Harvard's Feldstein: Fed Should Start Tapering QE Now as Risks Mount

Tuesday, 02 Jul 2013 12:05 PM

By Glenn J. Kalinoski

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Harvard economist Martin Feldstein wants the Federal Reserve to start winding down its program of quantitative easing and not wait for labor market improvement.

Feldstein, writing in The Wall Street Journal, said that the improvement "is unlikely to occur" and that the central bank must consider the likely effectiveness of the program and the risks and costs of continuing to purchase large amounts of bonds.

"Although the economy is weak, experience shows that further bond-buying will have little effect on economic growth and employment," wrote Feldstein, the chairman of the Council of Economic Advisers under President Ronald Reagan.

Editor’s Note: Put the World’s Top Financial Minds to Work for You

Feldstein added that low interest rates are generating excessive risk-taking by banks and other financial investors.

Along with a decline in unemployment to 7.6 percent from 8.2 percent, Feldstein outlined several events occurring over the past year, including: no increase in the ratio of employment to population; no decline in the teenage unemployment rate; virtually no increase in the real average weekly earnings of those who are employed; and the drop in the number of people in the labor force in the past 12 months exceeded the decline in the number of unemployed.

He wrote that in the coming months the poor labor-market conditions are unlikely to improve. Feldstein stated that the Fed's forecast of substantial employment gains is based on the assumption that real GDP will grow by about 2.5 percent in the four quarters of 2013 and more than 3 percent next year.

"That would represent a substantial rise from the growth rates of less than 2 percent in 2012, 1.8 percent in the first quarter of 2013, and a likely 1.7 percent in the second quarter," he wrote.

"Reaching the Fed's GDP forecast for this year requires the growth rate to jump to more than 3 percent in the third and fourth quarters."

Feldstein cited several factors that will make this difficult to occur, including: exports are falling in response to weaker growth in other nations and a stronger dollar; the sequester and higher tax rates that took effect Jan. 1 will continue to cut aggregate demand. These factors will more than offset the favorable "but small effect" on GDP from increased residential investment.

Other considerations include: corporate profits and nonfarm inventory investment fell during the first quarter; nonresidential fixed investment was essentially unchanged; spending by state, local and federal governments fell; personal income declined and after-tax personal income dropped even faster; GDP growth was sustained primarily by a faster pace of consumer spending that will be difficult to maintain with stagnant earnings and a household saving rate that has dropped to 3.2 percent.

"The higher interest rates that followed the Fed's announced plans for tapering its bond-buying will further weaken GDP and employment," he wrote. "This will make it even more difficult for the Fed to achieve the robust labor market it says is necessary to scale back the bond purchases."

The Fed should slow its asset purchase program, Philadelphia Fed President Charles Plosser said on May 9, adding that he wasn't sure how much the central bank's easy policy was helping the struggling labor market.

"I'd like to stop, but I would particularly like to see us begin to slow the pace down, gradually ease our way out of this if we possibly can," Plosser said on Bloomberg Television, answering a question about an exit from the Fed's easing.

"I've never felt that our asset purchases have been that effective in addressing what's the biggest problem we face in this country, which is the employment market and the labor market," Plosser said.

"The danger of mispricing risk is that there is no way out without investors taking losses," Feldstein wrote.

"And the longer the process continues, the bigger those losses could be. That's why the Fed should start tapering this summer before financial market distortions become even more damaging."

Editor’s Note: Put the World’s Top Financial Minds to Work for You

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