Slow Growth Doesn't Mean a Fast Fed

JUNE 4, 2011   THE WALL STREET JOURNAL

By DAVID REILLY

Cue the Fed. That is one reaction to signs of economic weakness that culminated with Friday's disappointing U.S. jobs figure.

It is easy to see why. Investors, especially in stocks, have become conditioned to thinking the Federal Reserve will ride to their rescue when times get tough. But barring a precipitous drop in markets, investors shouldn't count on the Fed acting too quickly. Nor should the Fed be itching to again expand its balance sheet, after it completes its second round of bond buying in June.

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Federal Reserve Chairman Ben Bernanke, pictured in May at the 'New Building Blocks for Jobs and Economic Growth' conference at Georgetown University

For starters, May's paltry 54,000 jobs gain doesn't signal a collapse in employment growth. The monthly figure is volatile, subject to revisions and may have been affected by effects from Japan's destructive earthquake. Since the start of the year, monthly employment gains have averaged about 155,000.

Granted, that level is　nowhere near enough to offset the millions of jobs lost during the recession.　And such gains are anemic from a historical perspective. John Lonski, chief economist at Moody's Capital Markets, noted that following the 1981-82 recession, work-force-adjusted payrolls rose by as much as 579,000 new jobs a month, on average.

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But today's recovery　was never likely to follow historical precedents. The　overindebted U.S. faces a balance-sheet recession. Even though fiscal and monetary stimulus　stopped a deflationary spiral, households and the government still need to reduce debt. Household debt as a percentage of personal income is down from bubble-era levels of about 130%,　but it still needs to fall markedly.

Fed Chairman Ben Bernanke already has indicated that the bar for further extraordinary measures is higher than before. After all, though bond buying pushes up the price of riskier assets like stocks, it also carries the risk of stoking bubbles and broader inflation as well as driving up commodity prices, which sap the spending power of the poor.

It also is worth　remembering the last time the Fed decided　on extraordinary action. In spring 2010, stocks peaked, the U.S. economic recovery faltered and financial markets became jittery over Europe's debt crisis. Yet the Fed waited and watched until mid-August, when Mr. Bernanke in a speech hinted at plans for another bout of government bond buying. During that time, stock markets fell about 15% from their April high to July nadir.

Granted, Europe is in crisis again. Global growth also is starting to slow, especially as China tries to rein in inflation. Yet markets are hardly　in free fall. The S&P 500 is off about 4% from its recent high, and is still up nearly 20% from a year ago. Riskier assets such as high-yield corporate bonds have seen yields fall to below 7%, a historically low level.

And the politics of extraordinary Fed action have become more complicated. The Fed's most recent bond-buying program was met with opposition domestically and internationally. Countries have accused the Fed of exporting inflation. China's moves to tighten policy are　one response and are raising the prospect of slowing global growth.

The likely result is a wait-and-see approach, as the Fed watches the incoming data as well as how the government responds to the debt-ceiling and deficit issues. If nothing else, Mr. Bernanke has to take off the markets' training wheels and force investors to try pedaling on their own.

Write to David Reilly at david.reilly@wsj.com