Troubled economy in search of a solution

Business Times - 31 Aug 2011


Troubled economy in search of a solution

Despite what was said at Jackson Hole, markets are still waiting for reassuring messages

By LEON HADAR
WASHINGTON CORRESPONDENT

IN THE aftermath of the decision by Standard & Poor's (S&P) to downgrade the US credit rating, Wall Street has been waiting for Washington - whether it's the White House or Congress or the Federal Reserve - to do something, or at least say something that would reassure the markets that the economy was getting better. At the very least, they wanted to be told the economy would be getting better in the not-so-distant future.

So it was not surprising that Fed chairman Ben Bernanke's speech delivered last Friday at the policy conference held at Jackson Hole, Wyoming was described by pundits as one of those 'much-anticipated' events.

Against the backdrop of the political and legislative stalemate in Washington that has made it close to impossible for the White House and Congress to agree on steps to put America's fiscal house in order, investors and other market watchers were hoping that the head of the US central bank would be laying out a monetary strategy to accelerate economic recovery.

Indeed, the US Commerce Department reported that gross domestic product rose only one per cent from April through June - less than the 1.3 per cent that most economists had predicted.

But Mr Bernanke seemed to have failed to fulfil those high expectations that, in retrospect, can be seen as wishful thinking. If anything, during his address, the Fed chairman seemed to be laying the blame for the poor American economic performance on the politicians in the White House and Congress.

Mr Bernanke insisted that the recent political infighting in Washington over the federal government's budget had sent the wrong message to the markets 'and probably the economy as well'. The United States 'would be well served by a better process for making fiscal decisions', he said.

And he warned the Obama administration and the Republican-led Congress that political battles over the federal government's borrowing and spending that dominated Washington during the summer 'could, over time, seriously jeopardise the willingness of investors around the world to hold US financial assets or to make direct investments in job-creating US businesses'.

But what really mattered to the markets, beyond Mr Bernanke's scolding rhetoric and his general commitment to 'employ (the Fed's) tools as appropriate', was the failure by the Fed chairman to discuss the monetary tools that the Fed would be ready to employ - if and when it decides to move in that direction at all.

No major action

Mr Bernanke did defend during his speech the Fed's announcement early in August that it planned to hold down short-term interest rates until mid-2013.

But he refrained from raising the possibility that the Fed would be taking any major action, disappointing economists and officials and lawmakers in Washington who have been arguing that a more aggressive approach on the part of the central bank by injecting more money into the economy could stimulate growth.

But in his address at the conference sponsored by the Federal Reserve Bank of Kansas City, Mr Bernanke seemed to be placing an emphasis on the constraints operating on the ability of the Fed to use monetary policy (such as managing interest rates) in dealing with the long-term problems facing the American economy.

'Most of the economic policies that support robust economic growth in the long run are outside the province of the central bank,' he said.

More specifically, there was not even a remote suggestion in Mr Bernanke's speech that the Fed would be ready to launch a third round of quantitative easing (QE3) - purchases of Treasury securities and other financial assets aimed at helping the economy by keeping long-term interest rates down while encouraging spending and pushing up stock prices.

But the idea of a QE3 or any other proposal to inject more money into the economy are not very popular among the conservative Republicans on Capitol Hill and those inflation hawks who are part of the Fed's policymaking committee.

These opponents of easing US monetary policy argue that, at a time when interest rates are close to zero, a QE3 would produce upward inflationary pressures and erode the value of the US dollar. But supporters of a more activist Fed approach note that in addition to its responsibility for price stability, the Fed's mandate also includes maintaining 'maximum employment', and that monetary policy remains the 'only game in town' as far increasing economic growth and bringing unemployment down are concerned.

Indeed, the expectation that the politicians in Washington would get their act together remains very low. Congress and the White House agreed to raise the debt ceiling as part of a deal to cut government spending by US$2.1 trillion. But Congressional committees still have to negotiate the details of those cuts before the November elections next year.

Anxious markets

Republicans remained opposed to any deficit-cutting programme that includes increasing the tax burden on rich Americans. And the White House and the Democrats will not agree to a plan that is based entirely on reducing government spending.

So the anxious financial markets are now waiting for other reassuring messages from Washington. President Barack Obama is planning to deliver a speech after Labour Day detailing proposals for job creation and spending cuts that some hope would put pressure on the Congressional committees to take action ASAP.

And then there is the scheduled meeting of the Federal Open Market Committee in late September, which would be extended to two days from one day 'to allow a fuller discussion', as Bernanke put it during his address. That's something to look forward to - but don't hold your breath.

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