For $2 trillion, Federal Reserve Chairman Ben S. Bernanke may buy little improvement in growth, employment or inflation over the next two years.
Firms with large-scale models of the U.S. economy such as IHS Global Insight, Moody’s Analytics Inc. and Macroeconomic Advisers LLC project only a moderate impact from additional Fed asset purchases. The firms estimate that the unemployment rate will remain around 9 percent or higher next year whether the Fed buys $500 billion or $2 trillion of U.S. Treasuries in a second round of unconventional stimulus.
“This is not a game changer for the economic outlook,” said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts, whose models show that $500 billion of purchases would boost growth 0.1 percentage point in 2011 and leave the unemployment rate at 9 percent or above for the next two years. “There is clearly a risk that people start to perceive monetary policy as impotent.”
The meager impact shows the conundrum U.S. central bankers face. Interest rates near zero have failed to produce the intended cycle of borrowing and spending among consumers and businesses. Unemployment hovering near a 26-year high, partly a symptom of weak demand, keeps downward pressure on prices, and further declines in inflation would raise borrowing costs in real terms, making credit more expensive.
“The danger of not doing anything would be pretty high,” said Antulio Bomfim, managing director at Macroeconomic Advisers in Washington. “Expanding the balance sheet might actually help reduce the risk of deflation.”
Yields on U.S. 10-year notes have fallen to 2.39 percent from 2.7 percent on Sept. 20, the day before the Federal Open Market Committee said it was prepared to ease policy further to support the recovery. The two-year note yield fell 2 basis points to 0.359 percent at 10:58 a.m. in New York trading and touched 0.3513 percent, the lowest ever.
Fed watchers expect the Fed will take further action at its next meeting Nov. 2-3. Economists predict unemployment will rise to 9.7 percent when the Labor Department releases its September report tomorrow, from 9.6 percent in August.
U.S. central bankers have kept their benchmark lending rate near zero for almost two years. In March, they finished $1.7 trillion in purchases of Treasuries, mortgage-backed securities, and housing agency bonds. A slowdown in growth in the middle two quarters of this year prompted the FOMC last month to warn that inflation rates were “somewhat below” its mandate to achieve stable prices and full employment.
New York Fed President William Dudley, who is also vice chairman of the FOMC, was more blunt in an Oct. 1 speech in New York, calling current levels of unemployment and inflation “unacceptable.”
Bomfim and Laurence Meyer, co-founder of St. Louis-based Macroeconomic Advisers, predict the Fed will begin with purchases of close to $100 billion a month starting in November, boosting the balance sheet by as much as $1.5 trillion if necessary.
Purchases of up to $2 trillion would raise the annual growth rate of gross domestic product by 0.3 percentage point in 2011 and by 0.4 percentage point in 2012, Macroeconomic Advisers estimates. Yields on U.S. 10-year notes could fall by as much as half a percentage point.
The unemployment rate would finish at 9.2 percent next year and at 7.7 percent in 2012, the firm estimates. Inflation would only be slightly higher than their current forecast for the personal consumption expenditures price index, minus food and energy, remaining below 1% in both 2011 and 2012. The price gauge rose 1.4 percent rate for the 12 months ending August.
Limits of Policy
Economists say further asset purchases could underscore the limits of monetary policy, which is hobbled by consumers’ desire to pay down debt and the reluctance of Congress to approve additional fiscal stimulus.
“At the zero boundary on interest rates, the burden shifts to fiscal policy, and fiscal policy is immobile because of the politics,” said Meyer. “So now, the burden has shifted back to monetary policy. You have to hope the economy’s own resilience and underlying strength is going to be enough to have growth a little bit above 3 percent.”
Dudley on Oct. 1 said that if the Fed were successful in reducing long-term borrowing costs through efforts such as asset purchases, it would have a “significant” effect on the economy. Homeowners would refinance their mortgages at lower rates, increasing disposable income.
An increase in refinancing isn’t likely to have a big impact on the housing market or consumer spending, said Joseph Murin, who was chief executive officer of Ginnie Mae, a federal agency that securitizes home loans, from 2008 to 2009.
“The theory is good,” said Murin, now chairman of Collingwood Group LLC, a consultant in Washington. “Practically speaking, I’m not sure.”
Homeowners who refinance are getting less money from cashing out home equity because property values have declined, Freddie Mac said in a July report. In some cases, homeowners are forced to increase their equity to qualify for new loans at lower interest rates. That’s a change from the years of the housing boom, when homeowners used growing home-equity to finance spending on consumer goods.
Twenty-two percent of homeowners who refinanced in the second quarter paid money to reduce their principal, the third- highest rate since Freddie Mac, the home-finance provider taken over by the government, started keeping the records in 1985.
Also, the net cash provided from converting home equity through mortgage refinancing was $8.3 billion in the second quarter, the lowest level in 10 years, according to the same July report. That compares with an average of $80 billion per quarter in 2006.
The cash generated by mortgage refinancing “will probably remain relatively low for the next couple of quarters,” said Frank Nothaft, chief economist at Freddie Mac in McLean, Virginia. “Many families are taking this opportunity to deleverage.”
Rates on 30-year fixed mortgages fell to 4.27 percent in the week ended today, a record low, according to Freddie Mac. The 30-year rate reached a 2010 high of 5.21 percent in April and was 6.46 percent in October 2008, the month before the Fed announced it would start purchasing mortgage-backed securities.
Lower home-loan rates may fail to spur additional refinancing because lenders are reluctant to give loans to people who are unemployed or have low credit scores, said Paul Havemann, vice president at HSH Associates, a publisher of consumer-loan data in Pompton Plains, New Jersey.
“We know the Fed is going to be doing something,” said David Rosenberg, chief economist at Gluskin Sheff and Associates Inc. in Toronto.
“The question is, in a cycle of contracting credit, how far will it work,” he said. “If taking rates to zero didn’t work, and if QE1 didn’t work, then the question, legitimately, is QE2 going to work?”
Quantitative easing refers to large-scale asset purchases as a tool of monetary policy. Bernanke has said the purchases support growth by lowering borrowing costs across a broad spectrum of debt as investors reallocate money they would normally invest in Treasuries into mortgage bonds, corporate notes, and other securities.
Mark Zandi, chief economist at Moody’s Analytics in West Chester, Pennsylvania, says $1 trillion in Fed Treasury purchases will boost growth by about 0.15 percentage point next year. As growth picks up, more people will enter the labor force, keeping the unemployment rate high. Inflation remains relatively unchanged in his model, he says.
“It is a small but meaningful benefit and the recovery can take all the help it can get,” Zandi said. Because purchases could have such a low medium-term impact, Fed officials may recast the strategy in terms of aiming at a level on an inflation index rather than the rate of change on the index, Zandi said.
The Fed “really doesn’t have any alternative but to give this thing a whirl,” former Fed Governor Lyle Gramley, now senior economic adviser at Potomac Research Group in Washington. “It has a mandate to create maximum employment and price stability. It has to try.”
--Editors: Christopher Wellisz, James Tyson
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