Fed Backs More Overseas Stimulus

By Jon Hilsenrath And Brian Blackstone 

        Federal Reserve officials, worried about weak growth overseas, are endorsing new measures by foreign officials--most notably at the European Central Bank--to stimulate their economies.
        Fed officials rarely comment on the decisions taken by foreign central banks and have generally played down risks to domestic growth emanating from abroad. Yet minutes of the Fed's Dec. 16-17 policy meeting included several references to the urgency U.S. officials and market participants are placing on new policy actions to counteract slow growth outside the U.S.
        The insight into the Fed's thinking comes as new figures released from the eurozone on Wednesday showed consumer prices fell 0.2% in December from a year earlier, a larger decline than economists had expected and the first drop since October 2009. Falling prices in Europe are in part a result of tumbling oil prices and a symptom of weak demand in Europe.
        Other global soft spots abound: Economic output in Japan contracted in the second and third quarters of 2014 and growth in China has disappointed, putting added downward pressure on commodities world-wide.
        The minutes showed Fed officials "regarded the international situation as an important source of downside risks to domestic real activity and employment." They added that the risks were particularly serious "if foreign policy responses were insufficient."
        In another place in the Fed minutes, officials warned that financial markets had been "importantly influenced by concerns about prospects for foreign economic growth and by associated expectations of monetary policy actions in Europe and Japan."
        The references, though subtle, amounted to a warning--particularly to the ECB--that markets and the global economy more broadly could respond negatively if foreign policy makers don't deliver on expectations for action.
        The Fed's assessment of overseas risks and its preoccupation with foreign policy makers is important as the ECB prepares for a Jan. 22 policy meeting at which officials are expected to launch a new bond-purchase program.
        Bond-purchase programs--controversial in Europe and elsewhere after several years of experimentation by the Fed and other central banks--are aimed at boosting economic growth by spurring financial markets, lowering long-term interest rates and encouraging investment and spending. However, their costs and benefits remain hard to quantify.
        Germany's Bundesbank has been particularly resistant to them.
        Krishna Guha--vice chairman of Evercore ISI, a research firm and the former communications director for the New York Fed--said he didn't see the references to foreign policy as a direct stab at the ECB or other central banks.
        Still, he said it was "notable that [Fed officials] see at this point that risks to the U.S. expansion don't really lie at home so much as they lie in the possibility of an insufficient policy response to developments overseas."
        New data released by the European Union's statistical agency Wednesday increased pressure on the ECB to do something as inflation drifts further below its 2% goal.
        Eurozone inflation has been below 0.5% since July 2014, threatening the ECB's credibility. Excluding food, energy and other volatile items, core inflation rose to 0.8%, up a notch from November though still well below the central bank's objective.
        "If inflation remains low for a long time, people might expect prices to fall even further and postpone their spending," ECB President Mario Draghi said in a Handelsblatt interview published last week. "We aren't there yet. But we need to tackle this risk."
        The Fed's implicit embrace of ECB action is all the more striking because it could cause challenges for the U.S. central bank. Market anticipation of higher rates in the U.S. coupled with new money-printing measures by the ECB have driven the U.S. dollar higher. That in turn holds down already-low U.S. inflation by pushing down import prices and could spur capital flows to the U.S. that distort financial markets. It also curbs U.S. exports by making them relatively more expensive in global markets.
        Fed officials are calculating that the benefits to the U.S. of a stronger global economy would outweigh the negative effects of a higher dollar.
        "A strong Japanese economy, a strong European economy--that's great for them. That's great for the global economy. In the end, that's great for the U.S.," John Williams, president of the Federal Reserve Bank of San Francisco, told reporters Monday in Boston.
        Mr. Williams is a close associate of Fed Chairwoman Janet Yellen, having served as her research director at the San Francisco Fed before she moved to Washington to join the Fed board in 2010.
        Another Yellen ally--New York Fed President William Dudley--recently endorsed easy-money policies in Europe and Japan.
        In a December speech, he noted that one side-benefit of falling oil prices was that they would pull down inflation and spur more expansive monetary policies. "We are already seeing this response in Europe and Japan," he said.
        Fed Vice Chairman Stanley Fischer, a former economics professor at the Massachusetts Institute of Technology, was one of Mr. Draghi's teachers when he earned his Ph.D. there.
        Despite concerns about slow growth abroad--and the uncertain implications of sharp declines in global oil prices on inflation and growth--Fed officials decided at their December meeting to signal that U.S. interest rates are likely to rise from near zero this year.
        Fed officials noted several reasons to remain upbeat about the U.S. economy.
        "Several participants, pointing to indicators of consumer and business confidence as well as to the solid record of payroll employment gains in 2014, suggested that the real economy may end up showing more momentum than anticipated, while a few others thought that the boost to domestic spending coming from lower energy prices could turn out to be quite large," the minutes said.
        Other factors gave officials pause, including a sharp drop in the price of oil, which has continued to decline since the mid-December gathering. Some saw the drop as a symptom of slow growth overseas, which could hold back the U.S. economy, though they saw this risk as outweighed by the benefits U.S. consumers would enjoy from lower prices at the pump.
        Downward pressure on inflation and inflation expectations from oil was also a source of puzzlement and concern. Falling oil prices were expected to pull inflation down further in the near term, keeping consumer price increases below the Fed's 2% target.
        Still, the downward pressure was expected to be temporary.
        Ben Leubsdorf contributed to this article.
        Write to Jon Hilsenrath at jon.hilsenrath@wsj.com and Ben Leubsdorf at ben.leubsdorf@wsj.com
        (END) Dow Jones Newswires

        January 07, 2015 19:03 ET (00:03 GMT)

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