Tags: US | Fed | Economy

Fed Still Faces Challenges Keeping Economy Growing

Wednesday, 22 Jun 2011 07:07 AM

 

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We may be into the second year of the economic recovery, but Federal Reserve Chairman Ben Bernanke and his colleagues are still facing plenty of challenges as they try to keep a fragile expansion on track.

A host of economic indicators have slowed in recent weeks and a sharp spike in gasoline prices earlier this year has made consumers and businesses more cautious about spending. The central bank, wrapping up a two-day meeting on Wednesday, is expected to acknowledge the recent soft patch but insist that growth should rebound in the second half of the year.

In a speech earlier this month, Bernanke maintained that the slowdown is temporary and said the economy should pick up later this year as the impact of high gas prices and supply disruptions caused by the March earthquake and tsunami in Japan abate. However, the Fed is now confronting renewed jitters that a debt crisis in Greece could spread to other heavily indebted European nations and send shockwaves through U.S. and global financial markets.

On Wednesday the Fed is expected stay the course, keeping interest rates unchanged and declaring that it will end on schedule a $600 billion Treasury bond purchase program at the end of this month. The central bank also is expected to repeat a pledge to maintain its current level of securities holdings, which stand at a record $2.6 trillion. The belief is that this sizable stockpile will keep interest rates from rising even though the Fed is not adding to its holdings.

Many private economists believe it will be another full year before the economy has recovered enough for the Fed to actually start raising interest rates.

The Fed will release an updated economic forecast which analysts believe will trim growth expectations slightly while predicting that inflation outside of volatile food and energy prices will remain under control. Bernanke will explain the new forecast at a news conference following the Fed's closed-door discussions. The media event — part of the chairman's efforts to make the central bank less mysterious — follows his first regular news conference in April. Bernanke is expected to hold four sessions with reporters each year.

The Fed is winding down its bond buying program, dubbed QE2 not for the Queen Elizabeth ocean liner but as short-hand for "quantitative easing." That's the wonky term that economists use to characterize the Fed's effort to drive down long-term interest rates by buying up Treasury bonds. QE2 marked the second round of such easing the Fed had taken; the first was in March 2009 at the depths of the recession.

Supporters say the bond purchases have worked, in part by keeping rates low and encouraging spending. Low long-term rates are vital for consumers buying homes and cars and for companies making investments.

They also argue that those lower rates fueled a stock rally. When Bernanke outlined plans for QE2 in late August 2010, the Standard & Poor's 500 index was down 6 percent for the year. Eight months later, the S&P 500 was up 28 percent. The lower rates made stocks more attractive to investors than bonds, whose yields were falling.

Mark Zandi, chief economist at Moody's Analytics, said the bond purchases gave a sagging economy a lift by slightly reducing borrowing costs for businesses and consumers and by raising stock prices to make people feel wealthier. Still, it didn't much energize home buying or other major purchases.

"It wasn't a slam-dunk success, but it was worthwhile," Zandi said.

Critics, including some Fed officials, saw things differently. They warned that by pumping so much money into the economy, the Fed increased the risks of high inflation later. They have complained that the Fed's outpouring of dollars hurt the dollar and contributed to a spike in oil and food prices. They also feared the bond purchases fed speculative buying that could inflate bubbles in prices of stocks or other assets.

Bernanke hit back at those critics in a speech last month. He argued that higher oil prices were due to Middle East turmoil and demand in fast-growing countries like China and blamed food-price inflation mainly on crop shortages caused by bad weather. And he said the falling dollar was largely linked to slower U.S. growth and the U.S. trade deficit.

© Copyright 2014 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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