Ben Bernanke has convinced his counterparts at the U.S. Federal Reserve that the way to stronger economic growth is on the unmapped path of quantitative easing. Now he has to persuade a skeptical public to follow along, too.
Mr. Bernanke and the rest of the Fed's policy committee effectively ended a vigorous internal debate about the wisdom embarking on a second round of unconventional stimulus policy, voting 10 to one on Wednesday to buy $600-billion (U.S.) of longer-term U.S. government debt over the next seven months.
The reason: The economy is growing too slowly to bring down the national unemployment rate of close to 10 per cent, and there's a danger that falling prices could result in corrosive deflation. Household spending is down because millions of people are out of work; employers are reluctant to hire staff; investment in non-residential structures is weak; and housing starts are depressed, the central bank noted. All of which means the Fed is in danger of failing in its mandate from Congress to achieve maximum employment and price stability.
"Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low," the Fed's policy-making committee said in the statement it issued at the end of a two-day meeting in Washington. "Progress toward its objectives has been disappointingly slow."
The idea behind quantitative easing is to lower the cost of money by creating more of it. The Fed isn't planning to draw on existing reserves to buy those Treasury securities, however. Mr. Bernanke will use his power to issue currency to flush money into the economy in the hope that the fresh supply of cash will keep interest rates low.
That would buoy consumer spending and perhaps nudge business executives and lenders to seek higher returns by investing rather than stockpiling.
Another benefit of quantitative easing, from the Fed's perspective, is that it stands to weaken the dollar. That would create inflation by making imports more expensive, and thus benefit U.S. exporters (although at the risk of irritating trading partners who would see their own currencies appreciate).
It's a bold experiment because central bankers have little experience in trying to calibrate the economy in this manner. The Fed bought $1.7-trillion of securities during the financial crisis, but that was in response to a historic collapse in private demand. The U.S. economy is growing now, if at a slow pace. Companies and banks are sitting on hundreds of billions of dollars that they are choosing not to spend.
The risk is high that such stimulus may generate unintended consequences - say, an asset price bubble if investors take advantage of record-low interest rates to buy stocks or commodities. Mr. Bernanke's challenge will be to persuade a critical mass of economists, investors and his political overseers that the greater threat to the economy would be to do nothing, condemning the country to a jobless recovery. It will not be an easy sell.
"What the Fed needs to do now, the most important thing, is explain in a coherent and believable way how they are going to get rid of more than a trillion in reserves without creating inflation," Allan Meltzer, a professor of political economy at Carnegie Mellon University who wrote a history of the Fed, said in an interview from Pittsburgh. "They certainly don't have a plan at the moment."
Ahead of Wednesday's meeting, five of 18 Fed policy makers had gone public with objections or doubts about more stimulus, according to Bloomberg News. Not all of skeptics had a vote, but they were in a position to influence the outcome. In the end, only Kansas City Fed President Thomas Hoenig dissented, saying the risks associated with further asset purchases outweigh the benefits.
The $600-billion program is in line with what most investors were expecting. The Fed will buy a total of $850-billion to $900-billion of securities through June, or about $110-billion a month, the New York Fed said Wednesday in a statement. This will include purchases from reinvesting the proceeds of payments on mortgage securities owned by the Fed from its previous stimulus campaign.
With the benchmark lending rate near zero, the Fed was under pressure to find new ways to breathe life into the economy. At 9.6 per cent, the jobless rate is almost double the rate the Fed targets to fulfill its employment mandate.
Quantitative easing "might not be as effective as it was in 2008 and 2009 because the markets have gotten better," said Vincent Reinhart, a resident scholar at the Washington-based American Enterprise Institute and a former Fed economist. "But at a time of economic distress, it's hard not to use a program that could work."
Mr. Bernanke started working to bring the American public on side by emphasizing that the Fed risks falling short of its price and employment targets. The committee emphasized in its statement that is has a "statutory mandate" to foster job creation and to stand against rapid inflation and deflation. In a speech last month, Mr. Bernanke for the first time revealed targets for both: an unemployment rate of about 5 per cent and inflation of about 2 per cent.
Five Fed officials have scheduled public speeches for Friday, an unusually large concentration for one day.