Ed Koch, the late mayor of New York City, used to stop residents on the street and ask, “How am I doing?”
With next month marking the four-year anniversary of the end of the 2007-2009 recession, the longest and deepest since the Great Depression, it seemed like a good time to ask the same question -- of the Federal Reserve. The Fed’s actions to right the economy, once described as “unprecedented,” now seem ordinary. The various emergency-lending facilities have been closed, but the overnight rate is still at zero to 0.25 percent, and the Fed is engaged in its third round of quantitative easing, or large-scale asset purchases, which this time is open-ended (until it isn’t).
So how’s the Fed doing? Based on standard metrics, economic growth has been tepid as far as expansions go. Real gross domestic product has increased at an average 2 percent pace since the second quarter of 2009. The unemployment rate has inched its way down to 7.5 percent from a peak of 10 percent in October 2009, a stark contrast to the rapid doubling of the rate from the recession’s onset in December 2007.
In other respects, the economy is doing just fine. Asset markets are elated at the Fed’s liquidity provisions. And to the extent that the goal of policy was to encourage risk-taking, inflate asset markets and hope for a spillover to the broader economy, I guess two out of three isn’t bad. The risk is that Nos. 1 and 2 create problems before No. 3 takes hold.
Some background first. Fed chief Ben Bernanke has gone out of his way to explain how monetary policy works once the traditional policy tool, the overnight interbank rate, hits zero. When the Fed buys long-term Treasuries, it depresses yields and forces investors to buy assets that carry more credit risk, such as stocks and corporate bonds. Lower yields make housing more affordable. Higher stock prices work through the wealth effect to increase consumer spending, leading to higher corporate profits and personal incomes in what he called a “virtuous circle.”
Let’s take a look at the results.
The Dow Jones Industrial Average and the Standard & Poor’s 500 Index set new highs this week, a reflection of either the Fed’s liquidity provision or record corporate profits, take your pick. (Price-earnings ratios remain well within historical norms.)
Credit spreads have narrowed, just as the Fed wished.
Home prices have come roaring back, posting large gains in parts of the country that were hardest hit by the housing bust. Phoenix led major U.S. cities with a year-over-year jump of 23 percent, followed by San Francisco (up 18.9 percent) and Las Vegas (up 17.6 percent), according to the S&P/Case-Shiller Home Price Indices for February. And the National Association of Realtors reported that the U.S. median price rose 11.3 percent in the first quarter from a year earlier, the biggest increase in seven years.
Then there’s the art market. After “giddy competition” last fall, the spring art auctions at Sotheby’s and Christie’s in New York featured catalogs that “weigh as much as a phone book and contain relatively hefty price tags,” according to the Wall Street Journal. Apparently there are a lot of new collectors, many from abroad, with money to throw at trophy art.
Another example: The average price of a New York City taxi medallion topped $1 million last month.
The Federal Advisory Council, a group of 12 bankers who advise the Fed, warned about a bubble in U.S. farmland prices and excessive risk-taking at their Feb. 8 meeting, according to minutes obtained by Bloomberg News reporters Craig Torres and Joshua Zumbrun under a Freedom of Information Act request.
Fed officials have started to walk back from their asset-price/virtuous-circle policy prescription, sprinkling recent speeches and press conferences with references to “reaching for yield” and “excessive risks” and invoking the central bank’s dual mandate of full employment and stable prices instead. At his March 20 news conference, Bernanke said the Fed isn’t “targeting asset prices.” Rather policy makers are “trying to identify, much more so than in the past, whether major asset classes are deviating in terms of their price or valuation from historical norms.” The degree to which assets are leveraged, something the Fed is monitoring, is crucial to determining potential systemic risk.
This is all good. But there’s a more important consideration. Four-and-a-half years of an overnight rate near zero and aggressive securities purchases by the Fed have succeeded in raising asset prices. The question is whether higher asset prices will deliver jobs and economic growth before they become destabilizing.
This is what policy makers are referring to when they talk about the costs versus the benefits of QE: the horse race between risk-taking and economic growth. It sounds as if Bernanke and the Federal Open Market Committee are getting ready to re-handicap the race at their meeting next month.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist. The opinions expressed are her own.)
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