The U.S. Federal Reserve’s unexpected decision at its September meeting not to start to wind down its stimulus program now looks remarkably prescient. The Fed was concerned that the fiscal follies just starting to play out on the other side of Washington might cool the U.S. economy’s tepid recovery. Now that an ugly armistice has been declared in the political budget and debt battles, the cost to the economy is being reckoned. The consensus of economists polled by Reuters is that the fiasco will lower fourth-quarter growth by an annualized 0.3%. That is still $12 billion in lost output. Standard and Poor’s has put the number at double that — and that is just the short-term cost; the effects of elevated interest rates will linger longer.
A trim of 0.3% to GDP growth might not sound much, but with growth for the quarter now forecast to be only 2.3%, it could be sufficient to stall the decline in unemployment, one of the key indicators the Fed is using to determine when the economy is robust enough for it to start to wind down its $85 billion-a-month bond-buying program. Nor is the political battle over the budget and debt ceiling done and dusted; it has just been suspended until early next year. While the brinkmanship over pushing the U.S. to the edge of default on its sovereign debt is unlikely to be repeated (at least we can’t imagine it will — but then we never thought it would be run as close as it was this time) financial markets are likely to dial up their disapproval from the relative mildness they have shown over the past couple of weeks. With the Fed having taken upon itself a mandate of ensuring financial stability, that is likely to make the central bank even more cautious about withdrawing its stimulus.
Taken with the uncertainties that will accompany the October releases of economic indicators whose data collection will have been disrupted by the partial government shutdown, it makes it increasingly possible that the Fed will hold off starting to taper at least until the new February 7 deadline for raising the debt ceiling has been safely passed. By that time, too, new Fed chair Janet Yellen (assuming she is confirmed by the U.S. Senate) will be in post following Ben Bernanke’s stepping down from the job. His term ends at the end of January, but he may step down after the December meeting if his successor is, as expected, confirmed by then.
It is still possible that the Fed will choose to start to taper in December. September’s decision was close-run, the meeting’s minutes have subsequently revealed. The Fed may consider the fourth-quarter GDP number to be a blip caused by extenuating circumstances, and that its base forecast for the economy holds up, allowing it to meet Bernanke’s June statement that the Fed expected to being tapering before the end of this year. Most of all the Fed might just want to reassure the world that it is not allowing monetary policy to held hostage by the political vagaries of the U.S. Congress.
Yet given how disconnected the political half of Washington is from the real economy, it would take a gutsy decision by the outgoing chairman to taper in December in the hope Washington couldn’t do more damage to the economy in the new year than it has done this fall. And a more rational mind — which Bernanke certainly has —would know that any forward guidance offered by a departing chair wouldn’t have the same credibility as that coming from his successor. The Yellen Fed is going to look much different from Bernanke’s with as many as four new regional Fed governors joining as voting members of its key decision taking Open Markets Committee: a new team with a new voice for a new phase of monetary policy — to come in the new year.