Bernanke on the Brink

Ben is in panic mode

By Robert Samuelson 

WASHINGTON -- We are reaching -- or may already have passed -- the practical limits of "economic stimulus." Last week, the Federal Reserve adopted an open-ended bond-buying program of $40 billion a month to goad the economy into faster growth. But even before the announcement, there was skepticism that it would do much to lower the unemployment rate, which has exceeded 8 percent for 43 months. The average response of 47 economists surveyed by The Wall Street Journal was that a similar program might cut the jobless rate 0.1 percentage point over a year.

At a news conference, Fed Chairman Ben Bernanke explained what the Fed hopes will happen. By buying mortgages, the Fed would push interest rates down. They're already low (3.6 percent in August for a 30-year fixed-rate mortgage) and would fall further. Lower rates would stimulate more homebuying and construction. Greater housing demand would raise home prices. Fewer homeowners would be "underwater" (homes worth less than mortgages). Banks would refinance more existing mortgages at lower rates because the collateral -- the homes -- would be worth more. Feeling wealthier, homeowners would spend more and cause businesses to hire more.

Good news would feed on itself. The brighter outlook would boost stock prices (the Dow jumped 206.5 points the day of the Fed's announcement). This rebuilds Americans' depleted wealth. Optimism, consumer spending and hiring would revive even more.

It could happen. Why, then, so much doubt?

One reason is history. The government has dispensed huge amounts of stimulus -- in the form of lower interest rates, government spending and tax cuts -- and the benefits have been overestimated. Based on experience, people have grown skeptical.

Let's do the numbers.

Start with the Fed. Since late 2008, it's held short-term interest rates (the Fed funds rate) between zero and 0.25 percent. Beginning in late 2008, the Fed purchased more than $2.75 trillion worth of Treasury bonds and mortgage securities to lower long-term interest rates. (By buying bonds, the Fed seeks to raise their price; when bond prices rise, their interest rates fall.) Interest rates have dropped, though it's unclear how much reflects the Fed's bond-buying and how much other factors (the weak economy, a flight to the "safety" of U.S. Treasuries).

Still, the recovery stumbled. There have been offsetting tendencies. Low interest rates mean less income for savers, which dampens consumer spending. Personal interest income has dropped about $400 billion a year, notes economist Timothy Taylor on his blog. Another reason: "Many of the problems facing the economy can't be addressed with lower interest rates," writes veteran economic journalist John M. Berry in The International Economy. Low rates don't matter if tougher credit standards prevent potential homebuyers from qualifying for loans. Or banks curb lending to restore capital.

Next, consider government spending and tax cuts. President Obama's first stimulus totaled about $833 billion, says the Congressional Budget Office. But the true stimulus also includes subsequent tax cuts and spending increases plus "automatic stabilizers." These refer to the budget's tendency to swing into deficit during a recession, because tax revenues fall and spending on unemployment benefits and other safety-net programs rise. Budget deficits broadly measure stimulus. From 2009 to 2012, they're about $5.1 trillion.

What impresses is this: the massive stimulus programs and the meek recovery. How much worse things might have been without stimulus is an open question. Economists argue ferociously, and the numbers vary widely. For example, the CBO estimates that Obama's initial stimulus has created between 200,000 and 1.2 million jobs in 2012. But whatever the benefits, massive stimulus clearly hasn't triggered a monster recovery.

Explanations abound. One is that the stimulus programs were still too timid. If we'd done more, we'd be in better shape. Another theory is that the trauma of the financial crisis and recession made households and businesses deeply cautious; they postponed spending, paid down debt and hoarded cash. Magnifying their anxieties were persisting threats: Europe's financial turmoil; the stubborn housing bust; the uncertainty of public policy (Obamacare's impact, the debt ceiling fight, and now the "fiscal cliff").

To these might be added a perverse possibility: the stimulus programs themselves. Intended to inspire optimism by demonstrating government's commitment to recovery, they could do the opposite. If consumers and companies interpret them as signaling that the economy is in worse shape than they thought, they might retrench even more. Some stimulus benefits would be offset.

There is a desperate air to Bernanke's latest move. At best, it will reinforce a long-awaited housing revival. At worst, it will founder on obvious problems. How much lower can the Fed drive long-term interest rates? How much money can the Fed shovel into the economy without rekindling inflationary expectations and behavior? The Fed is on the brink of moving beyond what it understands and can control.