Americans may never agree on who or what caused the financial crisis that began five years ago with the collapse of Lehman Brothers. But at least one consequence of the crisis is indisputable: the assumption of massive economic power by the Federal Reserve.
Anyone who doubts it need simply observe market behavior after Fed Chairman Ben S. Bernanke announced Wednesday that the central bank will continue buying securities at the rate of $85 billion per month — contrary to expectations that it would begin to “taper” those purchases, which have already swollen the Fed’s balance sheet to roughly four times its pre-crisis size. Bulls went wild, believing that the Fed’s easy-money policies, which help prop up the price of stocks and other assets, may continue at least through the end of Bernanke’s term early next year.
This much Fed power is not in the long-term interest of the U.S. economy, nor that of the world. We say this not because the Fed’s policies under Bernanke have been wrong. To the contrary, taking interest rates to zero was aggressive but appropriate in the face of an epic recession. Early in the crisis, the growth in the Fed’s balance sheet resulted from the extension of emergency credits — a classic case of the central bank acting as a panic-stopping “lender of last resort.” The Fed’s subsequent effort to push down long-term interest rates, and thus stimulate economic activity, by purchasing more than $1 trillion each in Treasury bonds and mortgage-backed securities with freshly created money is less precedented and therefore more controversial — but also plausible, given the economy’s intractable weakness.
Yet the Fed’s huge role represents more responsibility for the economy than a single technocratic institution — or any one fallible, unelected official, even a dedicated, talented one such as Bernanke — should bear for too long. Among the chairman’s innovations has been an attempt to fine-tune market expectations through more open communication of Fed intentions. Precision, though, can be elusive. In June, Bernanke candidly announced that the bond-buying “taper” might start by year’s end — inadvertently triggering a rise in interest rates that hurt the U.S. housing recovery and clobbered emerging markets. Bernanke’s decision not to taper is at least in part an attempt to undo that.
At a news conference Wednesday, he implicitly chided market mavens for betting too heavily on a taper. “We can’t let market expectations dictate our policy actions,” he said. Maybe not, but when the world’s most powerful central bank intervenes so heavily in markets, traders are going to try to profit from its chairman’s every utterance. Yet judging by the forecasts the Fed released Wednesday, the U.S. economy is in for several more years of subpar growth — and, therefore, no swift unwinding of the unconventional policies.
Bernanke seems to recognize the status quo is unhealthy, yet, as the Fed noted, it’s hard for the central bank to retreat as long as “fiscal policy is restraining economic growth” — that is, as long as Congress won’t do its part. The list of that body’s failings is long, from the indiscriminate sequester to the lack of a long-term budget-and-tax “grand bargain” to the current manufactured crisis over funding the government and raising the debt ceiling. Unless and until partisan gridlock ends, the Fed dominates, with all the benefits and risks that entails.