Can Ben Bernanke save the job market if 'fiscal cliff' talks fail?

The Federal Reserve said this week it would maintain ultralow interest rates until the unemployment rate falls to at least 6.5 percent, unless inflation starts looming as a near-term risk.

By , Staff writer

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    Federal Reserve Chairman Ben Bernanke speaks during a news conference at the Federal Reserve Board in Washington, Wednesday. The Federal Reserve sent its clearest signal to date Wednesday that it will keep interest rates super-low to boost the US economy even after the job market has improved significantly.
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The Federal Reserve this week sought to further buoy a weak economy. But will it be enough?

That's an important question for the US job market, as elected leaders struggle to reach a deal on fiscal policy to avoid steep tax hikes and spending cuts in the new year.

A new US recession is possible. And right now, the fact that the "fiscal cliff" is unresolved means that unelected officials at the Federal Reserve are operating virtually alone as a policy bulwark for the economy.

Recommended: 'Fiscal cliff' 101: 5 basic questions answered

The Fed's move this week was significant. The US central bank sought to clarify and strengthen communication about its resolve to aid the economy, by saying it would maintain ultralow interest rates until the unemployment rate falls to at least 6.5 percent, unless inflation starts looming as a near-term risk. Currently, the jobless rate is 7.7 percent.

The Fed also said it will continue a plan known as "quantitative easing" of monetary policy, by buying sizable quantities of bonds. The idea of the bond purchases is to keep interest rates low and support investor confidence – thus aiding job creation.

"The Fed remains the only proactive game in town, as Congress continues to spin ... wheels" on fiscal policy, writes Sam Stovall, chief equity strategist at Standard & Poor's Capital IQ. "We think equity prices will be aided by two things that the Fed did today: the increase in asset purchases and their change in communication."

But even if the Fed's action is successful, that doesn't mean it will have such a large impact that it could fully compensate for a lack of action by elected officials. The Fed can help. It can buy time. But it can't control all the economy, all the time, all by itself.

Fed Chairman Ben Bernanke said as much back in September.

"If the fiscal cliff isn’t addressed, as I’ve said, I don’t think our tools are strong enough to offset the effects of a major fiscal shock," he said in a press conference. "So I think it’s really important for the fiscal policymakers to, you know, work together and try to find a solution for that."

The fiscal policymakers are working on it.

For now, although the talks don't appear anywhere near conclusion, the prevailing expectation among investors and economists is that President Obama and Congress will reach a deal in time to avoid a recession. A bargain would scale back the tax hikes and spending cuts set to take effect Jan. 1, thus softening the immediate risks to job growth.

But a deal is also expected to contain sizable deficit reduction over the next few years, to give financial markets assurance that the United States is responding seriously to the threat posed by ever-rising national debt.

There's no guarantee, however, that the path to fiscal compromise will be quick or smooth.

The job market surely can use any help that policymakers can provide, whether they be elected or unelected. The economy has added jobs at only a tepid pace since March, and the jobless rate has been edging downward partly because many people are too discouraged to look for work. (The percentage of adults who are working has remained below 59 percent since the recession – well below the 62 or 63 percent that prevailed before the recession.)

Many economists agree with Mr. Bernanke that the Fed can provide only part of the solution to the nation's economic challenges. They generally support Bernanke's efforts to maintain a stimulative stance in monetary policy.

"While some have argued that the Fed’s efforts have been futile, we believe they have been exactly enough" to keep the economy growing, albeit slowly, Michael Darda, chief economist at the investment firm MKM Partners, wrote in an analysis of the Fed's action this week.

Mr. Darda called it "noteworthy" that gross domestic product is rising despite what amounts to tight fiscal policy. Although the federal government undertook a large fiscal stimulus when Mr. Obama began his term, that effort is now in the rear-view mirror, and many states are cutting spending and jobs.

The Fed's policy is not without its own risks to the economy.

"The Fed’s policy stance may breathe some more life into the US economy in coming years. But it could also sow the seeds of the next financial crisis by inflating new asset [price] bubbles," John Higgins of Capital Economics, a research firm in Toronto, London, and Singapore, wrote in a report this week.

An asset-price bubble, such as in stocks, could emerge even if there's not a high rate of inflation in overall consumer prices.

"What if the euro-zone holds together, US lawmakers compromise over the looming fiscal 'cliff,' and China’s economy does not implode?" Mr. Higgins asks. "Then there may be little left to dull investors’ appetite for risk" amid the atmosphere of low interest rates and monetary ease.

The Fed said this week that if it projects that inflation will be 2.5 percent or higher in the coming two years, it might tighten monetary policy.

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