The pace of real GDP growth fell from 2.4 percent in 2010 to 2 percent in the next four quarters, and then to 1.7 percent last year. The first official estimate of GDP growth in the second quarter of this year, scheduled to have been released on Wednesday, is likely to be less than 1 percent, implying that annual GDP growth in the first half of this year was considerably slower than last year.
So what does this imply about the Fed’s willingness to “taper” its pace of asset purchases? Ironically, it might help to rationalize the decision to begin tapering before the end of the year.
First, the lack of correlation between quantitative easing and GDP growth suggests that the pace of asset buying could be reduced without slowing the pace of growth. That is true even though, contrary to the assumption of Bernanke and some other Federal Open Market Committee members, interest rates will rise as the pace of purchases declines.
Second, if the extreme weakness in the second quarter is followed by a return to a sluggish growth rate of about 2 percent in the third quarter, the Fed could declare that it is observing the pick-up in growth that it has said is necessary to justify the beginning of tapering.
The policy of extremely low long-term rates is now doing more harm than good by driving lenders and investors to take inappropriate risks in order to achieve higher returns. Bernanke and the Federal Open Market Committee should recognize this and gradually bring the bond-buying program to an end during the next 12 months. They can take credit for what quantitative easing has achieved without holding its termination hostage to the economy’s future performance.
It is significant that Bernanke will be stepping down at the beginning of 2014. He did a remarkably good job in dealing with dysfunctional financial markets during the crisis years of 2008 and 2009. When the financial markets were working again, but the economy was still growing much too slowly, he turned to unconventional monetary policies to reduce long-term interest rates and accelerate the housing market’s recovery. So, although the economy is now weaker than he or anyone else would like, he may want to complete his policy legacy by beginning the exit from unconventional policies before he leaves the Fed.
Martin Feldstein is a professor of economics at Harvard University and president emeritus of the US’ National Bureau of Economic Research.
Copyright: Project Syndicate