The Fed Jumps on the Bandwagon

Too little too late? Depends who’s asking. Late last week, the U.S. Federal Reserve Board finally launched another round of what it calls "credit easing" — buying securities in the private market to improve the availability of credit — and also committed to keep short-term interest rates low through mid-2015. Some people, especially certain presidential incumbents running for reelection, would have liked to see this happen earlier. But now the real question is whether it will matter at all.

The Fed committed to buy $40 billion a month in mortgage-backed securities issued by Fannie Mae and other government-backed enterprises, thus injecting a huge amount of new money into a long-term lending market. The hope is that long-term interest rates will fall as a result of the increase in the supply of money; it’ll be easier for homeowners to refinance (giving them more cash) and for new buyers to get mortgages (creating more demand for housing).

Eventually — it typically takes several months — this cash injection is supposed to encourage companies to make new investments and hire more people. As a result, the Fed’s action may only boost Barack Obama’s chances of reelection through the spike in the stock market that followed the Fed’s announcement. Of course, the people who own most of the nation’s stocks don’t spend every increase in their wealth, if they even live in the United States, so rising markets don’t necessarily translate into higher consumption and new jobs.

Either way, the Fed’s action will continue to depress the dollar against other currencies, and in the long run this may make the United States less dependent on foreign investors, help American exports, and create jobs. Even if American imports are affected by the exchange rate, a recovery here will still be good news for the global economy, as billions in income generated in the United States flow abroad. And if the Fed does manage to bolster employment, it will also transfer some wealth from savers to workers by lowering long-term interest rates in a bid to spur job creation today.

So why did the Fed wait to act until now? For months, its officials had been saying that the U.S. economy’s growth was too slow but not slow enough to compel them to act. For one thing, they doubted the effectiveness of further easing because, quite simply, they didn’t think companies had very good opportunities to invest. The uncertainty caused by political tribulations in Washington and the rolling snafu in the eurozone were probably holding back businesses more than interest rates, which were still at historic lows.

What changed? Some of that uncertainty finally went away. Two weeks ago, Mario Draghi, the president of the European Central Bank, declared that he would use extraordinary measures to support the euro if necessary, and — perhaps because he was relatively new in the job and still had his credibility intact — the markets believed him. Then, Mitt Romney reloaded his revolver and shot himself in the foot a few more times over his economic plans and foreign policy, leading even conservatives to say he had lost an election he didn’t deserve to win, anyway. The chances that he and Paul Ryan — who was unconcerned by the notion of the United States defaulting on its debt as chair of the House Budget Committee — would win in November fell to about 30 percent in the prediction markets.

It’s possible that the Fed’s governors decided companies could at last be pushed off the fence by a further round of easing. Or perhaps they decided that they had to be seen doing something. After all, the Fed has a dual mandate to maintain price stability and promote full employment. Since Republicans in Congress had done their best to obstruct any fiscal policy that would support the economic recovery — back in 2010, their leader in the Senate, Mitch McConnell, even said he wished they had been able to "obstruct more"  — all of the burden for putting Americans back to work fell on the Fed’s shoulders.

The effects of that obstructionism are starting to dissipate, though, as job losses in state and local government, in large part the result of congressional stinginess, are finally slowing. The private sector has been slowly but steadily creating jobs since early 2010, so the unemployment rate could begin to fall more quickly at any moment.

As a result, if the economy finally does snap back to a healthy rate of growth, it’ll be tough to figure out whether the Fed’s action was decisive. Are we really supposed to believe that all the factors that made the Fed’s governors doubt their own effectiveness for the past year or so suddenly disappeared? Or are they just jumping on Mario and Mitt’s bandwagon of certainty?

We can’t go through history twice — once with the Fed buying securities, once without — so there’s no way to know for sure. Long-term interest rates like the Treasury’s 10-year note have actually risen since last week’s action, not fallen as the Fed might have hoped.  But even this signal is hard to interpret. It could mean that other sources of uncertainty are making lenders nervous. Or it could be a sign that the markets expected a strong recovery; a surge in profitable economic activity usually comes with more demand for credit, so rates tend to rise.

In any case, it’s too early to appraise the results of the Fed’s move; only days, not months, have passed. And the Fed isn’t just jumping on the bandwagon — it’s attaching a $40 billion per month turbocharger to the bandwagon. Still, the bandwagon carries the inertia of tens of thousands of businesses, so even a turbocharger might hardly make a perceptible difference.