Fed Alters Plans Amid Dismal Economic Data

Posted by - Thursday, June 7th, 2012

What will the Fed do now? That's the question on everyone's mind after May's dreary economic data. Ben Bernanke faces some tough decisions this summer...

In the midst of the growing fiscal woes across the globe, many in the U.S. believe the Fed should be doing much more in order to spur domestic GDP growth.

In the coming days and weeks leading up to the Fed's June 19 and 20 meeting, leaders are contemplating the proper course of action regarding the future of monetary policy.

With no definite answers in site, the Fed appears divided on the issue. A number of Fed officials aren't confident that buying more bonds when interest rates are already historically low will prove effective. Sources with the Wall Street Journal indicate that many Fed members are concerned about putting the country at risk for higher inflation or the potential for a future financial bubble possible if the Fed keeps adding on to its $2.8 trillion portfolio of securities and loans. 

Nonetheless, the jobless rating has remained rather stagnant over the past few months; it was 8.2% in May. Meanwhile, the economy only showed an annual growth rate of 1.9% in the first quarter. For these reasons alone, some Fed policy makers assert that more action (easing) is necessary in order to accommodate for the bleak economic outlook.

Charles Evans, president of the Chicago Fed, is one proponent of this philosophy. According to Evans, the Fed must assure the people that it will not raise interest rates until unemployments creeps back down below 7%. Evans worries that employment will stall and he will likely “shave his growth forecast” based on May's grim economic data.

Europe's financial blunders have become our own as the Fed will not dismiss the possibility of taking further monetary action in order to boost our nation's economy. Back in April's central bank meeting, the likelihood of more stimulus seemed low. But the Fed is now in the early stages of determining if May's economy statistics are poor enough to justify alternative measures to spur growth.

The next meeting may be too soon for the issue to be completely resolved, but it sounds like some Fed officials are convinced of the need for further action in order to more adequately sustain growth.

On the other hand, many aren't yet convinced that the situation is dire enough to go forth with further action:

James Bullard, president of the St. Louis Fed, said the weak May jobs report was disappointing, but not enough to substantially alter his expectation for "sluggish growth modestly improving over the coming year." Speaking in St. Louis, he also said new Fed policies wouldn't ease Europe's financial woes.

In an interview Friday, Cleveland Fed President Sandra Pianalto said she wasn't yet convinced that the outlook had significantly darkened. 

But there's no denying that things aren't pretty right now. Beyond the jobs situation, stock prices have slumped and Treasury bonds are at an all time low as high-risk debt options like corporate and mortgage bonds have become too costly for many.

In a speech to the Joint Economic Committee in Washington today, Bernanke addressed the economic risks currently at hand regarding the U.S. budget in terms of Europe's crisis:

The situation in Europe poses significant risks to the U.S. financial system and economy and must be monitored closely...As always, the Federal Reserve remains prepared to take action as needed to protect the U.S. financial system and economy in the event that financial stresses escalate.”

Bernanke's message resonated with lawmakers as he alluded to “a sever tightening of fiscal policy at the beginning of next year that is built into current law -- the so-called fiscal cliff -- would, if allowed to occur, pose a significant threat to the recovery.”

As we are just weeks away from summer and the end of Operation Twist, Mr. Bernanke has some tough fiscal decisions to make. Will he let it end or expand the $400 billion program in order to push investors back towards riskier assets? 

Or will he decide to launch yet another dose of quantitative easing via another round of securities?

And the real question at hand: will any of these options really do any good for the long-term picture? Find out why one critic says "Monetary Easing" can't fix what's already broken.

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