it's all up to the fed

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It's all up to the Fed Oct 14th 2010 | WASHINGTON, DC

From The Economist print edition

The Fed will try to force the economy into orbit with more

bond purchases

ROCKET science may be out of fashion on Wall Street, but it still hasa following at the Federal Reserve. All year long officials there havelooked for signs that the economy has reached ³escape velocity´:

growth that is strong enough to bring down unemployment once thepropellants of government stimulus and inventory replenishment

are spent.

Such signs remain maddeningly elusive. On October 8th, the lastbig jobs report before the mid-term elections showed that thecrisis¶s aftermath maintains a powerful downward pull. Non-farmpayrolls sank 95,000 in September. True, that was mainly becauseof a further big drop in federal government employment as

temporary workers taken on to carry out the decennial federalcensus were laid off. But private employment rose by only 64,000,or 0.1%. That is barely the pace of job creation in an economyrunning at full capacity, not 8m jobs short of it. Unemploymentstuck at 9.6%, roughly where it has been since June. To add insult

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to injury, the Bureau of Labour Statistics now says 366,000 more

jobs were lost than it first estimated in the year to last March. Barack Obama¶s critics blame the stagnation on the stifling effect of new regulations and overzealous bureaucrats. There may besomething in this, but the far more important cause is simply lackof demand. Households remain focused on paying down their debtsrather than spending more, and there is nothing that Mr Obama will

be able to do before election day to change that. Tim Geithner, histreasury secretary, argued forcefully last week that the rich world,

America included, has plenty of fiscal capacity for more stimulus,and Mr Obama has gamely campaigned for the $50 billion

infrastructure plan he unveiled a month ago. But Congressadjourned without acting on it and will return after the election withless appetite, not more, for fresh spending. Not only is federal stimulus winding down, but state and localgovernments are contracting. Since last December, they have cut

total employment by 269,000 jobs. September¶s decline of 76,000(0.5%) in local government payrolls, mostly at schools, was thelargest since 1982. In a survey of municipal financial officersreleased on October 6th the National League of Cities found that

35% of local governments had laid off employees in the past year,

and 74% had frozen hiring.

With fiscal policy out of the picture, the entire burden of stimulating

demand falls on the Federal Reserve. After lowering short-terminterest rates to zero in late 2008, the Fed then bought $1.7 trillion-

worth of Treasury and mortgage bonds with newly created money(³quantitative easing,´ or QE), to bring down long-term rates and

release liquidity. Those purchases ended in March. The Fed¶s leadersare now preparing the markets for a resumption. Current

unemployment and inflation, which is below the Fed¶s preferredlevels, are ³wholly unsatisfactory´, William Dudley, the president of

the New York Fed said on October 1st. No one is sure if QE2 will help. The lowest long-term rates in ageneration are of little help to homeowners who cannot meettoughened underwriting criteria or refinance a depreciated property.Yet the response of the markets is encouraging. As bond yields and

mortgage rates have dropped, mortgage applications both torefinance and to buy homes have risen. The stockmarket hasrallied, and the dollar has fallen. That will help America¶s exports

even as it aggravates tensions with the rest of the world. Rather than promise to buy a large amount of bonds by a certaindate, the Fed will probably announce more modest amounts overshorter periods, predicating future instalments on the outlook.

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Goldman Sachs predicts initial purchases of $100 billion a month.This would make it easier for the Fed to stop were conditions

suddenly to improve. That, however, seems unlikely. When Fedofficials look at unemployment just now, they think not of rockets

but of a different term from the world of maths: a ³saddle point´.That is when the unemployment rate, having flattened out, headseither lower or higher. The Fed will do all it can to ensure that thenext direction is down. So expect the next round of QE to rival the

first in size.

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it's all up to the fed

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