The Fed: We Have to Keep Printing Because of Congress

The stock market continues to trade near multi-year highs, and the economy is slowly showing signs of life, but that does not mean the Federal Reserve will pull the plug on its loose monetary policy anytime soon.

New York Federal Reserve President William Dudley delivered a speech on Monday to the Economic Club of New York. He noted improvements in the economy, but defended the central bank’s quantitative easing programs and gave no clear indication when they would end.

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Supported by historic low interest rates, housing has witnessed a bounce from the bottom. Dudley explains, “Over the past four quarters, housing starts rose by 33 percent, existing home sales climbed by 12 percent, and home prices, as measured by the CoreLogic national home price index, were up over 7 percent. Although the pace of recovery varies regionally, the U.S. housing sector as a whole is now clearly rebounding.”

Overall, the so-called recovery is a very slow one. Real gross domestic product grew only 1.6 percent last year, below the 2.2 percent pace of the preceding two years. Meanwhile, the unemployment rate still remains high and private non-farm payroll growth is only a bit stronger than last year. The employment-to-population ratio and job-find rates are also relatively unchanged.

So why isn’t the U.S. economy growing more quickly…

While some people believe the economy is going through a structural change and only remains afloat due to massive amounts of money-printing, Dudley blames fiscal policy.

He explains, “The fact that fiscal policy has turned significantly more restrictive is the most important reason. The impulse from state and local governments that subtracted from growth earlier in the recovery has gone from negative to close to neutral. But this has been overwhelmed by the sharp shift in federal fiscal policy from mild restraint in 2012 to much greater restraint in 2013. The increase in payroll tax rates, the rise in high income tax rates, the increase in taxes associated with the Affordable Care Act, and now the sequester—if sustained—will result in fiscal drag of about 1.75 percentage points of GDP in 2013.”

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Between the recent actions of Congress and the ongoing weak labor market, the Federal Reserve does not appear to be slowing down its printing presses. The central bank launched its highly anticipated fourth round of quantitative easing in December. The latest money-printing program came only three months after the central bank’s unlimited QE3 was announced. In total, the Federal Reserve now purchases $85 billion a month in mortgage-backed securities and U.S. Treasuries, in addition to its zero interest rate policy.

Balance sheet grows to new records…

Earlier this year, the Federal Reserve’s balance sheet broke through the $3 trillion level. In fact, it’s well on its way to $4 trillion by the end of the year. If the central bank continues purchasing $85 billion in securities through 2014, its balance sheet will easily climb near $5 trillion or more.

However, Dudley is confident the Federal Reserve can manage the risks and control inflation if needed. Although savers are punished by low interest rates, he believes the benefits of a stabilizing economy are worth the intervention.

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Dudley finishes the speech with, “I do not claim that there are no costs or risks associated with our unconventional monetary policy regime. But I see greater cost and risk in moving prematurely to a policy setting that might not prove sufficiently accommodative to ensure a sustainable, strengthening recovery. I remain confident that the benefits of a stronger and earlier economic recovery will trump the costs associated with our unconventional monetary policy measures.”

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