The Fed's Identity Crisis

Article excerpt

Byline: Robert J. Samuelson

Its power has given way to doubt.

It is widely, although not universally, assumed that the Federal Reserve will move in early November to bolster the economy by trying to nudge down long-term interest rates on Treasury bonds, home mortgages, and corporate bonds. Just how much rates would decline and how much production and employment would increase are uncertain. What's clearer is that the move would be something of an act of desperation, reflecting a poverty of good ideas to resuscitate the economy.

The Fed is suffering an identity crisis. Celebrated under chairman Alan Greenspan as a guarantor of prosperity, it is now struggling to regain its exalted reputation. In the acute phases of the financial panic, in late 2008 and the first half of 2009, it devised ingenious ways to provide credit to parts of the financial markets (commercial paper, money-market funds) that were being abandoned by private lenders. For almost two years, it's held its short-term interest rate near zero. All this arguably averted a second Great Depression, but it obviously did not trigger a vigorous economic recovery.

Chairman Ben Bernanke makes periodic speeches arguing that, despite lowering its short-term interest rate to virtually zero, the Fed still has ample policy tools to revive the economy and reduce the appalling levels of unemployment. The reality is otherwise; the Fed's remaining tools are arcane, weak, or both.

What the Fed is expected to authorize in November is a large purchase of U.S. Treasury bonds with the intent of driving down their interest rates, and rates on other long-term debt securities. It has already done this once. In late 2008 the Fed approved massive bond purchases; these ultimately totaled $1.725 trillion of mortgage-backed securities, U.S. Treasury bonds, and Fannie Mae and Freddie Mac bonds. Bernanke has said the program "made an important contribution" to the economic recovery.

But the measurable effects were small. A Fed study estimated that rates on all 10-year bonds might have dropped by 0.6 percentage points. The decline this time might be less, because starting interest rates are already low (about 4.3 percent for a 30-year mortgage) and the purchases might be smaller. …