Doubling Down on Zero

Editorial do WSJ

The Federal Reserve has kept its short-term interest-rate target at near-zero for 32 months, and yesterday its Open Market Committee announced that it'll keep the rate there for at least another 24 months. This is what a central bank does when it wants to appear to do something to help the economy but has already fired most of its ammunition.

The announcement of a specific mid-2013 target date supplants language that near-zero rates would continue for an "extended period." The idea is to assure markets that the Fed won't tighten for a very long time. Investors who want higher returns will have to go further out on the risk curve for longer, and so perhaps this will keep long rates lower for longer. Equities—one form of risky asset—certainly reacted well yesterday.

The Fed's statement was notable in particular for its dissent by three FOMC members, all of them regional bank presidents who weren't appointed by President Obama. They would have stayed with the Fed's previous extended period language.

This suggests that the policy statement may have been a compromise, and that others on the committee would have gone further, perhaps so far as to start a third round of quantitative easing (QE3). Or perhaps Chairman Ben Bernanke, who led the Fed majority, is content with the new mid-2013 target as a holding pattern to see if the economy heads into a double-dip recession. In any case such a major dissent is rare and a welcome signal of impatience with relentless easing.

The tragedy in our view is that the Fed has limited policy options if growth does turn negative. We supported the move to near-zero amid the financial panic in December 2008, but the Fed never did take advantage of the recession's end to return to a more normal risk environment. Had it gone back to 1% or so, it would have helped savers and encouraged more bank lending. This would still have been accommodative policy by any historical standard, but now the Fed would have the option of cutting rates if there is another recession.

Meanwhile, the Fed's QE2 experiment, which began last September, ended on June 30 with little to show for it. Asset prices rose as the Fed's bond purchases pushed investors into riskier assets (stocks and commodities). But the prices of those assets have since fallen back down to what investors think they're worth.

The Fed had hoped that boosting asset prices would create "wealth effects," or an increase in spending that accompanies an increase in perceived wealth. But the Fed can't dictate which asset prices will rise, and liquidity flowed into commodities as well as stocks.

Thus any wealth effect was offset by negative "income effects" as Americans suffered a decline in real income from paying more for food and energy because of the commodity-price bubble. Economic growth has decelerated over the past year despite QE2, so we wonder what good Mr. Bernanke thinks it did. We're hard-pressed to see what good QE3 would do as well.

The larger error is to assume that monetary policy will save the economy from its current malaise. That's the latest mantra from the same economists who told us that $1 trillion in spending stimulus was the answer in 2009. Since that has failed, we are now told the economy needs a bout of extended inflation to reduce our debt burden. Harvard's Kenneth Rogoff says the Fed should allow a "sustained burst of moderate inflation, say, 4-6% for several years."

There's no doubt that inflation can erode the value of money and debt. Argentina tries this every few years. Debtors and "millionaires and billionaires" (to borrow a phrase) do fine, but the middle class pays a huge price in a debased standard of living. Once you encourage more inflation, it's also hard to stop at 4%. In today's global economy with investors already suspicious of U.S. economic management, an overt declaration of such a policy might trigger a wholesale run on the dollar.

Mr. Bernanke and his Fed majority haven't gone that far, despite doubling down on zero yesterday. But if monetary policy by itself could conjure growth, or compensate for bad fiscal and regulatory policy, we'd already be booming.