JACKSON HOLE, Wyo. (MarketWatch) - The U.S. economy is looking sick and the doctors are bickering about what, if anything, to do.
That is the bottom-line conclusion from conversations at the Federal Reserve's annual policy retreat in Jackson Hole.
One year ago, there was relief here that the worst of the financial crisis appeared to be in the rear-view mirror. This year was characterized by renewed concern and caution.
News reports, recent Fed speeches, and discussions make clear that policy makers are divided over whether the economy needs more monetary medicine and what kind.
Some appear willing to try anything to avoid another downturn or an outbreak of deflation, a sustained drop in prices. But others wonder whether the Fed isn't trying to do too much, and they say that the costs of further easing are not being considered.
Diane Swonk, chief economist at Mesirow Financial in Chicago, said the Fed is more divided than she has ever seen.
The debate has undertones of debates from the 1980s between "freshwater" and "saltwater" economic schools. Economists located at universities near the Great Lakes, or freshwater, tend to favor limited government intervention while economists along the East and West Coast are mostly Keynesians of some stripe who believe the government plays a role in piloting the economy.
"It is a debate about what is the proper role for the Fed," said Mickey Levy, chief economist at Bank of America, who tends toward the less-government-intervention camp.
Some former Fed officials played down the tension between Fed policymakers
"Robust discussion is how the Fed operates. It is nothing new," said Randall Krozner, a professor at the University of Chicago and a former Fed governor.
Unconventional tools
The chief problem is that the Fed's traditional remedy for a slowdown - reducing short-term interest rates - is unavailable because rates have been close to zero for 20 months.
This leaves the Fed only unconventional policy tools, which bring with them more debate about their relative value because they've never been tried.
The Fed has already purchased $1.4 trillion of mortgage securities and $300 billion of Treasury securities in an effort to lower market interest rates. Earlier this month, in response to a slew of weak economic data, the policy-making Federal Open Market Committee took a symbolic decision to buy more Treasurys using funds received from principal repayments of its mortgage securities to hold the size of its balance sheet constant.
In essence, analysts said the FOMC flipped to an easing bias from its prior stance that leaned toward slow tightening.
Federal Reserve Board Chairman Ben Bernanke spelled out in great detail Friday the easing options under consideration. These include buying more assets, most likely Treasurys, to lower market interest rates; promising to keep ultra-low rates for longer than expected; or cutting the interest paid to banks for their excess reserves to push them to lend.
But will any of these steps be necessary? How much would the economy have to weaken or inflation to decline before the Fed decides to act? Experts here said Bernanke gave no hints nor did other Fed officials in private conversations.
Participants at the Jackson Hole seminar see no agreement among the Fed leadership on these key questions.
"The consensus is nowhere," Swonk said.
Participants' views
Participants at the conference were also divided. Those who say the economy will be weak expect the Fed to move. Others, who are more optimistic about the outlook, don't think further easing is necessary.
Alan Blinder, a former Fed governor, predicted that the Fed would ease again.
"I'll make a prediction ... that it won't be the last such step," Blinder said in a panel discussion at the conference.
In an interview, Blinder said Bernanke would likely persuade his colleagues that the economy needed help.
"Bernanke is pulling the committee behind him," he said.
Levy from Bank of America said the key question was whether the Fed would be able to withstand pressure from the market and Washington for further easing, which he said was uncertain to work.
"Would more quantitative easing stimulate demand? I am not so sure," Levy said.
Some opponents of more easing are worried it could lead to future instability and asset bubbles.
Others doubted its effectiveness.
Harvard economics professor Martin Feldstein said he was not too impressed by the list of options presented by the Fed chairman.
"It doesn't sound much can be gained from any one of them," he said.
Michael Mussa, a former chief economist at the International Monetary Fund and now a senior fellow at the Peterson Institute of International Economics, said he would be reluctant to go further on quantitative easing unless there was clear evidence the economy was moving back into recession.
Economic outlook
Few economists at Jackson Hole said the U.S. would see further quarters of negative gross domestic product - in other words, a double-dip recession. The risk of deflation was also seen as small. Mussa said the housing and auto sectors are so weak already that it was hard to imagine they could weaken enough to push the economy into negative growth.
Far more likely, experts said, is growth in the range of 1% to 2%. For some this is a disaster. For others, it is about the best that can be achieved in the wake of the burst housing bubble.
"The economy faces some real challenges ahead. We're stuck in a slow-growth pattern," said Lawrence Lindsey, a former Fed governor and now president of Lindsey Group.
Bernanke was, if not upbeat, also not downbeat about the economic outlook.
"Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place," Bernanke said.
He said the risks of a further drop in inflation seem low.
In the image of a track-relay race, Bernanke said consumer and business spending would grab the baton from government spending and keep the economy growing.
Many economists at Jackson Hole thought this was very optimistic.
"I am worried about the handoff," Blinder said.
Levy said the economy was in a "soft patch" but was "going to come out of it in 2011."
"I still put a low probability on deflation but now this is a concern," he said.
Richard Berner, chief economist at Morgan Stanley, remained relatively optimistic, saying the economy would grow at a 2% rate in the third quarter and 2.5% in the fourth quarter.
But even growth at this pace will be too slow to bring down the unemployment rate and will also pressure inflation downward, he said.
Feldstein was more pessimistic, predicting that housing prices would fall further, putting more downward pressure on consumer spending and confidence.
"We will be lucky if we generate growth in the 1% to 2% range," Feldstein said. "It is not clear where the good news is going to come from."
Thinking outside the box
Some experts at Jackson Hole suggested other ways to spur bank lending without the Fed using unconventional monetary policy tools.
Many endorsed Blinder's suggestion that the Fed instruct its bank examiners to ease up on healthy banks that are willing to make loans.
Bank regulators are being counter-cyclical at exactly the wrong time, they argued.
Feldstein from Harvard wants the government to prod banks to sell their troubled loans to the government and in return receive a grace period to rebuild capital.
The Treasury Department has a Public-Private Investment Program in place, but it hasn't been popular with banks because of their concern about capital levels, Feldstein said.
Bernanke did send a signal that any help from other bank regulators and fiscal-policy makers would be welcome.
"Central bankers alone cannot solve the world's economic problems," he said.
That is the bottom-line conclusion from conversations at the Federal Reserve's annual policy retreat in Jackson Hole.
One year ago, there was relief here that the worst of the financial crisis appeared to be in the rear-view mirror. This year was characterized by renewed concern and caution.
News reports, recent Fed speeches, and discussions make clear that policy makers are divided over whether the economy needs more monetary medicine and what kind.
Some appear willing to try anything to avoid another downturn or an outbreak of deflation, a sustained drop in prices. But others wonder whether the Fed isn't trying to do too much, and they say that the costs of further easing are not being considered.
Diane Swonk, chief economist at Mesirow Financial in Chicago, said the Fed is more divided than she has ever seen.
The debate has undertones of debates from the 1980s between "freshwater" and "saltwater" economic schools. Economists located at universities near the Great Lakes, or freshwater, tend to favor limited government intervention while economists along the East and West Coast are mostly Keynesians of some stripe who believe the government plays a role in piloting the economy.
"It is a debate about what is the proper role for the Fed," said Mickey Levy, chief economist at Bank of America, who tends toward the less-government-intervention camp.
Some former Fed officials played down the tension between Fed policymakers
"Robust discussion is how the Fed operates. It is nothing new," said Randall Krozner, a professor at the University of Chicago and a former Fed governor.
Unconventional tools
The chief problem is that the Fed's traditional remedy for a slowdown - reducing short-term interest rates - is unavailable because rates have been close to zero for 20 months.
This leaves the Fed only unconventional policy tools, which bring with them more debate about their relative value because they've never been tried.
The Fed has already purchased $1.4 trillion of mortgage securities and $300 billion of Treasury securities in an effort to lower market interest rates. Earlier this month, in response to a slew of weak economic data, the policy-making Federal Open Market Committee took a symbolic decision to buy more Treasurys using funds received from principal repayments of its mortgage securities to hold the size of its balance sheet constant.
In essence, analysts said the FOMC flipped to an easing bias from its prior stance that leaned toward slow tightening.
Federal Reserve Board Chairman Ben Bernanke spelled out in great detail Friday the easing options under consideration. These include buying more assets, most likely Treasurys, to lower market interest rates; promising to keep ultra-low rates for longer than expected; or cutting the interest paid to banks for their excess reserves to push them to lend.
But will any of these steps be necessary? How much would the economy have to weaken or inflation to decline before the Fed decides to act? Experts here said Bernanke gave no hints nor did other Fed officials in private conversations.
Participants at the Jackson Hole seminar see no agreement among the Fed leadership on these key questions.
"The consensus is nowhere," Swonk said.
Participants' views
Participants at the conference were also divided. Those who say the economy will be weak expect the Fed to move. Others, who are more optimistic about the outlook, don't think further easing is necessary.
Alan Blinder, a former Fed governor, predicted that the Fed would ease again.
"I'll make a prediction ... that it won't be the last such step," Blinder said in a panel discussion at the conference.
In an interview, Blinder said Bernanke would likely persuade his colleagues that the economy needed help.
"Bernanke is pulling the committee behind him," he said.
Levy from Bank of America said the key question was whether the Fed would be able to withstand pressure from the market and Washington for further easing, which he said was uncertain to work.
"Would more quantitative easing stimulate demand? I am not so sure," Levy said.
Some opponents of more easing are worried it could lead to future instability and asset bubbles.
Others doubted its effectiveness.
Harvard economics professor Martin Feldstein said he was not too impressed by the list of options presented by the Fed chairman.
"It doesn't sound much can be gained from any one of them," he said.
Michael Mussa, a former chief economist at the International Monetary Fund and now a senior fellow at the Peterson Institute of International Economics, said he would be reluctant to go further on quantitative easing unless there was clear evidence the economy was moving back into recession.
Economic outlook
Few economists at Jackson Hole said the U.S. would see further quarters of negative gross domestic product - in other words, a double-dip recession. The risk of deflation was also seen as small. Mussa said the housing and auto sectors are so weak already that it was hard to imagine they could weaken enough to push the economy into negative growth.
Far more likely, experts said, is growth in the range of 1% to 2%. For some this is a disaster. For others, it is about the best that can be achieved in the wake of the burst housing bubble.
"The economy faces some real challenges ahead. We're stuck in a slow-growth pattern," said Lawrence Lindsey, a former Fed governor and now president of Lindsey Group.
Bernanke was, if not upbeat, also not downbeat about the economic outlook.
"Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place," Bernanke said.
He said the risks of a further drop in inflation seem low.
In the image of a track-relay race, Bernanke said consumer and business spending would grab the baton from government spending and keep the economy growing.
Many economists at Jackson Hole thought this was very optimistic.
"I am worried about the handoff," Blinder said.
Levy said the economy was in a "soft patch" but was "going to come out of it in 2011."
"I still put a low probability on deflation but now this is a concern," he said.
Richard Berner, chief economist at Morgan Stanley, remained relatively optimistic, saying the economy would grow at a 2% rate in the third quarter and 2.5% in the fourth quarter.
But even growth at this pace will be too slow to bring down the unemployment rate and will also pressure inflation downward, he said.
Feldstein was more pessimistic, predicting that housing prices would fall further, putting more downward pressure on consumer spending and confidence.
"We will be lucky if we generate growth in the 1% to 2% range," Feldstein said. "It is not clear where the good news is going to come from."
Thinking outside the box
Some experts at Jackson Hole suggested other ways to spur bank lending without the Fed using unconventional monetary policy tools.
Many endorsed Blinder's suggestion that the Fed instruct its bank examiners to ease up on healthy banks that are willing to make loans.
Bank regulators are being counter-cyclical at exactly the wrong time, they argued.
Feldstein from Harvard wants the government to prod banks to sell their troubled loans to the government and in return receive a grace period to rebuild capital.
The Treasury Department has a Public-Private Investment Program in place, but it hasn't been popular with banks because of their concern about capital levels, Feldstein said.
Bernanke did send a signal that any help from other bank regulators and fiscal-policy makers would be welcome.
"Central bankers alone cannot solve the world's economic problems," he said.