Rosengren defends Fed policy
Boston Federal Reserve Bank President Eric Rosengren today defended the Federal Reserve’s controversial move to buy government bonds, arguing that it has already lowered interest rates and boosted stock markets, and will eventually make a significant dent in the unemployment rate.
Speaking in Providence, Rosengren said the Fed’s decision to buy $600 billion in long-term Treasury bills was driven by the desire to bring down a too-high unemployment rate and prevent too-low inflation from degenerating into deflation, a destructive downward spiral of prices that deepens economic slumps.
The national jobless rate, 9.6 percent, is about double what economists consider full employment, and underlying inflation, below 1 percent, is less half the rate policy makers view as needed to maintain stable prices over the long-term.
“Our economy has been faltering and sputtering, so it was necessary to take some steps to get it actually running,” Rosengren said in prepared remarks. “Solving the economy’s problems will take time and actions by public and private sectors – but getting the economic engine running is the essential first step to broader work ahead.”
The Fed, which has already cut its benchmark short-term interest rate to near zero, said earlier this month that it would provide another jolt of stimulus to the struggling economy by making purchases of long-term Treasuries through the middle of next year. Such purchases lower long-term interest rates on mortgages and corporate bonds, encouraging consumers and businesses to borrow and spend.
The move, however, has come under attack from conservative economists, Republican lawmakers, foreign policy makers, and even former Federal Reserve Chairman Alan Greenspan.
Here in the United States, critics say the policy, which essentially prints money, could spark runaway inflation once economic recovery accelerates. Overseas, they argue that the Fed is manipulating currency, driving down the value of the dollar, which makes US exports cheaper in foreign markets, and foreign imports more expensive in the United States.
But Rosengren, who has emerged as a leading voice for more stimulus from the Fed, said the central bank is merely pursuing its mandate to support maximum employment while maintaining stable prices. Based on the analysis of Boston Fed economists, Rosengren estimated the bond purchases alone would cut the unemployment rate by about half-percentage point by the end of 2012, the equivalent of more than 700,000 new jobs.
Inflation, meanwhile, is not only in check, but dangerously low, Rosengren said. Demand for goods and services is so weak that there is danger prices will fall farther and lead to deflation.
Deflation occurs when there is little demand for goods and services. Businesses slash prices to attract buyers, who stay on the sidelines waiting for prices to fall further. Inventories build, businesses cut production, and workers lose jobs. Consumers cut spending more, and the cycle repeats.
By not launching the bond purchases, Rosengren said, the Fed would have increased the risk of deflation as well as the “risks of continued and possibly worsening pain in the labor markets.”
Once the economy picks up, Rosengren added, the Fed has the tools to drain stimulus from the economy before inflation takes off.
Rosengren said there are already signs that the policy is working. Mortgage rates, while they have ticked up recently, fell to record lows as markets anticipated the Fed’s move. Stocks have rallied, too, which increases wealth, improves outlooks, and supports spending.
“These policy actions have basically had the expected effect,” he said, “and – despite some short run volatility as we get underway – should be broadly effective and helpful to the economy going forward.”