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Peter Crabb: Understaffed federal bank committee needs help guiding the economy

It’s unanimous, at least for those present. On Wednesday the Federal Open Market Committee of the Federal Reserve voted to keep its target interest rate at near zero percent. All members of the committee voted in favor of maintaining current policy.

The Federal Reserve was created in 1913 in response to earlier financial panics and operates the monetary policy of the United States through this committee. Monetary policy is any action undertaken by the U.S. central bank, the Federal Reserve, to influence the availability and cost of money and credit.

Historically, the FOMC used only three tools of monetary policy -- open market operations, the discount rate, and reserve requirements. The near-zero interest rate target is part of both open market operations and the discount rate – interest rates that influence banks’ ability to provide credit.

Today, however, the FOMC has gone well beyond this short list of tools. The central bank now operates in more sectors of the economy than just our banking system. The FOMC also announced Wednesday continued support to the mortgage lending and housing markets with a plan to purchase up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year.

Furthermore, the Federal Reserve will purchase up to $300 billion of Treasury securities through the fall of this year.

There will be plenty to buy.

The U.S. government also announced higher borrowing levels on Wednesday. The Treasury Department announced a record level of new securities for sale next week, and Treasury will sell 30-year-bonds 12 times a year, up from the current eight.

The FOMC is monetizing the U.S. government debt. The central bank is increasing the supply of money in the economy and using it to fund greater expansion of government purchases and services - all this while the committee is understaffed.

The committee normally consists of 12 members — the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis.

Today, there are only 10 members of the FOMC. Two Board of Governors seats remain unfilled. The current members of the committee are Ben S. Bernanke, Board of Governors and FOMC Chairman; William C. Dudley, New York Federal Reserve Bank, the FOMC Vice Chairman; Elizabeth A. Duke, Board of Governors; Charles L. Evans, Chicago Federal Reserve Bank; Donald L. Kohn, Board of Governors; Jeffrey M. Lacker, Richmond Federal Reserve Bank; Dennis P. Lockhart, Atlanta Federal Reserve Bank; Daniel K. Tarullo, Board of Governors; Kevin M. Warsh, Board of Governors; and Janet L. Yellen, San Francisco Federal Reserve Bank.

The committee has been operating shorthanded throughout the financial crisis and recession. Hopefully, the committee can pull us out of it. The most recent economic news is dire, but perhaps the worst news is behind us.

In its press release Wednesday, the FOMC said, “Household spending has shown signs of stabilizing” and “ inflation will remain subdued.”

The Commerce Department reported Wednesday that Gross Domestic Product fell 6.1 percent at an annual rate in the first quarter of 2009. GDP has now fallen in three consecutive quarters, which hasn't happened since 1975.

U.S. consumers, who account for more than two-thirds of our annual income and expenditures, did their part. Consumer spending increased 2.2% in the first quarter after dropping by 4.3% in the fourth quarter.

The consumer was not, however, spending money on houses. In just the past three months, residential fixed investment fell 38 percent, reducing overall GDP by more than 1 percentage point, and investment fell 22.8 percent, taking approximately 1 more percentage point out of GDP.

If consumer spending continues to grow, businesses will increase investment to meet demand. Businesses have had to pare down inventories dramatically and could quickly need to ramp up production and services soon.

The stock market moved up strongly following the FOMC announcement. In contrast, bonds sold off, raising interest rates dramatically. The possible indication of a turnaround in economic activity (higher stock prices) is offset by higher expected inflation (lower bond prices).

Spending may be stabilizing, but inflation is unlikely to remain subdued. Perhaps the FOMC should get some further input. All the Board of Governors seats should be filled immediately.

Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.

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