Analysis: Bernanke's twist may do little for jobs

Thu Sep 22, 2011 12:50am EDT

U.S. Federal Reserve Chairman Ben Bernanke smiles as he speaks at a conference on systemic risk, at the Federal Reserve in Washington September 15, 2011. REUTERS/Jonathan Ernst

U.S. Federal Reserve Chairman Ben Bernanke smiles as he speaks at a conference on systemic risk, at the Federal Reserve in Washington September 15, 2011.

Credit: Reuters/Jonathan Ernst

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(Reuters) - The Federal Reserve's latest effort to push down long-term U.S. borrowing costs may not do much for the central bank's main worry -- persistently high unemployment that could leave lasting scars on the economy.

Economists are increasingly anxious that the 9.1 percent jobless rate in the United States could become entrenched, as the skills of those out of work atrophy and their connections to the job market wane, sidelining them and chipping away at the U.S. economy's capacity to produce.

"The Fed is doing all that it can to stimulate the demand side of the economy in an environment where 'all that it can do' is 'not very much,'" said Mark Setterfield, an economics professor at Trinity College in Hartford, Conn.

He is the author of a book on persistently high unemployment, sometimes known as hysteresis.

The term is borrowed from physics, where it is used to describe a temporary effect that becomes permanent, even when whatever triggered the initial effect is removed. In the labor market, it is used to described a self-feeding cycle where even after demand returns, unemployment remains high.

"We went to 9 percent unemployment quite quickly, and we have basically been stuck there," Setterfield said. "There has to be the concern that that type of hysteresis effect is going to add insult to injury."

The Fed on Wednesday moved to offset what it called significant downside risks to the already weak U.S. economy with a new $400 billion program to weight its $2.85 trillion balance sheet more heavily toward longer-term securities.

DO THE TWIST

The idea behind the move, nicknamed by investors as "Operation Twist" after a similar policy in the 1960s, is to push down long-term borrowing costs to encourage mortgage refinancing and consumer and business borrowing.

The Fed also sought to give the housing market a direct boost by promising to keep its mortgage-backed securities portfolio at its current size.

But with unemployment so high, households worried about their future prospects may be more focused on paying down debt than taking out new loans.

If that sucks enough demand from the economy, economists such as Setterfield argue the jobless rate will level off at a high level, no matter how low the Fed pushes interest rates.

Several analysts left their economic forecasts unchanged after the Fed's move. An estimate from Goldman Sachs made ahead of the meeting put the economic impact of a "twist" operation at just 0.5 percentage points of added growth, and a reduction in the unemployment rate of just one-tenth by 2015.

Even the Fed does not know exactly what to expect; how much of an economic boost the program will deliver is, as the central bank explains on its website, "difficult to estimate precisely."

But such concerns probably will not prevent the Fed from doing even more if need be, said Eric Stein, a portfolio manager at Eaton Vance in Boston.

"I think (Fed Chairman Ben) Bernanke and (New York Fed President William) Dudley and (Chicago Fed President Charles Evans) and (Fed Vice Chair Janet) Yellen are committed to doing whatever it takes to get the economy going," he said.

"I think they'll continue pushing for things unless the world gets materially better -- I don't know what efficacy things will have, but I think they will keep pushing."

Bernanke has repeatedly cited sustained high unemployment as a chief concern. In its statement following Wednesday's policy-setting meeting, the Fed pointed to an "elevated" jobless rate that will decline only gradually.

"Chairman Bernanke may be...over-optimistic, in the sense that he is thinking about unemployment coming down slowly and painfully," said Laurence Ball, an economics professor at Johns Hopkins University.

That concern is not limited to academics.

San Francisco Federal Reserve Bank President John Williams, who rotates into a voting spot on the Fed's policy-setting panel next year, recently raised the specter of permanently high unemployment outside a recession, something unseen in the United States since the end of World War II.

"One of the concerns is, if unemployment stays very high for very long, people are out of work for several years, that's going to have a much more persistent effect, despite the history," Williams told reporters after a speech in Seattle in which he suggested there was more room for the Fed to ease monetary conditions.

While the Fed wants to bring down the unemployment rate, many economists say that it has little chance of success as long as politicians fail to deliver fiscal stimulus or effective jobs-promoting programs.

That's the argument made by Dallas Fed President Richard Fisher, one of three policymakers on the Fed's policy panel who dissented against its latest policy experiment on Wednesday.

Still, those concerns have not deterred the Fed's majority so far, and the ongoing threat of entrenched unemployment is likely to push them to do even more unless the economy picks up quickly.

As JPMorgan's chief economist Michael Feroli observed, "Monetary policy's toothpaste tube is rolled up to the very end, and Bernanke is squeezing it with both hands, but there's just not much left in there."

(Editing by Kim Coghill)

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