Is the economics version of defining deviancy downward mean that the new normal of high unemployment and inadequate job growth is seen as acceptable by policymakers (at least those not up for re-election this November)?
It’s one thing to recognize that we are working through a painful hangover after a private sector borrowing binge that produced a global financial crisis. It’s quite another to be complacent about bad conditions and steer clear of possible remedies.
The Fed unfortunately has been widely lauded for its emergency responses during the crisis (a view I do not share, but we’ll put that aside for now) and its actions afterwards are given a free pass in too many circles. The Fed now plays a far more openly political role than before, yet insists on the fiction of its independence; it was far more concerned about shielding banks and their investors from pain, and stood with the Paulson/Geithner Treasuries in opposition to resolution of sick big banks; it supported no-strings-attached rescues, both covert and overt, of financial firms, rather than other economic actors. As many readers have said, “Where’s my bailout?”
So now that the Fed sees the banking industry as being on the mend, it has become complacent (and note I am not advocating quantitative easing; I think monetary measures are likely to have little impact when banks are reluctant to lend. But the Fed’s body language has a big influence on policy discussions, so its lack of a sense of urgency undermines initiatives on other fronts).
Reader Doug pointed out a telling tidbit at the end of an article in the Washington Post earlier this week:
“I think we do have a variety of tools available, and we shouldn’t rule any tool out,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said in an interview. “If we’re uncomfortable with how long it’s going to take us to reach either element of our dual mandate [of maximum employment and stable prices], we’ll have to make some adjustments to policy.”
His comment: “So, they are currently comfortable with the pace toward ‘maximum employment’. Stunning. And adds grist to contention that official U3 of 9.5% is now acceptable.”
Tim Duy, a careful reader of the central bank’s tea leaves, reached similar conclusions. He was puzzled by the Post article, and turned to a recent Reuters interview of St. Louis Fed president James Bullard. Some mind-numbing observations by Duy:
First, Bullard and his colleagues underestimated the likelihood of a jobless recovery:
“We just started getting our job growth going three months ago, and then all of sudden we get a kind of a weaker number,” said Bullard, who is a voter this year on the Fed’s policy-setting panel. Nonfarm payrolls added a disappointing 41,000 private sector jobs in May, denting hopes for a speedy recovery.
Second, and related, the Fed actually believes we are experiencing a typical post-war recession in which output rapidly returns to trend:
Setting aside worries raised by softer economic indicators and Europe, the Fed continues to envision a moderate recovery, Bullard said.
“We would expect … at some point start to gradually withdraw the accommodation and then things would continue to recover, and then eventually we would get back to normal,” he said.
Does the Fed really fail to realize that the only reason the US economy returned to “normal” after the last recession was attributable to a housing bubble that was unsustainable? A topic for another time. Finally, the threshold for meaningful additional action is very, very high:
However, if the economy takes a decisive turn for the worse, the Fed would have to consider further stimulus, probably buying more Treasury securities to ease financial conditions, Bullard said.
“If things got really bad in some dimension and we were back in crisis mode, I think the FOMC wouldn’t hesitate to do more if we had to, but I don’t really think that that’s the situation we’re in right now,” he said.
Note: “back in crisis mode.” Note: “ease financial conditions.” Nothing like “to ease the pain of unemployment.”….
Other Fed officials appear even less likely to act.
This reading also confirms what I have heard repeatedly from former Fed staffers and people who know senior Fed officials: the central bank is remarkably insular. A former academic colleague of Janet Yellen, now a successful money manager, was telling anyone who would listen in early 2007 that the roof was about to fall in. He decided to call on her then. His comment” “She had no clue.” And per Bernanke’s March 2007 comment that subprime would be contained and produce losses of only $50 to $100 billion, she had plenty of company at the Fed.
Update 3:30 AM: Thorstein Veblen at Economists for Firing Larry Summers is also Not Impressed:
I’m actually curious what the point is of having an inflation target of 2% if you project inflation of 1%, and do nothing at all to get inflation to 2%. Seems like a credibility problem to me…
The Fed is now predicting that unemployment might still be 8.5% at the end of 2011, and 7.5% at the end of 2012 but, again, doesn’t see anything untoward about this. It’s just the natural order of things.
Underlying this, of course, must be an underlying belief in market fundamentalism. They must believe we’ve been hit with a real shock, and that the market should be left to adjust according to its own tune, and that the Fed is only there to prevent total armageddon. Getting us back to full employment or near to it would constitute unwanted interference with the market place. Unfortunately, it also has real costs — as people who are unemployed long-term lose skills, suffer depression, and are wasting years in which they could be doing productive things. During this time period, firms are also cutting back on Research and Development, meaning a slower rate of technological advance. Meanwhile, China is moving ahead with 10.6% growth expected this year…