To Ease or Not to Ease

It's not really the question. The Fed should go beyond bond buying to goose growth

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Illustration by Harry Campbell for TIME

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The problem is that while the Fed has pushed interest rates to record lows, it can't force banks to lend that cheap money. "Everyone who can refinance their home already has," says Paul Dales, senior U.S. economist for Capital Economics. "But there's evidence that a lot of people still want to and simply can't get financing." Data show that demand for prime mortgages rose strongly in the second quarter of 2012, but lending standards were tightened, creating a bottleneck. Banks are reluctant to lend not only because of credit risk but also because they worry about the global economy and are unsure of everything from what tax rates will be to how Congress will handle the fiscal cliff.

The Fed can avoid gridlock. It can (and very likely will) buy mortgage-backed securities, but that doesn't address the fundamental lending question. That's why some economists are pushing for the U.S. to institute a funding-for-lending scheme along the lines of what's being done in the U.K. Banks would be able to borrow money from the Fed and make a small profit on it but only if they lent that money to consumers. Such a plan would be outside traditional Fed policy, but as Mohamed El-Erian, CEO of Pimco, the world's largest bond trader, puts it, "More of the same isn't going to work. The Fed has to do something different."

These loans would of course boost the Fed's balance sheet and thus open it to new charges that it's stoking inflation. But frankly, the inflation argument holds less and less water. With the savings rate up nearly a point in the past year and unemployment still above 8%, the megaworry isn't 1970s-style inflation but a lost decade la Japan. Indeed, Fed rune readers are parsing hints that Bernanke may finally be willing to stop fighting the last war and let inflation rise a bit in order to stoke growth. That would be a welcome sign.


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