Why The U.S. Needs QE part 3




"Bernanke Making Sure Fed Governors Remind Congress Deficit Bigger
Than QE2"



Federal Reserve Chairman Ben S. Bernanke is trying to make sure the
U.S. central bank doesn't become a scapegoat for fiscal profligacy.

Fed officials are warning that Congress needs to balance the nation's
budget, showing that policy makers are concerned about a loss of
confidence in U.S. finances and want lawmakers to help prevent it,
according to Dean Maki, chief U.S. economist at Barclays Capital Inc.
Bernanke extended his campaign yesterday, telling the House Budget
Committee "anything that can be done now to change that path" would
have a "good impact on the current economy" and interest rates.

"There is this tremendous fiscal problem looming, and Congress has to
do something about it," said Mark Gertler, a professor of economics at
New York University who has co- authored research with Bernanke. "If
they have a fixed amount of time, spend it solving" that problem,
rather than "grandstanding about the Fed." The central bank's plan to
buy $600 billion in Treasury securities through June is "a relatively
modest policy undertaking" compared with balancing the $3.7 trillion
budget, he said.

The Fed sparked the harshest political backlash in three decades after
announcing a second round of so-called quantitative easing on Nov. 3.
Republicans, including House Speaker John Boehner of Ohio, said QE2
risks accelerating inflation, weakening the dollar and fueling asset
bubbles.

"What is needed is very clear communication to the Congress at large
and the American public," that the program isn't "crazy or highly
unusual and that it made sense, but that it does involve some risk and
that's being managed," said Alfred Broaddus, former president of the
Federal Reserve Bank of Richmond. "You've got to be careful about
turning this thing around."


'Can Be Overdone'

By acknowledging that buying government debt "can be overdone," the
Fed may bolster confidence that it will withdraw its record stimulus
in time to avoid a surge in inflation, said Broaddus, who was
president of the Richmond Fed from 1993 to 2004.

Bernanke defended the bond-purchase program yesterday in his first
House testimony since Republicans took control of the lower chamber
last month. He repeated that Congress should adopt a long-term plan to
control a federal budget deficit that's projected to reach a record
$1.5 trillion this year.

The Fed isn't monetizing the nation's debt because "what we're doing
here is a temporary measure, which will be reversed," Bernanke said.
QE2 is "providing significant support to job creation and economic
growth."


Biggest Drop

The unemployment rate fell to 9 percent in January from 9.8 percent in
November, the biggest two-month drop since 1958, and gross domestic
product rose at a 3.2 percent annual rate in the fourth quarter,
compared with 2.6 percent in the third and 1.7 percent in the second.

At the same time, "our nation's fiscal position has deteriorated
appreciably," and adjustments "must occur at some point," Bernanke
said yesterday.

"The Fed wants to make clear it's not going to underwrite large
deficits in the medium term," Maki said in a telephone interview from
his New York office. The central bank is responding to critics who've
said it "is allowing the Congress and the administration to run less-
responsible fiscal policy," he said.

One such critic is Sarah Palin, the 2008 Republican vice- presidential
nominee, who says she's considering a run for president in 2012.

"It's time for us to 'refudiate' the notion that this dangerous
experiment in printing $600 billion out of thin air, with nothing to
back it up, will magically fix economic problems," she wrote in a
letter to the Wall Street Journal published Nov. 18.


Curb Spending

So far, buyers of Treasury securities haven't forced Congress to curb
its spending by making it expensive for the nation to borrow. The
yield on the 10-year Treasury note was 3.65 percent late yesterday in
New York, lower than its average of 5.25 percent during the last
decade, according to data compiled by Bloomberg.

"Unfortunately, there's no sense of urgency right now," said John
Lonski, chief economist at Moody's Capital Markets Group in New York.
"Once you reach the point where concerns about the federal budget
deficit render financial markets dysfunctional, then Congress will
take action pronto."

Representative Paul Ryan, the Wisconsin Republican who chairs the
budget panel and offered his own plan last year for cutting spending,
asked Bernanke during his testimony if Congress could aid short-term
economic growth with a plan to control spending. "That's correct,"
Bernanke said.


Inflation Launched

Bernanke may not have won Ryan over on QE2, though. Ryan said during
the hearing he's concerned that "you're going to see inflation after
it's already been launched."

Representative Ron Paul, a Texas Republican who has advocated
abolishing the central bank, said yesterday that the Fed's policies
aren't working.

"They haven't been very efficient in producing jobs," and prices
"really aren't all that stable," Paul said at a hearing he held titled
"Can Monetary Policy Really Create Jobs?"

Since Bernanke fueled speculation about additional asset purchases
during an Aug. 27 speech in Jackson Hole, Wyoming, inflation
expectations have climbed. The breakeven rate for 10- year Treasury
Inflation Protected Securities, the yield difference between the
inflation-linked debt and comparable- maturity Treasuries, has risen
to 2.33 percentage points from 1.63 percentage points, Bloomberg data
show. The central bank prefers an inflation rate of about 2 percent.


Congressional Legacy

"Deficits and the unfunded liabilities of Medicare and Social Security
are not created by the Federal Reserve; they are the legacy of
Congress," Dallas Fed President Richard Fisher said in a Feb. 8
speech. Fisher has expressed doubts about the efficacy of quantitative
easing and said this week he'll oppose further asset purchases after
the planned $600 billion is completed.

The Fed "would be more comfortable running a very easy monetary policy
if it could see firm evidence that a more- sustainable fiscal
situation was being put in place on a long- term basis," Maki said.
Most Fed officials aren't seeking "sharp, immediate" cutbacks, given
that they want the economic recovery to gain traction, he said.

Quantitative easing is "hardly a panacea" and would benefit from
fiscal support, Fed Vice Chairman Janet Yellen said in New York speech
Dec. 1. "We would be wise to heed the abundant empirical evidence of
the superiority of taking action before a fiscal crisis is upon us,"
Richmond Fed President Jeffrey Lacker said Feb. 8 in a speech in
Newark, Delaware.

$35 Billion in Cuts

House Republicans have started looking at reducing some expenditures,
announcing last week that they will seek $35 billion in cuts.

Washington's spending spree is over," Ryan said in a Feb. 3
statement.

While Bernanke and other Fed officials have voiced concern that the
nation's financial situation is unsustainable, they have stopped short
of prescribing how lawmakers should fix it.

"The composition of spending and taxes is a Congressional
prerogative," Bernanke said yesterday.

Policy makers must "be very careful about getting into" too much
detail with fiscal recommendations because that also could politicize
the Fed, Broaddus said. Bernanke's predecessor, Alan Greenspan, was
criticized for expressing his opinions on matters such as Social
Security, he said.


'Different Tone'

"Chairman Bernanke has set a different tone than Chairman Greenspan in
that he has consistently avoided making near-term fiscal-policy
recommendations," Maki said. "He's taking this approach in part to
preserve the Fed's independence and avoid an image of partisanship."

Congress shouldn't become too involved in monetary policy, either,
because that could damage the credibility and effectiveness of the
Fed, Lonski of Moody's said.

"Their primary focus ought to be on fiscal policy, not on monetary
policy," Lonski said. "You have to worry about what you have direct
control over."