- The Washington Times - Friday, February 10, 2012


The Federal Reserve is keeping short-term interest rates absurdly low through late 2014, and that choice is going to cause long-term damage to our economy. Now there are signs that the Fed’s policy of driving down long-term interest rates, known as Operation Twist, is wreaking havoc with the long-term bond market as well. Such market distortions are the inevitable result of attempting to achieve the impossible.

With interest rates near zero for Treasuries with shorter maturities, investors looking for safe instruments are trying to buy 30-year Treasury bonds. These are the favorites of long-term investors like pension funds and insurance companies. With Operation Twist, however, the Fed has jumped in and crowded out these investors. Since October, the Fed has bought up over 90 percent of the new bonds maturing in 20 to 30 years issued by the Treasury, worth over $50 billion.

The good news is that Operation Twist is supposed to end in June, and we may not see any further quantitative easing. The signs of a weak recovery - especially the recent dip in unemployment - has been enough to convince even San Francisco Federal Reserve President John Williams that the case for further stimulus is getting weaker. Mr. Williams has generally sided with Fed Chairman Ben S. Bernanke on the desirability of quantitative easing.

On the other hand, the end of Operation Twist means that the single biggest buyer is going to leave the market, and prices will crash. Long-term interest rates would have to rise.

That doesn’t mean the Fed has given up on further intervention in the economy. If the economic recovery continues to drag, Mr. Williams and Mr. Bernanke have both suggested the Fed would consider buying mortgage-backed securities as part of a third round of quantitative easing. This is a bad idea, as the housing market needs to find its own equilibrium. More government interference from the Fed this time is simply going to delay the process.

More problems are on the horizon. Though inflation has remained low, core inflation has begun to rise. The core consumer price index (which excludes food and energy) increased 2.2 percent in 2011, and the overall CPI jumped 3 percent. That’s double the rate for 2010, which is a troubling trend. This is where the Fed’s attention ought to be focused.

The Federal Reserve’s dual mandate of maximizing employment and stabilizing prices with a single policy instrument represents an impossible task, and it is making our financial markets less stable. Monetary policy cannot influence real variables like employment in the long run. Federal Reserve policy is doing more harm than good. It’s time for a less ambitious Fed, one that limits itself to stabilizing prices.

The Washington Times



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