Is Congress Accidentally Stimulating the Economy?

Congress can't put off fiscal decisions forever, but it is helping to create a bit more Fed stimulus.


Congress' upcoming fiscal fights are one reason the Federal Reserve has not yet tapered its economic stimulus program.

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The Fed surprised almost everyone last week when it decided to hold off on tapering its monthly asset purchases known as QE3. Among the reasons that the central bank's open market committee gave were Congress' ongoing fiscal issues. In its statement about its latest decision, the FOMC said that the economy is growing despite the fact that "fiscal policy is restraining economic growth."

[READ: Federal Reserve Opts to Maintain Stimulus]

As a result of the unexpected extension in stimulus, the stock market rallied, with the Dow Jones Industrial Average jumping by more than 200 points the afternoon of the Fed's announcement.

New York Fed President William Dudley echoed the FOMC's sentiments in a Monday speech, remarking that "fiscal uncertainties loom very large right now" as the Fed considers what to do over the next few months. Dudley listed Congress' inability to get past its two looming fiscal fights as a key threat to his confidence that the recovery can create sustained improvement in the job market. All of which means that as Congress delays, the Fed has more impetus to keep its foot on the gas pedal.

"I think what policymakers intended was that by holding off tapering, that investors might not worry as much about all the political squabbling over the debt ceiling," says Gary Thayer, chief macro strategist at Wells Fargo Advisors.

Deadlines for congressional action are fast approaching – the government will shut down after September 30 if Congress does not act, and the debt ceiling will be hit in mid-October. And the fights over those two issues show few signs of abating. President Obama reportedly called Speaker John Boehner on Friday to inform him that the White House will not negotiate over the debt ceiling, and the coming fight among lawmakers appears to be drawn sharply along party lines.

[DEBATE CLUB: Has the Federal Reserve Overstepped Its Mandate?]

It's not just Congress' inability to perform routine tasks like fund the government and raise the debt limit that are preventing the Fed from dialing back its stimulus. Improvements in the job market have also been slow and fragile. But a strong economy and congressional actions (or lack thereof) are inextricably interwoven – as Congress proved the last time gridlock threatened the debt ceiling, the hit to consumer confidence rippled throughout the economy.

Together, a shaky economy and intransigent lawmakers may now mean three more months of the Fed's controversial stimulus program. Now that September is off the table, a majority of economists say they now believe the taper now won't come until the FOMC's December meeting, according to a Bloomberg survey.

Which is not to say that there is anything fundamentally good or helpful in more fiscal standoffs. A threat to withhold payment from the nation's financial obligations means a threat to the nation's credit rating, which notably took its first hit ever when Congress came dangerously close to hitting the debt limit in 2011. That August, Standard and Poor's downgraded the U.S. from a AAA rating to AA+. Hitting the limit or even another credit downgrade could have massive economic consequences.

Even if the Fed continues to try to make up for Congress' shortcomings, the blunt tools of monetary policy may not be enough to counteract the uncertainty coming from Capitol Hill.

"I'm not sure that the Fed can compensate for what Congress does or doesn't do," says Thayer. In addition, many economists believe that each successive round of quantitative easing has brought about diminishing returns. It's also possible that QE3 has lost its former potency, says one expert.

[MORE: The Fed’s 6.5 Percent Unemployment Target May Be a Long Time Coming ]

"The power of QE3 was in its infinite nature," says Guy Lebas, chief fixed income strategist at financial services firm Janney Montgomery Scott. When Ben Bernanke began signaling the coming end of QE3, says Lebas, the program became increasingly "useless."

It's also possible that with the future of tapering in question, the Fed is itself making for more volatile markets.