There’s a term in chess called zugzwang, which describes the point in a game when it’s your turn to move but every move you could make would worsen your situation. That’s pretty much what the chessboard looked like for Federal Reserve chairman Ben Bernanke when he testified before Congress this morning. What everyone most wants to know is when the Fed is going to start tapering off its bond-buying program (called Quantitative Easing), which has flooded the banking system with money for the past five years and kept interest rates abnormally low. And that was something Bernanke couldn’t answer.
In his testimony, the Fed chairman gave a carefully hedged commitment that the central bank would continue buying bonds – currently $85 billion a month – until the economy is stronger. And he repeated last December’s official statement that the Fed intends “to maintain highly accommodative monetary policy as long as needed to support continued progress toward maximum employment and price stability.” When asked at what point the bond-buying policy might change, Bernanke was more evasive, saying that the Fed might need a few more meetings to make that decision. Asked if it would be decided by Labor Day, he demurred.
Bernanke’s hedging isn’t primarily a sign of indecisiveness. His real problem is that given current economic conditions, there aren’t any good moves he can make. The conventional wisdom – and the presumption behind the Fed’s current policy – is that the economy is steadily improving, even if progress is slow. And while easy money eventually leads to higher inflation, that threat could still be several years away. So ideally, the Fed’s stimulus could get the economy back to a normal rate of growth before inflation becomes a problem, at which point the Fed could taper off its bond buying little by little and gracefully exit the picture.
But what if the economy isn’t getting better, or is improving so sluggishly that it will take years to get back to normal? The picture would look entirely different. “A long period of low interest rates has costs and risks,” Bernanke acknowledged. Among them is “the possibility that very low interest rates, if maintained too long, could undermine financial stability.”
On the other hand, if the Fed stops buying bonds before a recovery has firmly taken hold, the economy is likely to deteriorate further. “A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery,” Bernanke explained. “Moreover, renewed economic weakness would pose its own risks to financial stability.”
Risks to financial stability vs. undermining financial stability – it’s not a great choice for a central banker.
Some commentators believe that a successful exit strategy is still possible. For one thing, they’re optimistic about the strength of the recovery and point to the booming stock market as a sign that investors expect the economy to get a lot better over the next three years or so. But I believe that the stock market’s run-up actually reflects economic weakness rather than strength. Because the Fed is holding interest rates very low, corporations can borrow very cheaply and use the money to buy back stock or redeem older, more expensive debt. That means the Fed’s easy money is to some extent subsidizing corporate profits rather than generating new business and new jobs.
There’s another factor that’s fattening corporate profits, and it doesn’t bode well either. Perverse as it may seem, one of the reasons that the stock market is so strong is that the job market is lousy. Since the recession ended, unemployment has come down from 10% to 7.5%. But as Bernanke noted: “Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down. Moreover, nearly 8 million people are working part time even though they would prefer full-time work.”
That level of unemployment and underemployment is still far too high to create the kind of competition for workers that would bid up wages. And at the present rate of job growth, it could take more than five years for unemployment to decline to a level at which gains for the overall economy will boost wages for the typical American worker rather than flow largely to corporate profits.
All this suggests that the Quantitative Easing doesn’t have much oomph – and that means Bernanke is caught in a stalemate. In short, if the conventional wisdom is wrong, and the economy doesn’t get back to normal within a year or so, the Fed will find that it has no exit strategy. It will be risky to continue Quantitative Easing – and dangerous to stop.
For Bernanke himself, there may be a personal way out of this dilemma: Many Fed watchers believe that he will step down as Fed chairman when his current term expires in January. Indeed, in a response to recent press questions, Bernanke reportedly said: “I don’t think that I’m the only person in the world who can manage the exit [from Quantitative Easing].”
But of course whoever replaces him will face the same dilemma – and is unlikely to find it any easier to resolve.