Fed statement a vote of no confidence in economy through 2013?

posted at 10:05 am on August 10, 2011 by Ed Morrissey
printer-friendly

The current historically-loose monetary policy will continue, according to a Federal Reserve statement last night — for two more years.  The Fed normally doesn’t offer projections with such unambiguously lengthy timelines, preferring to keep its options open.  These, however, are not normal times — nor do we have normal leadership:

    The Federal Reserve announced on Tuesday that it plans to hold the benchmark interest rate at “exceptionally low levels” through at least mid-2013, breaking from the central bank’s usual less precise timelines.

    The action — which sent the Dow Jones Industrial Average swinging wildly up and down — signals the Federal Open Market Committee sees the path to economic recovery as longer and slower than anticipated even a few months ago.

    With the Fed’s decision, the target interest rate will stay flat at between 0 and 0.25 percent for close to the next two years, if not longer.

This appears to be the Fed’s alternative to another round of quantitative easing, a currency-devaluing exercise that remains the only real tool left in the Fed’s bag these days.  So far, the pledge seems to have helped calm global markets, at least for now:

    A pledge by the Federal Reserve to keep extremely low interest rates for another couple of years has calmed investors’ jitters, sending stock markets around the world higher Wednesday.

    The Fed’s surprise announcement Tuesday that it would likely keep its Fed funds rate at near zero percent through 2013 to help the ailing U.S. economy helped Wall Street surge late in the session — the Dow Jones industrial average rallied 6 percent just in the final hour of trading, one of the biggest turnarounds ever seen.

    That continued into the Asian and European trading sessions, although traders remained nervous after the market turmoil of recent weeks, which has sent many global markets officially intobear market territory — falling 20 percent from recent peaks.

This prompts the question, though, of what the Fed does next week or next month if markets get jittery again.  A QE3 won’t make investors any happier, and the Fed has nothing else to do now that they have made a two-year commitment on monetary policy.  Adding a third year in September or October, for instance, won’t have much impact on investment in the short term.

The rather unprecedented move should have people wondering why the Fed feels it has to commit to a loose-money policy for so long.  It was almost certain that they wouldn’t tighten the money supply anyway, not with inflation risks low and the global economy on the cusp of a recession.  Any move to a tighter policy would only come after a period of torrid growth in order to hedge against inflation damaging a full recovery, and that’s obviously a long way off.

So why make this policy so explicit in terms of length?  To calm markets, to be sure, but a six-month statement would have been just as effective.  The only reason to commit to a two-year policy of ultra-loose money is because the Fed doesn’t see any real prospects for economic growth through mid-2013.  They see no real need to have the option of tightening the money supply.  Economic conditions won’t change enough for the Fed to contemplate a change of policy, or so Ben Bernanke and the Fed board appear to say.

That to me sounds like a vote of no-confidence in the American economy, and in American economic leadership.  And, like the S&P downgrade that preceded it, it’s completely understandable, too.