The Quandary At Jackson Hole: Is It Time To Step Back From Stimulus?

With the economy showing signs of positive momentum, the Federal Reserve is facing familiar questions at its monetary symposium in Jackson Hole, Wyo. Chief among these: Are interest rates too low? Robert Siegel asks Alan Blinder of Princeton University.

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ROBERT SIEGEL, HOST:

With the Dow Jones Industrial Average going over 17,000 today with housing starts up and unemployment claims down, the Federal Reserve is facing some familiar questions at its monetary policy symposium in Jackson Hole, Wyoming. Is it time to back off the policy of monetary stimulus - which has held the Fed's benchmark interest rates near zero percent for almost six years? And have those very low interest rates made fixed interest securities, bonds so unattractive that investors have put too much money into equity stocks. In other words, is that 17,000 Dow evidence of a bubble and an omen of bad things to come or is it confirmation of a stronger economy in which companies are earning more money, which naturally pushes up the value of their stocks? Well, we're going to put those questions now to Alan Blinder, professor of economics at Princeton, who is a former vice chairman of the board of governors of the Fed, and he is in Jackson Hole. Welcome to the program once again.

ALAN BLINDER: Thank you, Robert.

SIEGEL: Are equities now in a bubble?

BLINDER: Well, you know, a lot of people are asking that question and the truth is nobody knows. I mean, some of this is surely due to the super low interest rates which can't last forever, although they will I believe last for a little while longer, and part of it is definitely due to the performance of U.S. companies. As we all know profits are way up and stock markets are supposed be discounting profits. So it's not very surprising that it's high right now.

SIEGEL: But bubbles burst. I mean, would you be astonished if one day the Dow dropped by you know, a thousand points?

BLINDER: A thousand would be - I would be astounded, but if it dropped 350 in a day I wouldn't be - no, but I'd be alarmed. Stock markets do trend upwards over long periods of time, but there are dips for sure. I guess I would call attention as Janet Yellin did in the testimony - there is a corner of the stock market, which at least to me looks very bubbly, but maybe it's because I'm an old guy and that's some of these tech stocks.

SIEGEL: Well, let's say that the voices calling for the Fed to change course prevail sometime soon. Would the Fed be able to sell off all of those treasury bonds it's been buying for years in some kind of gradual, orderly way or is the exit strategy terra incognita and potentially a very difficult time?

BLINDER: It is technically terra incognita. The Fed has never had a portfolio anything remotely close to this size. But I don't think it's that complicated. Think about how the Fed got all these assets - how did it get them? Well, it when out in the open market and it bought them. So when it decides it needs to unload large amount, and that time is not with us yet by the way, but when it does the Fed's going to go out there and sell. So you know, I think a reasonable way to think of it is doing in reverse what they've already done.

SIEGEL: What they've been doing for several years, does that mean they'd be doing the other for several years?

BLINDER: Well, they may take several years. You know, actually the Fed party line to which I don't subscribe is - they won't have to sell any at all - that it'll just run off by natural maturity. You know, two year bonds take two years and they pay off. And the Fed is claiming that that'll be enough and they won't actually have to go actively selling. I frankly, don't believe that, but I don't think they're going to be selling a $1 trillion in a short period of time.

SIEGEL: I'm just curious - when you say that now is not the time, this is not the time that the Fed is going to reverse course - what are the indicators out there? What are the numbers that make it so clear to Janet Yellin and to you as well, that this is not the time?

BLINDER: Well, I think you start, as Janet Yellin always does, by looking at the labor market. And we've got a 6.2 percent unemployment rate, which is a lot better than it was, but still high. Secondly, you look at the GDP and while we had a nice quarter last quarter, we had a horrific quarter the previous quarter. And the first half of this year we had very, very slow growth. You look at the rate of inflation, you look at the rate of wage increases, and they're all turning up a bit but not dramatically and in particular, the inflation measure that the Fed favors is still well below the Fed's target.

SIEGEL: Professor Blinder, thank you very much for talking with us.

BLINDER: You're welcome.

SIEGEL: Alan Blinder of Princeton University who is in Jackson Hole, Wyoming where the Federal Reserve's monetary policy symposium is about to begin.

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