Fed’s Quantitative-Easing Strategy Lets Trillions Sit Idle, Slowing the Recovery
By Norbert J. Michel
WASHINGTON (Tribune News Service/TNS) – Two reasons why the Federal Reserve should stop trying to stimulate the economy:
One: The policies they’ve enacted so far have contributed very little to the economic recovery.
Two: They’ve likely already reached the limits of what monetary policy can do to boost the economy.
The Fed’s unconventional quantitative-easing programs have filled the banking system with excess reserves. The federal-funds market — the lending market where banks borrow and lend all those reserves — now contains nearly $3 trillion in excess reserves, all ready to go, but with hardly any takers.
Why haven’t these excess funds been put to some good use — such as being lent out?
Part of the reason may lie with the Fed’s decision to pay interest on these reserves. Why should a bank risk lending to a startup business when it can make money by just sitting on the funds? And there’s no doubt factors beyond the Fed’s control, such as general economic weakness around the world, have inhibited lending, as well.
Bank lending has picked up recently, but that’s something we would expect after a financial crisis. Even so, most of the “new” money the Fed injected into the banking system is still sitting at the Fed. It simply hasn’t made it into the broader economy even though employment and nominal spending have rebounded.
In reality, the most anyone could have expected from expansionary monetary policies was a short-term boost to the economy. But nearly six years into quantitative easing, that “short term” is likely past. Historically, increases in the money supply can boost nominal economic growth, but not price-adjusted “real” growth.
Even that temporary boost sometimes derived from “easy money” creates risks, for one must then hope that the central bank can tame inflation in the aftermath. Economists disagree on the exact amount of time that separates short-run versus long-run effects, but we’re past the five-year mark now. That’s not the short run.
To truly stimulate economic growth, the best option is to make fiscal and regulatory changes that lead to structural improvements in our economy. The fact that the Fed now has more than $4 trillion on its balance sheet — more than five times the amount it had prior to the crisis — only prolongs these types of changes.
The QE approach to stimulus has created serious economic hazards. The Fed now owns more than one third of all outstanding Treasurys.
This means the nation’s central bank is more and more deeply involved in financing the government. That makes it both more difficult for the Fed to conduct normal monetary policy and more likely that future Fed actions will be driven by political, rather than economic, considerations.
Furthermore, the Fed now holds only long-term Treasury securities, the type of investment that stands to lose the most value when interest rates rise. Those rates have been at historic lows for the last several years, so it’s only a question of when — not if — they will go back up. When they do, those long-term securities will become increasingly less valuable.
Critics are quick to point out that the Fed can’t really suffer losses on these securities the same way private banks do. But the only reason the Fed doesn’t face the same insolvency problem is that the central bank can create money to cover its losses. And that’s a prescription for runaway inflation.
Given the current fiscal situation in the U.S., the amount of assets on the Fed’s books and the corresponding potential losses, it’s imperative that the Fed start to reverse its QE purchases.
These purchases have demonstrably failed to kickstart the economy. Better to pull the plug on QE and concentrate on tax and regulatory reforms that can create a climate conducive to vibrant economic investment and expansion.
Norbert J. Michel is a research fellow in financial regulations at the Heritage Foundation.
Fed’s Policy Is Working, But Needs More Time for Total Success
By Mark Weisbrot
WASHINGTON (Tribune News Service/TNS) – A lot has changed in the last 20 years since then Federal Reserve Vice Chairman Alan Blinder had the audacity to suggest, in a speech, that the Fed could use interest-rate policy to help reduce unemployment in the short term.
It was real blasphemy back then, and despite the fact that the Fed had by law a dual mandate to maintain both “price stability” and full employment, his remarks ignited a firestorm of controversy.
Now, thanks to the Great Recession and Ben Bernanke’s willingness to use zero-percent interest rates and venture into uncharted territory with quantitative easing, the “dual mandate” is widely accepted.
Both Bernanke and current Fed Chair Janet Yellen also spoke out in favor of using fiscal policy that includes deficit spending to increase employment, something that U.S. Fed Chairs didn’t say in the past.
In a recent speech, Yellen noted that “the lack of fiscal support for demand in recent years also helps account for the weakness of this recovery compared with past recoveries.”
These are important institutional advances, even if other branches of government — most importantly the Congress — are not smart enough to take advantage of free money to create some of the millions of jobs that are so desperately needed.
But today’s Fed could still be a threat to full employment if it proceeds too early with the “normalization” of interest rates that even Yellen is talking about. Nearly everyone is talking about normalizing interest rates sometime next year, and that is too early.
To “normalize” interest rates by beginning to raise short-term rates, we would want to see at the very least a “normalized” labor market. Unemployment at 5.8 percent might look like it is getting somewhat close to “normal,” but other statistics show that it is not.
We can look at the percentage of prime-age workers — those 25-54 years old — who are working, and it has not recovered even half of its loss since the peak before the Great Recession. Since these are prime-age workers, this cannot be attributed to demographics; it is due to people dropping out of the labor force and therefore not being counted as unemployed.
As my colleague Dean Baker has pointed out, it would take another 7-8 million jobs to get us back to pre-recession levels of employment.
Another measure of the economy’s current weakness is lost output: The Congressional Budget Office estimates that we are 4 percentage points below our potential gross domestic product — or a loss of about $2,000 per person.
The percentage of long-term unemployed — those out of work for at least six months — is also still highly elevated, at about twice its pre-recession level; and these people can become permanently unemployed if they are without work for too long.
African-Americans have about twice the unemployment rate as do white workers. And then there are wages, which have barely risen more than inflation in more than five years of recovery.
Some analysts think that the Fed should hold off on raising interest rates, but only until real, inflation-adjusted wages begin to rise. But this would only perpetuate the intolerable increase in inequality that the majority of this country has suffered for more than three decades. Wages can safely rise faster than inflation not only because productivity — output per worker — increases annually, but also because profits are extraordinarily high. There is a lot of catching up to do, and the Fed shouldn’t cut it off early.
With inflation still running at 1.7 percent and downside risks such as the slowing world economy, there’s no excuse for the Fed to be throwing people out of work by raising interest rates.
Let’s hope that public pressure and an improved debate over Fed policy can keep this country moving toward full employment.
Mark Weisbrot is co-director of the Center for Economic and Policy Research.