*THE VERSION SENT OUT YESTERDAY WAS NOT MY COLUMN ALTHOUGH THE HEADLINE WAS
CORRECT. HERE IS THE CORRECT COLUMN*
*
*
*Marty Feldstein*
Originally Publised in THE FINANCIAL TIMES
September 22, 2013
The Fed is wrong to put off the return to normality
(PDF Version)
The US Federal Reserves decision last week to delay the start of its
so-called tapering has confused investors about the reliability of its
forward guidance. It has also created a trap that will make it difficult to
start the tapering programme in the future unless the Fed changes its basic
approach.
More specifically, Ben Bernanke, the Fed chair, explained that the Federal
Open Market Committee (FOMC) had decided not to reduce its pace of
bond-buying because current economic conditions were not as favourable as
the FOMC members had expected in June. Looking ahead, he said the Fed could
begin tapering later this year if the data confirm our basic outlook.
That may be a difficult test to pass; the FOMCs projections in recent
years have been repeatedly too optimistic. It looks as though they are
repeating the mistake again. At the end of its recent FOMC meeting the Fed
released a summary of the economic projections of the FOMC members the
governors of the Fed and presidents of the 12 regional Federal Reserve
banks. The central tendency of these projections foresees real gross
domestic product growth of 2.0-2.3 per cent for the 12 months starting with
the fourth quarter of 2012.
That would be higher than the US economy has achieved in any of the past
three years. For the first half of 2013 the official annualised GDP growth
number is now only 1.8 per cent, and more than one-third of that growth was
just inventory accumulation. Private estimates for GDP growth in the
current third quarter are at about the same level. To reach the midpoint of
the FOMCs central tendency range for this year as a whole would require
the growth rate to jump to an annualised rate of 3.2 per cent in the fourth
quarter.
Looking further ahead, the FOMC projections call for a growth rate of
between 2.9 per cent and 3.1 per cent in 2014. That forecast is already a
substantial reduction from the range of 2.9 per cent to 3.5 per cent that
the FOMC was predicting less than two months ago. As we get closer to 2014,
the prospects for that year are likely to look weaker again.
As Mr Bernanke noted, the rise in long-term interest rates since May is
likely to depress the pace of residential construction, the strongest
sector in the past year. Consumer spending is likely to remain weak because
real after-tax income per capita is lower now than it was a year ago. A
fall in the household saving rate has helped to sustain consumer spending
but leaves little scope for a further decline in saving to boost future
spending. Making the start of tapering depend on the economy achieving the
Feds optimistic outlook is therefore likely to lead to another decision to
continue the current pace of bond-buying.
It is hard to argue with the Feds approach that its economic policy should
depend on the data. But it is equally hard to reconcile a strategy of
multiyear forward guidance with policies that are sensitive to changes in
month-to-month economic news.
There is a better strategy that would allow the Fed to start tapering in
October and end bond-buying by the middle of 2014. The Fed has stated that
the pace of bond-buying should reflect a balancing of the benefits that the
policy achieves in strengthening employment and growth against the costs
that they impose on the economy. Putting that into practice would justify
indeed require the Fed to begin tapering.
Although the initial burst of bond-buying may have helped to stimulate
demand in 2010 and 2011, the current strategy is now doing very little to
stimulate economic growth and employment. At the same time, continuing to
buy long-term bonds and promising to keep the real short-term rate below
zero even after the economy has returned to full employment have serious
costs. They distort the investment behaviour of individuals and
institutions, driving them to reach for higher yields by taking
inappropriate risks. They lead banks to make riskier loans in order to get
higher returns. The longer this process of abnormally low rates continues,
the more disruptive will be the return to normal conditions.
It would be wise, therefore, for the Fed to shift away from its focus on
short-term data, to recognise that it has achieved as much as monetary
policy can do, and to start at its next meeting on a path to stabilise the
size of its bond portfolio.
The writer, a former chairman of the Council of Economic Advisers, is
professor of economics at Harvard University
Copyright: The Financial Times Limited
Page 2 of 2
9/24/2013
Received on Tue Sep 24 2013 - 07:22:57 EDT
