Why Shouldn’t the Fed Do More?

Financial FAQs

Fourth Quarter Gross Domestic Product growth was a bust. And so cries are rising for the Federal Reserve to do more to promote growth (since Congress and the White House can’t or won’t). Actually the Fed has done more in the past to promote growth—mainly by ignoring its own inflation goals.

An excellent piece by New York Times’ Binyamin Appelbaum highlighted the controversy over whether the Fed’s $85 billion per month purchasing of Treasury and Mortgage Backed Securities is enough to stimulate more growth.

What, you say? Isn’t $3 trillion already on their books too much? Not really, when you look at what even Fed Chairman Bernanke’s predecessor, wily Alan Greenspan (master of do what I say, not what I do), was able to engineer during his almost 20-year tenure. How did he do it? He basically ignored the 2 percent inflation Federal Reserve target when he wanted to stimulate more growth, while supporting record-breaking budget deficits during the GW Bush administration, in particular.

Inflation rose as high as 6 percent during the late 80s in an attempt to boost growth for the first Bush, before the 1991 recession sunk his chances at reelection. And he tolerated 5 percent plus inflation in the early 2000s. Both times unemployment fell to between 4 to 5 percent. This was considered full employment before Greenspan finally put on the credit brakes by raising interest rates.

It is obvious Chairman Bernanke does not have Greenspan’s panache, for want of a better word. History shows higher inflation is needed to boost growth, and developing countries such as China tolerate much higher inflation rates precisely for that reason. Yet the Federal Reserve Bank of Cleveland calculated in a January report that average expected inflation over the next decade was just 1.48 percent per year.

The Fed seems to have painted itself into a corner with its stated mandate of 2 to 2.5 percent inflation. It’s a scenario eerily similar to Germany’s fixation on inflation since its 1920s hyperinflation, and the reason Germany is punishing the Mediterranean countries with its austerity demands. Such intransigence is causing Europe to fall back into recession. Great Britain’s conservative government is slavishly following Germany’s lead, leading to its own triple-dip recession since its Conservatives Party took office.

It’s as if the Fed can only look in the rear view mirror. Inflation (price stability) became its dominant goal in 1977 over maximum employment, after years of what came to be called stagflation—rising unemployment plus inflation. The Federal Reserve Reform Act of 1977 enacted a number of reforms to the Federal Reserve, making it more accountable for its actions on monetary and fiscal policy and tasking it with the sometimes conflicting goals to “promote maximum employment, production, and price stability”.

But the 70’s inflation was mainly caused by the Arab Oil Embargo and spiking oil prices, among other things—a scarcity of supply—which is no longer the case. It spawned supply-side economics, or, the theory of diverting more wealth to the actual suppliers so they will produce more to bring demand and supply back into equilibrium—with large tax breaks, for starters. And that stimulated the supply of everything with a vengeance; due to globalization (and consequent loss of employee wage bargaining power), corporate monopolization, and deregulation so that oversupply and falling prices became the problem.

Now the greater danger is continuing the tepid growth policies that break the record for length of long term unemployment. As the latest very unprogressive tax accord shows, the U.S. might repeat Germany’s mistakes with greater government austerity when precisely the opposite is needed. Neither Presidents Reagan or GW Bush had any problem with deficits—in fact created the largest federal deficits since WWII.

Why can’t this Democratic administration learn the same lesson? It’s time for the Fed Governors to take the side of consumers and drop their inflation bias. It has become a straitjacket when higher inflation is needed to boost growth. Consumers and employers might tolerate a bit higher inflation, if they knew Fed policy had corrected its inflation bias to encourage more income and jobs growth after 30-plus years of wage stagnation.

Harlan Green © 2013

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen

About populareconomicsblog

Harlan Green is editor/publisher of PopularEconomics.com, and content provider of 3 weekly columns to various blogs--Popular Economics Weekly and The Huffington Post
This entry was posted in Economy, Keynesian economics, Macro Economics, Politics, Weekly Financial News and tagged , , , , , , . Bookmark the permalink.

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