Fed Holds Firm on Current Rates, Policy

U.S. Federal Reserve Chairman Ben Bernanke announced its position as unchanging during the Federal Open Market Committee meeting Wednesday as it draws down a second and final round …

U.S. Federal Reserve Chairman Ben Bernanke announced its position as unchanging during the Federal Open Market Committee meeting Wednesday as it draws down a second and final round of “quantitative easing” designed to stimulate the economy. Analysts say the current Fed position is one born of necessity as a weak economy and the threat of inflation leave it with nowhere to go other than to maintain low interest rates and avoid making any decisions or announcements that would trigger a financial crisis. For more on this continue reading the following article from Money Morning.

Caught between a weak economy and the threat of inflation – two problems that argue for opposite solutions – the Federal Open Market Committee (FOMC) has little choice but to essentially stand pat at the culmination of its meeting today (Wednesday).

Faced with that challenge, it’s likely that U.S. Federal Reserve Chairman Ben S. Bernanke will maintain his established course of downplaying the growing threat of inflation and making only minor policy adjustments.

Most economists expect the Fed to maintain its historically low federal-funds rate at the 0% to 0.25% level where it has been since December 2008 and end of the $600 billion bond-buying stimulus program known as quantitative easing (QE2) as planned.

Meanwhile, the prospects for a third round – QE3 – appear very dim, at least through the rest of 2011.

"I expect the Fed to maintain the low interest-rate environment, with no hint of any change to policy either," Frank Lesh, broker and futures analyst with FuturePath Trading, told Forbes.

Despite $2.79 trillion in various Fed stimulus programs over the past two years, U.S. unemployment has ticked back up above 9%, and gross domestic product (GDP) growth slumped to 1.8% growth in the first quarter.

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Meanwhile, the massive infusion of money into the economy has jump-started inflation. The consumer price index rose 3.6% year-over-year in May – its fastest pace since 2008.
About the only positive result of the Fed’s flood of money has been the robust stock market rally, although even that has waned in recent weeks.

The Fed’s two primary policy mandates are to control inflation and foster maximum employment. And with the poor economy limiting its options, the Fed appears unlikely to pursue money-tightening policies that would reduce the threat of inflation.

Money Morning Contributing Editor Martin Hutchinson says any more of the Fed’s flood of money will have serious consequences. The benefits of any more stimulus would be "very limited – and will be quickly overwhelmed by spiraling inflation as energy, commodities and other goods rise in price," he said.

The Fed won’t be taking any money out of the economy, even with the end of QE2. Its policy of re-buying maturing assets already in its portfolio – much as a consumer rolls over credit card debt from one card to another – will create a "QE2 lite."

That strategy continues to put more Treasuries on the market, maintaining the stimulus and its inflationary effects, although at lower levels.

And as long as the economy remains in the doldrums, the Fed won’t raise interest rates to head off inflation, raising the specter of 1970s-style "stagflation" – the deadly combination of high unemployment and high inflation.

Instead of taking direct action to fight inflation, the Fed may announce a target of about 2%, but that would be excluding food and energy. The idea would be to reassure the public and critics that the Fed is serious about the threat of inflation.

As he did at the last FOMC meeting, Bernanke will speak at a press conference following the release of the policy statement at 12:30 p.m.

In explaining the Fed’s decision, Bernanke will need to acknowledge that the policies so far have had mixed results, and that further stimulus would yield little benefit.

He hinted as much earlier this month in a speech to bankers in Atlanta: "Monetary policy cannot be a panacea."

In fact, in his remarks Bernanke could well toss the ball back to Washington’s politicians, who continue to argue over the budget deficit, budget cuts and raising the debt ceiling.

"Policymakers urgently need to put the federal governments’ finances on a sustainable trajectory," Bernanke said in Atlanta. "Establishing a credible plan for reducing future deficits now would not only enhance economic performance in the long run, but could also yield near-term benefits by leading to lower long-term interest rates."

This article was republished with permission from Money Morning.


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