Federal Reserve Faces Stimulus Dissent

Brian Hicks

Updated February 22, 2013

The Fed’s commitment to sustaining its stimulus program is admirable, but what if it inadvertently sets the stage for major inflation problems?

That’s the fear that has seemingly led the Federal Reserve to agree to a thorough review of its ongoing bond buying program, under which the Fed buys up $85 billion a month. The review is expected to take place during the Fed’s policy meeting, March 19-20, per the USA Today.

The Fed’s balance sheet currently reads in excess of $3 trillion. Given the still-unstable state of the market and inflation—a near-inevitable risk of stimulus programs—just how much can the Fed continue to buy up?

Its goal in buying $85 billion a month in long-term Treasury bonds and mortgage-backed securities is, essentially, to keep long-term interests rates down, thus encouraging people to buy homes, cars, and so on. It has previously declared that such stimulus action would continue until the nation’s unemployment numbers dip below 6.5 percent—as of January, that number was at 7.9 percent.

Now, it looks like at least some minds in the Fed are keen on charting out an end-game to this strategy. It wouldn’t be the first time, either; back in December, there were already voices calling for some sort of closure through 2013.

What’s really important here is that the public relies on the Fed to keep interest rates down. That impression could easily be hurt if it turns out there is a toxic state of affairs within the Fed over this issue—that there is intense dissent over the question of whether to continue or bring the bond-buying program to an end.

The New York Times quotes part of the Fed’s Open Market Committee report on the risks of curtailing a stimulus program prematurely:

Those officials “noted examples of past instances in which policy makers had prematurely removed accommodation, with adverse effects on economic growth, employment and price stability,” it said. “They also stressed the importance of communicating the committee’s commitment to maintaining a highly accommodative stance of policy as long as warranted by economic conditions.”

Concerning the more immediate problem of dissent within the Federal Reserve, the naysayers do not yet have enough votes on the committee—comprised of 12 members—to enact any real policy change. However, the mere fact of growing dissent is enough to cause troubles, which is why the Fed absolutely needs to attend to the issue soon.

Also, should Congress continue slashing spending, as is expected on March 1 (a delayed effect of the fiscal-cliff drama earlier this year), then growth will likely be hurting all over again. The New York Times estimates such a spending cut could retard growth by 0.6 percent and cost at least 750,000 jobs.

Meanwhile, the market has already made its thoughts on these things clear. Thanks not only to the fraught news from the Fed but also renewed indications that the Eurozone economy is still highly problematic, platinum dropped to its lowest in six weeks, while gold didn’t move much at all.

Per Bloomberg, services and manufacturing in the Eurozone contracted much faster than earlier analyses, meaning platinum futures for April on the NYMEX dropped 1.6 percent, reaching $1,620 as of 1:24PM Eastern. Gold futures for April barely rose (sub-0.1 percent) to $1,578.60/oz on the Comex.

It’s possible, of course, that resurgent demand from India could buoy bullion in short order, but right now gold is in a tough spot, and investment guidance from the Eurozone and the Federal banks is just not promising.

Over at the Fed, there seems to be a definite conflict brewing over the faction that would like to see a tapering-off of the stimulus program and the faction that believes the Fed cannot increase its stimulus action much further, but can very well sustain it for longer than initially anticipated. Such a move would, of course, continue exerting pressure on interest rates, keeping them down and (ideally) encouraging consumers to, well, consume.

The problem right now is that unemployment numbers have been remarkably stubborn. Fortunately, inflation has remained low, if steady. Of course, that’s exactly what the dissenters are worried about—persistent inflation that ends up encouraging speculation, thus leading to new asset bubbles and generally destabilizing the markets.

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