Weak remedies

The Federal Reserve is suffering diminishing returns from its ideas to prop up the US economy. The members of its Federal Open Market Committee decided on Wednesday to extend Operation Twist to the end of the year in an attempt to keep long-term interest rates low. That means both monetary and fiscal policy remain locked on stimulus. But economic and jobs growth are slowing. The obvious effects of Washington’s drugs are starting to wear off.

Of course, Fed Chairman Ben Bernanke reckons pushing back the end of Operation Twist is the way to stop matters from getting worse. As he pointed out at his post-meeting press conference, new data led the committee to revise downwards its growth, employment and inflation forecasts.

But Bernanke’s prescription to ward this off rests on the belief that it’s the amount of asset purchases that count, not how quickly they’re done. That means he regards extending Operation Twist as adding an extra $267 billion to the stimulus, whereas in actual fact it will simply be maintaining it at its current level — which surely thus has far less effect.

Bernanke has even come close to admitting that, saying the Fed is doing about all it can in the Operation Twist area. And keeping the program going raises another issue: it adds even more low-yielding paper to the Fed’s balance sheet. If US Treasury bond sales continue at the same pace as in the first half of 2012, the Fed will absorb two-thirds of the $390 billion of new seven-, 10- and 30-year government debt. That leaves the central bank even more on the hook once rates rise.

While the latest somber economic data may indicate that more stimulus is needed, experience in Europe currently and the Weimar Republic in 1919-1923 argue that the side-effects of such an increase are not worth it. Maybe it’s time to find new medicine.