With every Federal Reserve speech, every Open Market Committee meeting minute release or every other public pronouncement from Chairman Ben S. Bernanke, the market seems to be holding its breath and holding out hope that the central bank will arrive on the scene with news of a flattering recovery.
Whether it is through additional quantitative easing or some new, innovative measure, there's an assumption that the Fed still holds the keys to the pace of the recovery. Unfortunately, these assumptions are increasingly misplaced and deny the reality that the Fed is increasingly limited in additional corrective measures. The real holder of the keys to this recovery sits at another address in Washington, D.C., with fiscal policymakers. So while Fed pronouncements make good media headlines, our time and attention may be better spent on the opposing ends of Pennsylvania Avenue.
As the economy moves into the fourth quarter, the optimism from the beginning of the year seems tempered, if not a distant memory. The structural issues affecting the recovery are all too real. Considering the magnitude of the housing problems and the long-term rebalancing in consumer balance sheets, we are likely to continue to experience the "crawl, stagger, crawl" of the past few quarters, moving into next year.
Against this backdrop, the primary question is what else can (or should) the Fed do to accelerate growth and facilitate the rebalancing?
More quantitative easing to lower rates further? That won't have much impact given tepid loan demand.
Officially cutting short-term rates to zero? It's not clear what good that would do.
Changes in reserve requirements for banks? There is more than sufficient liquidity, and banks are gradually improving their balance sheets. Legitimately, there are market expectations to be managed, but any lift on this front is likely to be short-lived.
Perhaps more challenging is the fact that anything the Fed does could be wiped out without some clear direction and action on the fiscal policy front. Pending tax increases, higher regulatory burdens and state and local corrective actions loom large and will have a significant impact on the recovery. On the tax front, the underlying trends are very troubling. Higher income, capital gains and estate taxes will place an additionally significant burden on one of the most fragile recoveries in modern history and potentially restrain growth over an extended period of time.
So while the media and the markets gear up for the next morsel from the Federal Reserve, the more appropriate focus should shift more heavily to the fiscal policy debate where one would hope some logic and common sense prevails.
Without some fiscal policy prudence, the Fed will find its tool chest further compromised and continue to scramble for some magic elixir to cure our economic woes.
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