The Impasse of Monetary Policy, Part 4 - failures

Why The Fed, by itself, cannot deliver a sustainable recovery?

Part 4 -  what the Fed couldn't do 

2.4   What the Fed could not accomplish

·     Full Employment: Although unemployment is now below 6% from 10% in the dark moments of the Great Recession, a number of things cast a cloud on that metric. Most labor economists agree that the current metric, which ignores the underemployed and the discouraged, does not tell the real story. The labor participation rate, presently at a 36 year low –  with an estimated 10 million fewer people aged 15-64 working than  before the Great Recession – is still  exhibiting signals of a sluggish job market.

The assumption made by the Fed with QE3 was this: by specifically targeting financial asset-price appreciation it would engender a “wealth effect” for increased investment and job creation. Unfortunately, levitated stock prices have not given rise to the types of productive investments needed to boost employment, consumer-demand or national prosperity. The “transmission” of wealth from Wall Street to Main Street simply failed.

In reality, a number of other factors are behind this employment-slack, including: a shortage of suitably skilled applicants, a declining appetite in business investments, the pressures of globalization and unfavorably changing demographics. None of these factors have anything to do with monetary policy. The untold story is the disturbing “disconnect” here with the Fed’s secondary mandate of achieving full employment:  the latter faces a lot more challenges than lax monetary policy can possibly overcome.

·     Bolster business investments: To-date, one of the top beneficiaries of low-interest rates was larger corporations which used cheaper credit either for business expansion or debt rescheduling. Banks have been more reticent in lending to small businesses which typically present larger credit risks. This is unfortunate because the majority of new jobs are created by small businesses.  The Fed can make plenty of money for banks to lend, but it cannot assume credit risk for them. Thus business investment remains tepid.

·       Regaining consumer confidence: Although consumers have also benefited from ultra-low interest rates to reduce their debt loads, they have become a lot more unwilling of boosting their spending patterns with borrowed money. Cheap credit has to-date visibly failed to boost consumer confidence to the desired levels of economic vitality.

·    Restoring economic growth: Consumer demand is sustained by a strong job market. But a strong job market -- and job creation -- depends specifically on rising business confidence for making productive investments. Yet, in a reciprocal logic, those investments are made primarily because of increased consumer demand that those new jobs can generate. A circular relationship of sorts is clearly evident here. But, where it should start to gain traction toward the end goal is far less obvious.

Although there is strong “circular causality” between jobs, consumption and investment, the role of low interest rates in that circle is remarkably less obvious. Take Japan for example:  it has over twenty years of tireless experience in the practice of low interest rates and cheap credit (ZIRP & QE), yet precious little to show in terms of economic growth. To-date, most economists have yet to admit that expecting cheap credit, alone, as a primary catalyst of economic growth is either naïve or unrealistic.

·  “Be understood” by Congress: In American politics, where theatrics of governance eclipses convergent policy choices, one thing stands out: the exceptional influence the Fed has with the business world and political circles. The business media, seldom shy in clinging headlines to abstract notions, once called this exceptional dependency “In Fed we Trust.” Yet, the Fed has never been properly understood.

When former Chairmen Bernanke said “there are limits to what monetary policy can do” or when former chairman Greenspan suggested that “perhaps we should have gone back to the tax rates of the Clinton years”, they were not properly understood by policymakers. That they were overtly complaining about having to live with disjointed fiscal and trade policies have invariably fallen on deaf ears.

Hopefully one day the Fed will convince Congress that it cannot work magic: without effective fiscal, trade and other associated policies supplementing monetary policies financial stability and economic revival will likely remain distant objectives.