Federal Reserve Chairman Ben Bernanke is afraid the bickering between Congress and President Obama could easily wreck the economy.
With the White House and Capitol Hill on a collision course over the federal budget and debt ceiling, Bernanke made a defensive choice on Wednesday that defied Wall Street’s expectations.
In a surprising move, the Fed chairman said the central bank would continue its unique stimulus program of buying $85 billion in bonds each month. It’s an attempt to cushion a fragile recovery from any shock waves caused by a government shutdown or a first-ever default on the national debt.
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“These are obviously part of a very complicated set of legislative decisions, strategies, battles, et cetera,” Bernanke said. “The government shutdown and, perhaps even more so, the failure to raise the debt limit could have very serious consequences for the financial markets and the economy.
“The Federal Reserve will do whatever it can to keep the economy on course,” he added.
DATA DRIVEN
Bernanke likes to stress that the decisions of the Federal Open Market Committee, the central bank officials who set policy, hinge on what the economic data say. But over the next few months, the data could be shaped by the dysfunctional relationship between the White House and Capitol Hill.
Many economists – dissecting past statements by Bernanke – had predicted the Fed would trim its monthly purchases by $10 billion to $20 billion, as the unemployment rate has improved by eight-tenths of a percentage point over the past year to 7.3 percent.
“We can’t let market expectations dictate our actions,” the Fed chairman said at a press conference following the decision by Fed officials to continue the purchases and hold the key interest rate near zero percent.
But those expectations stemmed from Bernanke, who had previously said the purchases – known as QE3 – would end when the unemployment rate dipped to 7 percent. Bernanke acknowledged the metric had its shortcomings, masking the weakness of an economy full of aging and discouraged workers.
“The unemployment rate is not necessarily a great measure in all circumstances of the state of the labor market overall,” he said. “For example, just last month, the decline in the unemployment rate came about … because of declining participation, not because of increased jobs.
“There is not any magic number that we are looking for,” he added. “We are looking for overall improvement in the labor market.”
MARKET REACTION
Just as the stock market plunged in June after Bernanke first spoke about the possibility of a pullback, the S&P 500 closed on Wednesday at a new all-time high of 1,725.52, a 1.22 percent gain. The yield on the 10-year Treasury had flirted close to 3 percent, only to plummet back down to 2.69 percent yesterday.
Investors were pleased the Fed would continue to pump $85 billion into the economy for at least another month. But the stock market surge was the byproduct of Bernanke’s anxieties, rather than his confidence in the economy.
Fed officials lowered their forecasts on economic growth on Wednesday. They lowered their projections for Gross Domestic Product growth this year to 2 percent to 2.3 percent, a decrease of three-tenths of a percent.
CAPITOL CLASH
The accuracy of that estimate could easily be decided by the political maneuvering of the next few weeks. The White House and Congress must agree on a stopgap spending measure before Oct. 1 to keep the government operating. And by mid-October, they must reach a deal to raise the government’s $16.7 trillion debt ceiling, or risk a treacherous default.
As of Wednesday, congressional leaders seemed more determined to burn their bridges, instead of rebuilding them.
House Speaker John Boehner (R-OH) – under pressure from conservatives in his caucus – has turned the budgetary issues into a referendum on Obamacare. The House plans to vote Friday on a bill that would defund the health insurance program but keep the government operating through mid-December.
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The president is unlikely to sacrifice his signature achievement—the 2010 law mandating health insurance coverage – to placate his ideological rivals. And until a path toward compromise becomes clear, the stalemate threatens to snuff out a modest recovery from the 2008 financial meltdown.
Bernanke noted that the last debt ceiling showdown in 2011 destroyed economic confidence for months. Had he decided to taper the bond purchases this month, the Fed might have needed to reverse that decision. Bernanke, whose term ends at the start of next year, could begin the taper after the upcoming October and December meetings of the Federal Open Market Committee.
“[W]e see December as the more likely time of the first taper,” said JPMorgan Chase economist Michael Feroli in a client note. “We should mention that there is no guarantee that housing and the labor market will look better by December.”
Obama has yet to nominate a successor to Bernanke, and his alleged favorite, former Treasury Secretary Larry Summers, withdrew from consideration this past weekend after facing opposition from four Democrats on the Senate Banking Committee.
Bernanke’s legacy could be defined by whether he is involved in the unwinding of the same unusual policies that the Fed employed to salvage the economy from the depths of the Great Depression.
But should the Obama administration and GOP lawmakers fail to reach a budget deal, Bernanke emphasized that Americans would feel the sting, regardless of what the Fed does to soften the blow.
“Our ability to offset these shocks is very limited,” he said. “It’s extraordinarily important that Congress and the administration work together to make sure that the government is funded, public services are provided, that the government pays its bills.”
