Last Friday’s labor market report was better than expected and provided comfort to some who feared the U.S. economy was heading into a double dip. The news also took some pressure off the Federal Reserve Board to provide additional stimulus to the economy at its next meeting on Sept. 21. That said, the report was not strong by any means. Private payroll growth, at an average of 78,000 over the past three months, has not been keeping up with our growing population and, as a result, has been too low to reduce the unemployment rate.
If hiring continues at this pace, further action by the Fed to bolster the economy seems highly likely. Last month, I argued that the most promising of the current options for the Fed is additional purchases of U.S. Treasury securities. Such purchases would bring down long-term Treasury rates, and, in turn, lower the private interest rates influencing consumers and businesses.
In his recent speech at the Fed Jackson Hole conference, Fed Chairman Ben Bernanke indicated that he also believes that an expansion of the Fed’s large-scale asset purchase program has the potential to provide much-needed support to our weak economy. Yet, he also mentioned disadvantages to the move. What to make of these downsides—are they important enough to outweigh the advantages?
One disadvantage Bernanke cited is that we do not know precisely how additional Treasury purchases will influence the economy. To be sure, the historical experience is limited—the Fed’s $1.7 trillion securities purchase program that ended earlier this year represents the only modern use of this nontraditional policy tool. Given the dire conditions in financial markets when the program was announced in late 2008, it is perhaps not surprising that studies are finding that the purchases had a big impact on lending conditions. Financial markets are not back to normal, but conditions are now much improved, raising questions about how much bang for the buck an extension of the program would have.
I agree with the point about uncertainty, but it does not follow that the Fed should not at least try to provide additional stimulus through more purchases of Treasurys. Were the economy just a little weak, one might worry about the uncertain impact of such a move because of the risk of the economy overshooting its potential and creating inflationary pressures. However, given the enormous slack in our economy, the current risk of overshooting seems pretty minimal.
A second disadvantage Bernanke cited is that more large-scale purchases could raise inflation expectations if they created a widespread perception that the Fed had accumulated so many assets on its balance sheet that it would be difficult to unwind the purchases as the economy recovered. This point also strikes me as an important consideration under stronger economic conditions, but not right now. Inflation expectations are very hard to measure, but the available evidence, if anything, suggests that they may be drifting downward.
The 12-month change in actual core prices is at its lowest level in nearly 50 years. Surveys of professional forecasters and yields on inflation-adjusted Treasury securities suggest a possible decline in long-term inflation expectations. According to Google Trends, searches for the words “deflation” have been trending upward in recent months, particularly here in the United States. Such evidence should allay our concern about the risk that Bernanke raised and suggests that boosting inflation expectations a bit might not be a bad thing.
Central bankers need to be clear, thoughtful, and deliberate in order to preserve the credibility of their institutions. In this regard, I think Bernanke was just right to be voicing his reservations about further quantitative easing at the Jackson Hole meeting. However, if economic developments continue to unfold as they have been, these obstacles seem unlikely to be important enough to stand in the way of further monetary stimulus.