published Wednesday, September 19th, 2012

Personal Finance: Fed action is intended to ease unemployment

Chris Hopkins

Last Wednesday, the Open Market Committee of the Federal Reserve Board voted to undertake additional monetary stimulus aimed at fostering a more robust economic recovery. Two actions were announced: extending the expected duration of zero interest rates into 2015, and committing to an open-ended bond purchase program. So why did the Fed take these actions, and what is likely to be the impact on average Americans?

The primary responsibility of every central bank is the maintenance of price stability; that is, keeping inflation under control. Unfortunately, since 1977 the U.S. Federal Reserve has been given another, somewhat contradictory responsibility: promoting full employment. The Fed’s dilemma is that once interest rates are effectively at zero, the bank has very few wrenches left in the tool kit with which to crank policy affecting the unemployment rate.

In this extraordinary environment the Fed resorts to issuing specific language to convey its intention regarding low rates, and engages in so-called “unconventional” intervention like buying and holding bonds to pump cash into the economy. The bond-buying program is often referred to as “quantitative easing” or QE, in reference to its objective of augmenting the quantity of money in circulation. This particular version, being the third round, is popularly called “QE3.”

The fact that a Republican Fed Chairman appointed by a Republican president is promulgating somewhat risky policies that are likely to benefit a Democratic president is a testament to the degree to which the Federal Reserve is apolitical. Bernanke is genuinely alarmed at the stubbornly-high level of long-term unemployment and particularly concerned with how acutely skills degrade and stigma attaches once a worker has been out of a job for an extended period of time. Given the unprecedented level of extended joblessness, such unorthodox measures are at least understandable.

But the policy comes at a price. Conservative investors and savers have nowhere to go for income and are effectively being coerced into either taking on more risk or spending down principal to meet monthly expenses. The injection of sugar water into the monetary IV drip has jacked up stock prices in the short term, but is hardly a nutritious substitute for a genuine pro-growth fiscal policy and is not likely to prevail in the absence of significant tax and spending reform.

Chairman Bernanke is genuinely concerned with the scourge of long-term unemployment and is exhausting the Fed’s capability to counter it. Unspoken but clearly implied in his scrupulously nonpartisan comments is the failure of Congress and the president to fulfill their responsibilities. The federal government has not adopted a budget for over three years, and has created a confluence of expiring tax provisions and spending cuts referred to as the “fiscal cliff” looming Dec. 31. While few observers expect our legislators to actually push us off the cliff, the uncertainty surrounding the ultimate outcome is clearly retarding job creation through normal market channels.

Meanwhile, the Fed tries to do what elected leaders won’t. Please hand me that pipe wrench.

Christopher A. Hopkins CFA, is a vice president at Barnett & Co.

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