Criticism has mounted against the Federal Reserve’s easy-money policy; even within the central bank itself there are detractors who believe that its method of lowering interest rates in order to increase the available money supply could destabilize the financial system. But Chairman Ben Bernanke is more concerned about the across-the-board sequestration cuts set to take effect Friday, stating before Congress on Tuesday that the $85 billion in cuts to the federal budget combined with the earlier tax increases could pose a “significant headwind” for the economic recovery.
Despite the nearness of sequestration, the primary reason for Bernanke’s appearance before the Senate Banking Committee, reported on by Reuters, was to defend the Fed’s bond-buying stimulus program. He argued that its benefits exceed any possible costs.
The potential problems are numerous — the Fed’s record $3.1 trillion balance sheet may encourage excessive risk-taking by investors and complicate its exit from the stimulus program — yet Bernanke said that the Fed’s policymakers are aware of the potential risks of their extraordinary support for the economy. These concerns are immaterial at the moment, in his estimation.
“To this point, we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation,” Bernanke told the committee.
Bernanke’s firm stance belies the fact that expert opinion on the subject of the central bank’s monetary policy is far from united. Minutes of the Federal Reserve’s January 29 and 30 policy meeting revealed that the institution itself was divided over the policy, and that revelation sparked uncertainty in financial markets last week.
A number of officials now feel that the potential risks posed by buying bonds could warrant a change in policy, or at the very least, a slowdown in asset purchases.
As a response to the financial crisis and the deep recession of 2007 to 2009, the Federal Reserve lowered official interest rates to effectively zero and bought approximately $2.5 trillion in Treasury and mortgage debt in order to push down interest rates and therefore boost investment. As the economy continued to languish, the central bank began purchasing $85 billion in bonds each month, a policy that has been carried into 2013. Until this recent round of questioning began, the Fed’s strategy was expected to be kept in place until the outlook for the labor market improved, which so far, it has not. The labor market is still showing an incomplete recovery; unemployment remains at a relatively high level, ticking up to 7.9 percent in January.
According to Bernanke, the danger to economic recovery is not the Federal Reserve’s policy, but Washington itself. In his testimony, he criticized lawmakers for not finding a compromise to avoid the federal spending cuts that are expected to lower economic growth by 0.6 percent this year.
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