Members of the Federal Open Market Committee meet this week to consider a range of unconventional tools for additional monetary stimulus.
One such tool, “forward guidance,” was unveiled at the Aug. 8-9 meeting: The Fed pledged to hold the benchmark rate near zero at least through mid-2013.
The odds-on favorite to debut at the conclusion of the two-day meeting is an effort to extend the maturity of the Fed’s portfolio, with the goal of lowering long-term interest rates.
If these tools don’t strike you as home runs, it’s because they’re not. They aren’t even singles. Bunts, perhaps, or to mix sports metaphors, punts is more like it. If policy makers want to appear to be doing something while doing no harm, the least-worst option is fiddling with the maturity of its portfolio. The size of the Fed’s balance sheet won’t change as a result of any duration shift, so the hawks on the committee aren’t apt to balk.
This is not the first time officials have tried their hand at yield-curve manipulation. In 1961, the U.S. Treasury and Fed embarked on a rare coordinated effort to raise short-term rates to prevent capital outflows and lower long-term rates to stimulate investment. (We were all Keynesians then, too, apparently.)
Operation Nudge, as it was known in internal government documents, and Operation Twist outside official circles, was considered a failure by those who were involved at the time and by academics who applied economic theories to evaluate it after the fact. (It couldn’t have been a total failure, though, because the idea keeps coming back.)
Part of the problem with the 1960s experiment was that neither the Fed nor the Treasury was a committed participant. A Joint Treasury-Federal Reserve Study of the U.S. Government Securities Market undertaken in the early 1970s found that the Fed was a net seller of bills, but only one-third of its coupon purchases had maturities longer than five years and a tiny fraction exceeded 10 years. At the same time, the Treasury was extending the maturity of its debt -- something it’s doing again now.
In the second quarter of this year, the average maturity of marketable debt stood at 62 months, up from a 25-year low of 49.4 months in the third quarter of 2009. Shortening the maturity of the debt would subject the Treasury, and taxpayers, to unnecessary rollover risk, one reason the Obama administration might be reluctant to participate.
Even if the two parties were to play their parts perfectly, it’s not clear what lower long-term rates would accomplish.
For starters, there’s no imperative for either businesses or households to borrow for 10 years or longer. They have options.
Secondly, the level of rates isn’t the problem. Potential homeowners are probably drooling at 30-year mortgage rates of 4 percent and adjustable rates below 3 percent. The problem is access. They can’t sell their home, don’t qualify for refinancing or owe the bank more than the house is worth. Another quarter-point reduction isn’t going to change that dynamic.
Yes, economics operates at the margin, so there will be marginal benefits. The Fed’s two-pronged attack -- fixing expectations about short-term rates, which are a crucial input for long-term rates, and buying long-term notes and bonds -- should produce some reduction in long rates. Arguably, it already has.
If you aren’t bowled over by forward guidance and Operation Twist 2.0, consider some of the other unconventional options outlined by Fed Chairman Ben Bernanke over the past year. The Fed can reduce or eliminate the interest on excess reserves (IOER) to encourage banks to lend. It can tinker further with its communications. And it can target a higher rate of inflation.
Some economists expect the Fed to adjust the IOER, currently 0.25 percent, as early as this week. If the Fed wants to nudge banks to lend, eliminating the interest or imposing a fee for holding banks’ deposits would create more of an incentive. Then again, banks would probably pass along the cost to depositors.
The second option would entail communicating more specifics about how much the unemployment rate would have to fall for the Fed to begin reversing its accommodative policies.
This is ivory-tower thinking run amok -- rational expectations theory taken to its (il)logical conclusion. Why would the Fed set up an expectation that it would do X when the unemployment rate drops to Y when the trade-off between inflation and unemployment is a short-run phenomenon at best?
Missing the Target
Besides, if the Fed is concerned about its credibility, which it is, it should not make promises it may not be able to keep.
Things change; sometimes quickly. In early 2010, policy makers were worried about banks’ $1 trillion in excess reserves igniting a rapid expansion of credit. Six months later, they were looking for ways to accelerate the process.
Targeting higher inflation is a nonstarter for both moral and practical reasons. Morally, the Fed wants higher inflation just as much as the Republicans want higher taxes. As a practical matter, the Fed wasn’t very good at hitting its money supply targets back in the 1980s. Why should we expect better results targeting higher inflation, the result of its money creation?
Alas, printing money is the Fed’s only viable tool; everything else is minor housekeeping.
I’m not advocating more outright purchases of Treasuries, which the Fed views purely as a means of lowering long-term rates. The economy’s problems stem from a long period of excess credit creation, which requires a period of deleveraging to correct.
But if policy makers determine that the economy is suffering from inadequate credit creation, verbal promises and portfolio reshuffling are poor substitutes for the real thing.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist. The opinions expressed are her own.)
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