The Fed Boosts The Economy, But What About The Risks?
The Federal Reserve continued to keep its foot on the accelerator in 2012, using unusual tactics to try to boost economic growth. But there's disagreement among economists about whether the Fed's policies were effective or whether the risks to the economy outweighed the rewards.
Chairman Ben Bernanke and the Fed employed two main tools in 2012, to try to boost economic growth — Operation Twist, in which the Fed bought long-term Treasury bonds, and a program to purchase mortgage-backed securities. Both were aimed at driving down long-term interest rates.
A Boost For Housing
Mark Zandi of Moody's Analytics says the Fed's effort has been a big plus for the housing market.
"It's lowered mortgage rates, which has helped lots of homeowners refinance their mortgages and lower their monthly payments," Zandi says. "It's certainly been key to turning the housing market around, and housing is vital to the strength of the broader economy. It's helped to lift stock prices, and stocks are very important to collective thinking and people's perception about how well we're doing."
And, Zandi says, the Fed's efforts have kept the value of the dollar low, which has helped U.S. exports.
Nariman Behravesh, chief economist for the research firm IHS Global Insight, also thinks the Fed's policies provided an important boost for the economy in 2012.
"You know people say, 'Oh, it's done more harm than good.' I think that's nonsense. It has had a small, but nevertheless positive impact in particular on housing," Behravesh says.
Asset Bubbles Feared
Harvard professor Martin Feldstein says the Fed's policies in 2012 and for the past few years have created a risk of higher inflation. And he says "there's serious risk that they're producing asset price bubbles that, like all bubbles when they burst, could be very damaging."
Feldstein believes the Fed's success in pushing long-term interest rates lower is inflating the value of assets like homes and stocks and bonds. And when the Fed has to reverse course, as the economy picks up, the prices of those assets will take a tumble and damage the economy.
"It feels good now while it's happening but I think it lays a trap for us later on," Feldstein says.
Peter Fisher, a former Treasury official who's now senior managing director at the Wall Street firm BlackRock, says the Fed's policy of pushing long-term interest rates to extremely low levels comes with trade-offs.
"On the one hand you can be holding down the cost of refinancing a mortgage and hope to encourage people to borrow," Fisher says. "On the other hand by holding down the long end you are discouraging lenders."
An Effect On Banks
That's because when rates get extremely low the profit margins that lenders can make on loans shrink, so banks make fewer loans and credit gets tight. Despite his concerns, Fisher generally supports the Fed's actions, except for Operation Twist.
Moody's Zandi argues the economy would be significantly worse if the Fed had demurred.
"If the Fed had not engaged in the extraordinary actions, the economy would feel a lot worse," he says. "You know, we'd have an unemployment rate closer to 9 percent than 8 percent; that's a palpable difference."
Harvard's Feldstein says it's likely to be a couple of years before we see the negative effects of inflation and asset bubbles. But clearly Bernanke and most of the Fed's governors think the rewards of the policy outweigh the risks. They've made clear they'll very likely hold rates low throughout 2013.
Source: NPR [http://www.npr.org/2012/12/26/167964104/the-fed-boosts-the-economy-but-what-about-the-risks?ft=3&f=1003,1004,1007,1013,1014,1017,1019,1128]