Is Congress the ‘enabler’ of a loose Fed?

We heard it more than once at today’s hearing of the Joint Economic Committee featuring Fed Chairman Ben Bernanke: the central bank’s low interest rate policies are allowing Congress to delay tough decisions on long-term spending.

As U.S. senator Dan Coats asked pointedly: “Is the Fed being an enabler for an addiction Congress can’t overcome?”

Yet, if you read the subtext of Bernanke’s testimony closely, it may actually be Congress that is enabling a loose Federal Reserve.

That’s because it is the very fiscal tightening mandated by Congressional inaction that is forcing the Fed to continue stimulating growth. Chicago Fed President Charles Evans said on Tuesday the economy could be expanding as quickly as 3.5 percent were it not for the fiscal drag from Washington.

Bernanke echoed that sentiment in his testimony on Wednesday:

The Congressional Budget Office estimates that the deficit reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points during 2013, relative to what it would have been otherwise. In present circumstances, with short-term interest rates already close to zero, monetary policy does not have the capacity to fully offset an economic headwind of this magnitude.

The irrelevance of slightly better U.S. economic data

The latest round of reports on the U.S. economy, while hardly the ringing endorsement of a robust recovery, have been a bit better overall. Jobless claims, while still high, have fallen to a seven-month low of 388,000. Industrial output, meanwhile, posted its largest increase since July as factory and mining production expanded strongly.

But investors are far too obsessed with the mess taking place in Europe to pay the modest improvements any mind. Even if Europe’s financial morass were not an ongoing cloud over the U.S. outlook, the incremental gains in U.S. economic activity remain far too modest to warrant any sort of optimism about a substantial decline in unemployment. Moreover, analysts are worried that the current political propensity in Washington for spending cuts rather than renewed stimulus poses another threat to growth.

Thomas Lam at OSK-DMG sums up the sentiment nicely:

Incoming data over the past month or so have been generally more spunky. […] The continued tightening in financial markets and depressed sentiment indicators still imply downside risks to growth in subsequent quarters. But the key driver to the 2012 outlook, at least for the early part of next year, is fiscal policy considerations.