Federal Reserve Chairman Ben Bernanke told Congress recently that while the U.S. economy continues to recover, the rate of recovery has slowed. Karen Dynan, vice president and co-director of the Brookings economic studies program and former member of the Federal Reserve Board of Governors, says that monetary policy can indeed help the economy, and there is more that the Fed can do. Congress, too, can help by addressing the fiscal cliff facing the nation. Dynan recently spoke with U.S. News about what the Fed's next step should be and why it is cautious about more quantitative easing. Excerpts:
What did Bernanke's testimony signal for the economy?
Chairman Bernanke was fairly downbeat about the prospects for the U.S. economy. He said that he thinks the available indicators suggest that the economy is moving forward but not very fast, and not as fast as it was earlier this year. So, for example, Chairman Bernanke mentioned that we had been creating 200,000 jobs per month, and now we are down to about 75,000 jobs per month, which is not enough to bring the unemployment rate down.
Has Bernanke been doing the right thing for the economy?
The Fed has acted to support the economy. They of course have a dual mandate, so they are both trying to keep employment at what they call its "maximum level" and also to keep inflation stable. There's been a whole slew of steps they have taken over the last few years, but most recently, at the June Federal Open Market Committee meeting, the FOMC announced that they were going to shift the composition of the Fed's portfolio of treasury securities such that they're holding more longer-term securities, which tends to drive down longer-term interest rates and pushes up demand for risky assets, which tends to raise prices on stocks and create a wealth effect for the economy.
What does Congress need to do?
They need to make sure that two things happen, and one is that Europe addresses its problems, but the other one is that Congress needs to address our fiscal challenges. What Bernanke has said is that Congress needs to address the fiscal cliff, that they need to make very comprehensive fiscal changes with an eye both towards the fragile economic recovery and also towards the longer-term sustainability of the budget. But at the same time, we can't do it so suddenly that the economy crashes.
Can the public expect the Fed to take any bold action in the next few months?
There's a lot of debate about what the Fed's next step is. They have signaled that they are worried about what's going on right now and looking at incoming data very carefully to see if this slowdown in the economy is merely a soft patch or whether it's going to be some sort of more protracted deceleration in activity. Bernanke has made it clear that if we don't continue to see improvement in the labor market, that the Fed stands ready to act. He hasn't been really specific about what he means, but I think it's fair to say if we don't start to see the unemployment rate start to come down further, it's highly likely we'll see further Fed action.
What are the potential costs of another round of quantitative easing?
Quantitative easing is controversial. I think the argument would be that you're buying the securities and you're flooding the market or flooding the economy with liquidity, and that runs the risk of driving up inflation. I think that's not the most likely outcome at all, but I do think that's part of why the Fed is being so cautious.
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