QE for short. It’s not as complicated as it sounds. QE just means the Fed creates money at will and uses that cash to buy Treasury bonds or other assets from banks and other investors.
It did so in 2009 to the tune of about $1.75 trillion in Treasury and mortgage bonds. And since August the Fed has been buying Treasuries again, this time with the money it earns on its mortgage portfolio.
A new QE program, as Bernanke discussed Friday, would involve another large commitment of cash to buy more Treasuries and perhaps other assets.
One goal would be to push down longer-term interest rates in general. On that count the Fed already has succeeded, because officials have been chattering publicly about a new QE plan since August. Treasury bond yields have dropped almost across the board, and that has pulled down interest rates on corporate bonds and mortgages. Home loan rates are at generational lows.
Even if longer-term interest rates don’t fall further, QE has another objective: getting more cash into the real economy. How? As the Fed pays banks and investors cash for their bonds, those recipients have to do something with the money. The Fed naturally hopes banks would be more inclined to lend to businesses and consumers.
But the rap on banks since the 2008 financial crash is that they’re reluctant to lend. They say the issue is that many businesses don’t have any need to borrow because the economy is so weak. And as for consumers, the people who most need money are those who can’t qualify for a loan because they don’t have enough income or collateral.
Say the Fed creates $1 trillion in fresh cash and pumps it into the financial system. Does it get into the economy? The Fed can’t guarantee as much, but that’s where policymakers may use inflation psychology to try to increase their odds of succeeding.
Bernanke spent much of his speech Friday explaining the Fed’s concerns about too-low inflation. If the Fed decides to tell us that it’s going to boost efforts to lift the rate of inflation, maybe we’ll start to believe them. The creditworthy business owner who needs new machinery, but has been reluctant to go for it because of economic uncertainty, might decide that it’s finally time to talk to a bank about a loan.
Likewise, U.S. consumers who have the wherewithal to spend — and there are tens of millions of them out there, even in an economy with a horrid 9.6% jobless rate — also might decide that there’s no point in putting off spending on things they want or need.
That also could have implications for some of the $8 trillion that’s now sitting in short-term bank accounts and money market mutual funds, earning virtually zero. If inflation is less than 1%, you may not care much about earning nothing on your money. But if you believe that inflation could rise back to 3%, suddenly a zero return is harder to accept.
By just publicly discussing a potentially massive new QE push to underpin the economic recovery, the Fed in the last month has motivated some investors to jump into the stock market. The Dow index is up 10.5% since Aug. 31. Many foreign stock markets have risen even faster.
Less comforting to the Fed is that prices of many commodities, including gold, also have soared. The prospect of more easy money has devalued the dollar, in turn fueling the appeal of hard assets. Still, rising asset prices overall serve the Fed’s purposes via the wealth effect: An appreciating investment portfolio is more likely to make you feel better about spending money.
But as many Americans clearly sense, the idea of infusing the financial system with another huge amount of cash carries enormous risks. If the money just sits at the banks, the Fed may accomplish very little, damaging its credibility.
And trying to drive up inflation expectations is a dangerous game. The Fed could succeed too well — and instead of 3% inflation we end up with 5% or 10%. For a central bank, “The 800-pound gorilla in the room . . . is the imprecise nature of moving inflation and inflation expectations, then moving them back when it suits you,” warned economist Robert Brusca at Fact and Opinion Economics in New York.
What’s more, the Fed is encouraging an economy that’s heavily in debt to create more debt. And consumers who need to save more for the long run are being goaded to spend.
The glaring absurdities aside, if the Fed launches Plan B it has to work, and not do harm. Because there probably is no Plan C.
