September 22, 2011 / 5:15 PM / 8 years ago

UPDATE 1-FED FOCUS-Bernanke's twist may do little for jobs

* Economists, Fed fear entrenched long-term unemployment

* Fed’s action designed to push down long-term rates

* Economists see up to 0.5 pct added to GDP growth

* Stocks dive on gloomy Fed outlook, global slowdown (Adds markets’ reaction, economists’ forecasts for twist impact)

By Ann Saphir

Sept 22 (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 say they are increasingly anxious that the 9.1 percent jobless rate in the United States could become entrenched. Those out of work for a long period face a vicious cycle as their skills atrophy and their job market connections 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, Connecticut.

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 describe 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.”

On Wednesday, the Fed 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. For more, see [ID:nS1E78K1V1]

But Wall Street sees only a 15 percent chance that the Fed’s latest plan will give the U.S. economy a meaningful boost, according to a Reuters poll conducted after the Fed’s announcement. [ID:nS1E78K28V]

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For more stories on Fed policy, see [FED/AHEAD]

For the Fed statement, see [FED/FOMC]

For a Factbox on the Fed’s action, see [ID:nS1E78K1PR]

Graphic-Fed balance sheet: link.reuters.com/cub62s

Fed Hawkometer: link.reuters.com/ryv97p

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DO THE TWIST

The idea behind the move, nicknamed “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.

Without new spending, economists like Setterfield argue, the jobless rate will level off at a high level — no matter how low the Fed pushes interest rates.

The Fed’s grim outlook for the U.S. economy and data showing China’s contracting factory sector drove U.S. stocks down 3 percent on Thursday on fears of a global recession.

“Investors seem to be waking up to the fact that monetary policy is pushing on a string,” said Capital Economics analyst John Higgins. “The stock market and commodities are likely to continue to struggle, given the gloomy outlook for the economy that the Fed openly acknowledged on Wednesday.”

Thomas Lam, OSK-DMG chief economist, put the economic impact of the Fed’s “twist” operation at less than half a percentage point of added growth — slightly below a Goldman Sachs estimate.

Even the Fed does not know exactly what to expect, saying it is “difficult to estimate precisely” how much of an economic boost the program will deliver.

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,” Stein said.

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.

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

The concern is not limited to academics.

San Francisco Federal Reserve Bank President John Williams, who rotates into a voting spot on the policy-setting Federal Open Market Committee next year, has raised the specter of permanently high U.S. unemployment outside a recession, something unseen 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 September speech, hinting the Fed had more room to ease policy.

While the Fed wants to cut the unemployment rate, many economists say it has little chance of success as long as politicians fail to deliver fiscal stimulus or job programs.

That’s the argument often made by Dallas Fed President Richard Fisher, one of three FOMC members who dissented on Wednesday against its latest policy experiment — or ‘twist.’

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

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.” (Reporting by Ann Saphir; Editing by Jan Paschal)

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