One of many mysteries:
Joe Gagnon: The Fed Shirks Its Duty: On June 20, 2012, the Federal Reserve System’s Federal Open Market Committee extinguished the last shred of doubt as to whether it intends to achieve its mandated objectives. Despite a substantial markdown of an already inadequate forecast, the Fed did not take any actions that would make it possible to achieve either of its objectives over the foreseeable future. The action that was announced—additional purchases of longer-term Treasuries worth $267 billion—is estimated to reduce the 10-year Treasury yield by no more than 5 to 10 basis points. That is an amount that is lost in the daily fluctuations of the Treasury market and not enough, even in the Fed’s own models, to have an appreciable effect on the economy.
For more than two years, the Fed has dragged its feet and resisted the obvious need for more aggressive action. At this point it is not clear that the Fed has the tools it needs to get the best possible outcome without help from fiscal policy. Nevertheless, the Fed has considerable firepower remaining. It should aggressively push down mortgage interest rates and state clearly that it would welcome an inflation rate temporarily above its 2 percent target in order to make faster progress on its employment objective. These measures, discussed below, would substantially improve the economic outlook, even if there is disagreement about whether they are sufficient by themselves.
Why No Action?… What lies behind the Fed’s inaction?…
Martin Feldstein… argues that the sluggish recovery proves that monetary policy has lost its potency. He has succumbed to the fallacy of the driver who wonders why pressing on the accelerator does not cause the car to speed up as it starts to climb a hill….
Tim Duy, in his Fed Watch blog, wonders if the uncertainty over the effect of unconventional monetary actions has caused the Fed to be so timid. One thing is certain: Unconventional actions taken to date have not been sufficient to achieve the Fed’s mandate. Surely the lesson must be to take larger steps, not smaller ones….
Paul Krugman guesses that the Fed is intimidated by Congressional Republicans. Indeed, it is remarkable that despite falling short of both of its objectives, neither the Administration nor Congressional Democrats have criticized the Fed for doing too little, whereas Congressional Republicans have denounced the Fed for doing too much….
After his dissenting vote last week, the president of the Federal Reserve Bank of Richmond, Jeffrey Lacker, stated: “I do not believe that further monetary stimulus would make a substantial difference for economic growth and employment without increasing inflation by more than would be desirable.” The view that unconventional monetary policy will lead to inflation is commonly held on Wall Street. Yet, more than three years after the launch of such policies, inflation remains at or below the Fed’s target…. A large majority of the committee projects [pdf] that inflation will be below target over the next two and a half years. If they assign any weight to their employment objective, they should be willing to accept inflation at least modestly above target in order to get a better outcome on employment.
Purchasing more long-term assets at low interest rates raises the risk that the Fed will incur losses in the future. That might give the Fed some political discomfort. But maximizing profit is not part of the Fed’s mandate….
In his press conference, Chairman Bernanke listed the potential risks of unconventional monetary policies as those related to market functioning, financial stability, and the exit process. Considering the staggeringly high cost of record long-term unemployment, these risks would have to be serious indeed to justify the lack of policy action. Yet, the Fed has provided no evidence that these risks should be taken seriously….
What Is to Be Done? The best option within the Fed’s legal authority is to announce a target range for the 30-year mortgage rate of 2.5 to 3 percent to be maintained for the next 12 months. This target would be enforced through unlimited purchases of MBS guaranteed by the federal housing agencies. The 12-month commitment would encourage banks to beef up their mortgage staffing and it would give potential homebuyers some assurance of the financing they could expect while they shop for a house. This is similar to a program I outlined last fall. The Administration could help by forcing the housing agencies to stop dragging their feet on refinancing and loan modifications for underwater borrowers whose mortgages are already guaranteed by the agencies.
Although not a panacea, the above measures are substantial and would be viewed as such by market participants. The Fed could enhance their effects by stating clearly that a little more inflation would be welcome. A temporary increase of inflation to as much as 4 percent would be justified to the extent that it enabled a faster return to full employment….
If necessary, the above program could be extended in time at a slightly lower interest rate….
The main alternative instrument in the Fed’s toolkit is foreign exchange, generally in the form of sovereign bonds of foreign governments…. A foreign-exchange program that would not face opposition from abroad would be large-scale purchases of Italian and Spanish bonds. That would defuse the euro debt crisis at a stroke, thereby eliminating the main downside risk to the US economy. But such purchases would expose the Fed to even stronger domestic political attacks than it has already faced. Chairman Bernanke explicitly ruled out this option last week.
The best alternative would be to purchase exchange-traded funds of the total US stock market. That would have broad-based benefits, repairing household balance sheets and unlocking consumption and investment. Unfortunately, the Fed is not authorized to buy equities and Congress is not likely to grant it that power anytime soon.
But the Fed could buy the bonds of foreign governments that bought equities…
Where oh where are the lawyers who said that intervention in Libya was not "hostilities"?
