Every time there's talk about the Federal Reserve stepping in with further monetary stimulus, investors' reaction is something akin to a crowded schoolyard after somebody's announced that the ice cream truck is coming by with free treats for everyone.
On that topic, last weekend I was interested to read the view of Christina Romer -- Cal Berkley professor and former chair of the Council of Economic Advisers. Her point of view could be boiled down to this: Do more, Fed, and do it now.
Romer's larger point was that the Fed seems to be limiting itself because of a reluctant Congress and the threat of inflation. Neither, in her view, should be roadblocks, as the Fed is an independent body for a reason -- and, thus, can (and should) tell Congress to kiss off when necessary -- and because inflation is at a comfortable level. Since the Fed's mandate is both stable prices and maximum employment, it's high time it pulled some more levers. Or, as Romer put it:
More fundamentally, the Fed’s dual mandate doesn’t say it should care about unemployment only so long as inflation is at or below the target. It’s supposed to care about both equally. If inflation is at the target and unemployment is way above, it’s sensible to risk a little inflation to bring down unemployment.
But I can't help but wonder: Would further monetary easing really do much of anything? Or, at least, would it do enough to justify the risks?
I'm inclined to think not.
To date, the Fed has acted mightily as far as dousing the economy via low rates and asset purchases. But due to the nature of monetary policy, further impact from Fed easing will be mitigated by at least two issues.
First, the banks are major gatekeepers here. The Fed can loosen policy, but if banks like Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), and Citigroup (NYSE: C) feel that the better outlet for cheap capital is low-risk securities or other, non-economically-stimulating avenues, then the Fed succeeds in doing little beyond en-richening banks and bankers. And the threat is real -- banks can make bundles of money on the un-riskiest of investments when they can secure nearly free capital.
But even if the banks are willing to lend and willing to lend cheaply -- which is one ideal outcome of looser Fed policy -- there needs to be borrowers on the other end that are excited about putting capital to use in the economy. That's a hard sell when businesses are still feeling psychologically weak-kneed and glass-jawed.
To be fair, if the Fed does charge the market with a big asset-buying spree, pushing down the yields on safe assets, it could nudge other buyers -- mutual funds, hedge funds, pension funds, etc. -- to riskier assets. That could push up stock indexes like the Dow Jones (INDEX: ^DJI) and S&P 500 (INDEX: ^GSPC), make people feel wealthier, and encourage spending and boost the economy that way. Maybe that sounds a little like black magic, but it's a legitimate and likely impact.
But the concern is how big of an impact that could really have at this point. The classic (cliche?) imagery that wonks like to use is pushing on a string -- that is, the Fed can push, push, push, but there's really very little that it can do now.
The problem is that the Fed wasn't meant to be the only front in combating a sputtering economy. Ideally, monetary policy would work alongside fiscal policy -- that is, government spending -- to help reignite the economy. That's not happening. In fact, the government is actively working against that end, pushing for reduced spending and balanced budgets at precisely the wrong time. And that "fiscal cliff" that's on the tip of everyone's tongue? More of the same.
It's not as if Congress is coming out of left field -- many Americans share the same view. In fact, I'd be surprised if I don't see a few comments below telling me what an unbelievable moron I am for suggesting that government spending is the answer right now. Whether it's the ill-conceived view that the government's budget is somehow like the standard household budget, a belief that there's some glory at the other end of economic penance and austerity, or a dogged faith in the absolute power of the market's invisible hand, there are a lot of folks that think government spending is the absolute wrong move.
Not that they have much to worry about. A sea change in congressional views on fiscal stimulus seems about as likely as a Donald Trump presidency (where would he put the tanning beds anyway?).
Maybe the economic signals will get to the point where the Fed feels compelled to do something. Or maybe it won't. Either way, the prospect isn't nearly as exciting as many investors seem to think.
