Saturday, June 9, 2012

The Fed’s Dilemma

The Fed’s Dilemma
 
Chairman Bernanke will be testifying on Thursday, June 7th before the Joint Economic Committee of Congress. His testimony comes against a background of gloomy economic data. The U.S. economy grew at just a 1.9-percent annual rate in the first quarter of 2012. At that anemic growth rate, the economy cannot produce enough jobs to accommodate an expanding labor force. That fact was evidenced in the rise in the unemployment rate to 8.2 percent. The jobless rate for recent graduates is much higher. And this is occurring in the third year of economy recovery. Harvard economist Robert Barro has analyzed this pattern as unprecedented in economic recoveries.


Clearly something is very wrong with the policy mix.
The Fed has run out of viable policy options. Three years into a range of policies intended to keep interest rates very low, near zero for short term interest rates, it is time for the Fed Chairman to recognize that more of the same policy will produce more of the same results: weak growth and high unemployment. Commercial banks are not lending all the reserves the Fed is creating. Failure to fix the financial system in the wake of the financial crisis has left us with a hobbled banking sector. The ill-advised Dodd-Frank Act worsened rather improved matters. The Fed Chairman is not responsible for Dodd-Frank. But the unprecedented low interest rates have not produced credit for manufacturers, farmers and other productive sectors. Instead they are fueling bubbles in the bond markets and financial-market speculation. The fiasco with JP Morgan’s losses in London is symptomatic of how easy money fuels speculation rather than investment.
On the fiscal side, policy is equally wrong. The mindset of the Obama administration is that spending lots of money today, and taxing its citizens tomorrow to pay for todays’ spending, will make them feel wealthy and stimulate spending. That view is at odds with the lessons of Economics 101 and commonsense. Tuesday’s election in Wisconsin was less about an endorsement of Scott Walker the man, as an endorsement of his commonsense Midwestern antipathy to debt and large government as a solution to the economic woes that have befallen us. It is in that sense that Wisconsin is a bellwether for the nation.

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