Stocks are sharply higher thanks mainly to comments by Boston Fed President Eric Rosengren. Rosengren said he supported "open-ended" asset purchases by the Federal Reserve. This change in strategy, while seemingly subtle, represents an aggressive departure from the approach taken so far by the Fed. Rather than establishing a target amount of bonds that the Fed would purchase with a specific end date for the program (as was the case with QE1 and QE2), Rosengren believes the Fed should buy an unlimited quantity of bonds until certain growth and employment targets are met. Among these targets, Rosengren said, should be nominal GDP growth of 4.5 percent (i.e., growth before subtracting inflation) and an unemployment rate of 7.0 percent. For comparison purposes, nominal GDP grew 3.1 percent in the second quarter, and the unemployment rate currently stands at 8.2 percent. "You continue to do it until you have documented evidence that you're getting growth in income and the unemployment rate consistent with your economic goals." These comments were exactly the music the crowd wanted to hear.
Obviously, Rosengren believes that the Fed can do more in its support of the economy. In a CNBC appearance yesterday morning, the Fed President spoke about the ability of monetary policy to support the housing market, push up stock prices, lower the value of the dollar (which would boost exports), and keep the federal deficit down (through lower interest costs). Moreover, Rosengren believes further aggressive Fed action would serve as defensive policy as well as proactive, stimulatory action. Specifically, he does not believe we can count on the European Central bank to take the measures necessary to stabilize the debt crisis across the pond. In addition, Rosengren thinks that monetary policy can be an effective tool to manage the uncertainty associated with the fiscal cliff (expiration of tax cuts and implementation of forced budget cuts scheduled for early next year).
Rosengren's sentiments stand in stark contrast to the beliefs, held by many, that the Fed has become impotent and that further monetary policy will do nothing help achieve our economic goals (which we assume to be faster growth and lower unemployment). The challenges we face, which include a European debt crisis, a fiscal cliff, and an overleveraged consumer, are not likely to be solved by taking interest rates even lower than current record lows. Furthermore, further Fed action at this time is very likely to exacerbate some very real risks that many officials, including Rosengren, appear to be discounting. We discussed these risks several weeks ago in one of our Market Commentaries (June 20), but now may be a good time to revisit.
- The spending power of savers has been dramatically impaired by the Fed's low-interest-rate policy
- Fed policy has led to a flattening of the yield curve, which is bad for bank profits and their propensity to lend
- It is not clear that even lower rates will increase the supply of or demand for credit (ie, there are other factors determining lending and borrowing decisions)
- Still-lower rates will not lead to the loosening of lending standards for those in most need of credit
- Low interest rates may have actually inhibited a recovery in housing as lower housing prices would have allowed the market to clear by now
- The creation of trillions more dollars will eventually lead to the risk of widespread inflation, including asset inflation (stocks, bonds, real estate, etc.)
- Further reductions in long-term interest rates will affect the funded status and contribution requirements for countless pension plans
- And perhaps most important, further Fed easing may reduce the sense of urgency felt by Congress to address the fiscal cliff and long-term structural deficits
I understand Rosengren's frustration. And it must be very difficult to sit idle when faced with very loud criticism and pleas to do more. However, our current predicament was not caused overnight, and the solution cannot be as simple as aggressive monetary policy. Moreover, it is time for the Fed to stop enabling Congress to skirt their responsibilities regarding our debt problems. Monetary policy alone cannot fight the overwhelming tide of deficit spending and ever greater debt accumulation. Congress must exercise restrained and responsible fiscal policy, and it must not wait.