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GHEI: The Fed’s twisted policy

Interest-rate gimmicks don’t address fundamental economic problems

- The Washington Times - Thursday, September 22, 2011

The Treasury's money-printing presses might finally be getting a break. After efforts to pump massive new reserves into the economy through two rounds of "quantitative easing," the Federal Reserve finally realized its easy-money policy hasn't worked. Fed Chairman Ben Bernanke decided Wednesday to channel the 1960s and do "The Twist."

That's the term for a plan that will alter the composition of the Federal Reserve's portfolio, shuffling about $400 billion in an effort to drive down long-term interest rates. Three of the 10 voting members of the Federal Open Market Committee would rather sit out on this particular dance number. They realize it's not going to do much to jump-start an economy suffering from a 0.7 percent annual growth rate and staggering 9.1 percent unemployment.

The Fed plan to rebalance its $2.87 trillion portfolio involves selling off a chunk of short-term Treasuries for others with maturities of six to 30 years. The Federal Reserve is also planning to reinvest the proceeds of maturing securities in the mortgage market in an effort to shore up that troubled sector and encourage mortgage refinancing. The risk of inflation is reduced because the operation is "sterilized," meaning the Fed is simply swapping debt of different maturity, not exchanging bonds for cash.

This latest decision follows an August announcement that the Federal Reserve would hold short-term interest rates at close-to-zero levels. This month's actions will force long-term rates down, and - so the Fed hopes - encourage firms to borrow and invest. Don't bet on it.

Corporations are already sitting on more than $2 trillion in cash, and interest rates have been low for quite some time. The cost of borrowing isn't what's holding back investment. It's that the reward for creating a successful venture could soon be little more than a fat bill from the Internal Revenue Service. Business leaders also know federal busybodies may soon grant themselves the power to decide which companies survive and which will be forced to close because of unrealistic regulatory mandates. Obamacare is in legal limbo right now, so firms cannot know today what the cost of hiring will be tomorrow. So they wait, don't hire and don't invest.

The same is true for the housing market. Interest rates have never been lower, but those without jobs can hardly qualify for a mortgage. When unemployment is at historic highs and consumer confidence dips, there's little incentive to spend, so consumption falls.

That's why the Fed's latest gimmick isn't going to work. The only thing the Federal Reserve knows how to do is manipulate interest rates, and this policy instrument isn't sufficient to fulfill the Fed's dual mandate of keeping prices stable and maximizing employment. That's the real problem. The Fed should not be acting in any fiscal capacity. The dual mandate politicizes the Fed and undermines its independence. The Fed should use its singular tool to fulfill a single, core mission: stabilizing prices. Two for one does not work when it comes to the Fed doing the Twist.

Nita Ghei is a contributing Opinion writer for The Washington Times.

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