NAROFF ECONOMIC ADVISORS, Inc.
Joel L. Naroff
President and Chief Economist
September 21, 2011 FOMC Decision
“To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities.”
Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%
The FOMC met today and announced it would drive down longer term rates. With the economy recovering slowly and with “significant downside risks to the economic outlook, including strains in global financial markets”, it was deemed necessary to do a lot more than had already been done. Indeed, the size of the program, $400 billion of purchases of assets with maturities of six years or longer offset by sales of assets with maturities of three years or less, is somewhat greater than expected. But given the warning that the modest recovery could get worse, a large program made sense. You either go all in at this point or fold your cards and the Mr. Bernanke has gone all in.
Will this so-called “operation twist” work? Clearly, the emphasis on driving down longer term rates is an attempt to get mortgage borrowing and capital spending going a lot faster. But businesses are flush with cash already and it isn’t rates that are stopping them from hiring or investing more. Companies are just uncertain about the direction of the economy and demand is not growing fast enough to require greater job growth. Households are reducing their debt, not adding to it, and as we saw from today’s National Association of Realtors existing home sales report, failed contracts are growing. That is more an issue of appraisals and cautious lending practices than rate levels.
Where this will work is in the refinancing sphere. If you can get the refinancing done, the additional cash flow will help both consumer and business spending. On the mortgage side, the lowering of rates coupled with the Fed’s decisions to “reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities” should drive down mortgage rates to levels that will entice an awful lot of potential buyers and refinancers. Again, with the issue being appraisals not rates, this may not work that well but you have to give then kudos for trying to help the housing market.
Looking outward, once confidence returns, the lower rates, which should continue well into 2013, will become a major positive. As the economy improves and the desire to borrow grows, the extraordinary low rates will likely lead to rapid increases in borrowing. But that is likely to be in the future, not in the next six months. And it is that potentially strong growth in borrowing that presents the risk of inflation ramping up. But again, that is not right now.
The Fed is in a tough position. Fiscal policy is becoming more restrictive just as the risks to a disappointing recovery from Europe ramp up. The Fed Chairman is betting that any future (2 years or more down the road) inflation pressures can be handled. Instead, Mr. Bernanke wants to do whatever he can to prevent a double-dip. Given the state of confidence and the political gridlock, I believe the risks are worth taking even though three members of the FOMC differed and cast dissenting votes.
One final comment: Politicians of all stripes are taking shots at the Fed. That is their right but it shouldn’t be happening. You cannot say that the recovery is too weak and jobs have to be created and then do nothing, especially if there are dark clouds out there that could rain on the limping parade. Demanding that the Fed to “don’t just do something, stand there” is not reasonable and probably self defeating. The last thing a Fed Chair wants to be perceived as being is intimidated by politicians. An independent Fed, even a wrong-headed Fed, is a lot better than a politically driven Fed and you can be sure that this and every other Fed has not been politically driven.
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