Tags: Feldstein | Fed | QE3 | dangerous

Harvard’s Feldstein: Fed Playing a ‘Dangerous’ Game with Monetary Stimulus

Friday, 28 Sep 2012 10:42 AM

The Federal Reserve is following a "dangerous strategy" with its decision to jolt the economy with a fresh round of monetary stimulus measures, possibly stoking inflationary pressures and swelling asset bubbles, said Martin Feldstein, former chairman of the Council of Economic Advisers and a professor of economics at Harvard University.

The Federal Reserve recently announced it will buy $40 billion a month in mortgage-backed securities from banks to pump liquidity into the financial system in a way that pushes down interest rates across the broader economy to spur recovery, a monetary policy tool known as quantitative easing.

Side effects to such a policy tool — branded by many as printing money out of thin air — include a weaker dollar, rising stock and commodity prices and mounting inflationary pressures.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

The Federal Reserve's monetary policy body, the Federal Open Market Committee (FOMC), hopes open-ended easing will lower unemployment rates.

"Although economic weakness now prevents inflationary price increases, these conditions will not last forever. At some point, demand will increase and companies will recover the ability to raise prices," Feldstein writes in a Financial Times opinion piece, adding that inflation could arrive before unemployment rates fall.

"Such price inflation has historically been associated with tight labor markets and rising wages. But this time the unprecedented high level of long-term unemployment could cause the unemployment rate to remain high even when product markets tighten." Feldstein added.

Quantitative easing won't spur recovery and create the demand for jobs that the Fed wants to see.

The policy tool functions by lowering interest rates when cuts to benchmark lending rates don't work on their own.

However, fiscal uncertainty is preventing many businesses from investing and hiring, Feldstein points out.

At the end of this year, tax cuts expire while automatic cuts to government spending kick in, a combination known as a fiscal cliff that could send the country sliding into a recession if left unchecked by Congress.

Add to that, President Barack Obama's Affordable Care Act will raise taxes on investment income.

Households, meanwhile, won't borrow either, as banks keep lending standards sky high despite low interest rates.

"Under current conditions, the Fed’s new policy is not likely to strengthen the economic recovery. Mortgage rates are at record lows and home sales are already up sharply. Other potential homebuyers are blocked by tough credit standards (that is, by the need for a high credit score) rather than the level of mortgage rates," Feldstein wrote.

"Lower mortgage rates may spill over to reduce rates on corporate debt, but large businesses with enormous cash balances are reluctant to invest and to hire because they fear future tax increases. Many small businesses, which depend on local banks, are unable to secure credit because their banks lack the capital needed to increase lending."

Federal Reserve officials themselves have said that monetary policy can only do so much for recovery.

The Fed's decision to roll out quantitative easing to spur recovery marks the third time the U.S. central bank has resorted to the monetary stimulus tool since the 2008 financial crisis.

Two previous rounds saw the Fed buy a combined $2.3 trillion in assets from banks in the last four years.

Fiscal clarity, Fed officials have said, must take priority over monetary policy.

"Congress could show they have consensus, even if it's maybe not the completely ideal policy, but if they had consensus and you knew what the taxes were going to be in the future, then businesses will go ahead and make their bets based on that tax code," Federal Reserve Bank of St. Louis President James Bullard told CNBC.

"What they don't like is the notion they might invest in a business, the business might do well, possibly become a target and get taxed in the future. They don't want to be in that kind of a situation. So I think that that's inhibiting investment."

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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The Federal Reserve is following a "dangerous strategy" with its decision to jolt the economy with a fresh round of monetary stimulus measures, possibly stoking inflationary pressures, said Martin Feldstein, a professor of economics at Harvard University.
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Friday, 28 Sep 2012 10:42 AM
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