America has been mired in its worst unemployment crisis since the Depression, and everything policymakers in Washington have tried to fix the problem has — at best — been not good enough. Huge stimulus programs from Congress and low interest rates paired with massive asset purchases on the part of the Federal Reserve have by most accounts improved the unemployment situation. But four years after the financial crisis, the unemployment rate remains above 8%, and would be even higher if not for the hundreds of thousands of workers who have abandoned the workforce entirely.
And while Congress and the President have been locked in an ideological struggle over the role of government in the economy, unable to come to terms on any solutions to the crisis of joblessness, America’s central bank has been in a position to act unilaterally — above the political fray that is paralyzing Washington’s legislative process. That’s why many critics of the bank and its chairman, Ben Bernanke, have been calling vociferously for it to take more action to goose the economy and bring down unemployment.
But it’s not like the Federal Reserve has been sitting on its hands for the past four years. In fact, this is arguably the most activist central bank regime the country has ever seen. It has kept short-term interest rates at basically zero since 2008. It has purchased trillions of dollars in U.S. government debt and mortgage-backed securities in an effort to reduce interest rates further and stimulate the housing market, the collapse of which precipitated the financial crisis. And it has even made announcements regarding its expectations of interest rates in the future, more or less promising that short-term rates would stay near zero for years to come.
Critics of recent Fed policy cite this as reason why it shouldn’t do more. They say that each successive round of asset purchases has yielded diminishing returns, while ratcheting up the ever-present danger of inflation. These detractors have decades of economic data that indicate that increasing the money supply will always, eventually, lead to inflation, and though we haven’t experienced any yet, that only means it will hit with a vengeance when it finally rears its ugly head.
Yesterday, Ben Bernanke and the Federal Open Market Committee came down on the side of those calling for more action, announcing a bold, open-ended mortgage-backed-security purchasing program, which will pump $40 billion a month into the economy indefinitely until the unemployment market improves significantly. Said Bernanke in yesterday’s press conference:
“If we do not see substantial improvement in the outlook for the labor market, we will continue the MBS purchase program, undertake additional asset purchases, and employ our policy tools as appropriate until we do. We will be looking for the sort of broad-based growth in jobs and economic activity that generally signal sustained improvement in labor market conditions and declining unemployment.”
So what makes this program different than the previous asset purchases, which have seemingly decreased in efficacy each time around? It’s the open-ended nature of the program that supporters believe will make all the difference. The Federal Reserve derives its power from its ability to set interest rates, but that tool has been stretched to its limits in recent years. Beyond that, the Fed can affect expectations about where short- and long-term rates will be in the future. Open-ended purchases of mortgages will have the effect of lowering interest rates, helping more people qualify for mortgages or refinance. But more importantly it will — in theory — have the effect of creating an expectation of generally higher asset prices in the future, which will motivate people to get off their duffs and spend money now. If companies and individuals are indeed convinced that prices will rise in the future, that would encourage them to spend, hire, and jump-start the economy out of its chronic underperformance.
But not everyone’s convinced that the plan will work. More purchases of financial assets, critics say, will raise the price of financial assets, but those higher prices won’t translate into a more robust economy or greater employment. As David Dayen of Firedoglake argues, there’s only so much the lifting of asset prices can do without appropriate fiscal policy to accompany it:
“[Y]ou have to question the role of monetary actions by themselves to generate an economic boost, especially at this time. Lower mortgage rates may or may not prove helpful . . . without fiscal stimulus and a reversal of the current trajectory of deficit reduction, we will never get to the desired trend for growth.”
Others, meanwhile, are afraid that the Fed’s new policy will spur inflation. Lord Abbott fixed income strategist Zane Brown was thusly critical of the Fed’s actions: “I imagine the Fed is likely to come under considerable criticism for assuming that monetary policy can be effective in creating employment,” he told CNBC.com. “When you consider they are going to have this highly accommodative stance, even after the economic recovery strengthens, almost by definition it will generate inflation”
It’s difficult for me to see how, in this current economic environment, we could have sustained inflation at the same time as high unemployment. A huge part of product costs are labor, and median wages have actually been on the decline. It’s highly unlikely that we’d experience inflation without a commensurate rise in wages. And it’s difficult to see a significant rise in wages without unemployment first coming down, which is the whole point of this Fed action in the first place.
It’s clear from the numbers that unemployment is a far bigger problem than inflation for the time being, and in that context — and given the Federal Reserve’s mandate to promote full employment — taking actions aimed at reducing unemployment makes sense. The only question now is whether it will work.