Fed Keeps Finger on Trigger

By DAVID REILLY

It’s a case of when, not if. At least, that is the market’s thinking on the Federal Reserve again buying more bonds to boost the economy.

But the unanswered question remains: Having failed so far to significantly reduce unemployment through previous extraordinary actions, can or should the Fed continue trying?

Certainly, revised economic projections released by the Fed following its two-day meeting, as well as comments from Chairman Ben Bernanke, seemed to lay the groundwork for further easing. The Fed now expects unemployment to be between 7.8% and 8.2% in 2013, compared with a forecast in June of 7% to 7.5%. It also released 2014 projections, which showed joblessness at 6.8% to 7.7%. Meanwhile, economic growth in 2012 is likely to come in between 2.5% to 2.9%, a far cry from the 3.3% to 3.7% expected in June.

So while inflation looks to be under control, things are “very unsatisfactory in terms of the rate of growth and unemployment,” Mr. Bernanke said. He also said that given that the moribund housing sector is “a big reason the economy is not recovering more quickly,” purchases of mortgage securities are a viable option for the Fed.

This prompted many to ask why the Fed didn’t just pull the trigger now. Indeed, Wednesday’s Fed statement saw one dove, Chicago Fed President Charles Evans, dissent over a lack of such action.

But there were good reasons for the Fed to hold its fire. The economy is growing, albeit not at a rate the Fed would like, and deflation isn’t an imminent risk. As recently as August, the Fed took the unprecedented move of saying it would keep short-term interest rates zero-bound until mid-2013; in September it moved to bring down long-term rates by shifting its holdings of Treasurys to longer-dated securities. So it was time for a pause, to see what impact those unconventional moves have.

The Fed may have also wanted to keep its powder dry as it waits to see how Europe’s sovereign-debt crisis plays out. And as it watches the possibility that deficit battles in the U.S. could lead to spending cuts that act as economic drags.

A bigger reason for hesitancy may be that the Fed is uncertain as to how much extreme monetary policy can directly influence unemployment. True, the Fed’s prior actions appear to have staved off the threat of deflation and helped arrest the collapse of the housing market.

But even as the Fed has expanded its balance sheet to about $2.8 trillion through purchases of mortgage bonds and Treasurys, unemployment has remained stuck above 9%. And while the Fed has helped through its latest actions to bring mortgage rates down to about 4%, this isn’t yet proving a tonic for housing.

So for now, wait-and-see is warranted. Though the Fed’s trigger finger will remain itchy, especially if stock markets again swoon.