Monetary stimulus isn't "treason." It's Ben Bernanke's job. And it's high time for the Fed chair to do it.
The U.S. economy is in bad shape. A growing pile of economic data--slow GDP growth, falling employment, falling consumption--only confirms what more than twenty million people who can't find full-time jobs already know. Yet Congress and the White House are unable or unwilling to do anything about it. As spending from the 2009 stimulus bill peters out, fiscal policy is hurting the economy, and the Republicans' unanimous insistence on spending cuts is keeping it that way.
But some Republicans are not content with preventing fiscal policy from reducing unemployment. They also want to intimidate the Federal Reserve--a historically independent agency--from using monetary policy to reduce unemployment. Yesterday presidential hopeful Texas Governor Rick Perry said that it would be "treasonous" for Ben Bernanke to "print money" to attempt to stimulate economic growth.
In these economic circumstances, "printing money" is Ben Bernanke's job. The Federal Reserve has a famous dual mandate: maximum employment and stable prices. Right now, they're doing fine at one and abysmally at the other. This chart shows excess unemployment for the past sixty years: the difference between the unemployment rate and the "natural" rate of unemployment estimated by the CBO (currently 5.2 percent). The only other time excess unemployment climbed above 4 percent, in 1982, it fell back below 2 percent within five quarters. This spring was the ninth quarter since excess unemployment first passed 4 percent, and it's still at 3.9 percent. The Fed itself estimates it will be well above 3 percent through the end of this year.
As for inflation, although Rick Perry says that monetary expansion is "devaluing the dollar in your pocket," every indicator available shows that inflation is low. After a slight uptick due to commodity prices earlier this year, it has settled down again, with two-year inflation expectations at only one percent. So why isn't the Fed doing more to reduce unemployment?
THE FEDERAL RESERVE VS. 'POLITICS'
The traditional worry about central banks is that they will be too willing to stimulate the economy, since everyone likes growth and no one likes a recession. In particular, the fear was that if central bankers took orders from elected officials like the president or Congress, it would stimulate the economy before every election, potentially creating an inflationary spiral. This is why the Federal Reserve is so independent of the rest of the government--so it can take action against inflation, even when the executive and legislative branches want more growth.
What's bizarre today is that we're seeing exactly the opposite of the traditional fear. Unemployment is high, the economy is stuck, and all the president and Congress can talk about is deficit reduction. In this situation, the Fed's independence should be a virtue: Ben Bernanke should be saying, "I know all those politicians have lost their minds, but I'm going to do what's right: I'm going to save the economy."
That's exactly what Rick Perry is afraid of--that Bernanke will help the economy--because he knows that a bad economy is his best shot at becoming president. And that's why he's playing politics with the Federal Reserve (using the strange non-logic that if Bernanke just does his job and follows the dual mandate, he's the one who is playing politics).
Monetary expansion is especially important when it's abundantly clear that Congress and the White House have their minds set on a fiscal contraction. Some people seem to think that cutting the deficit can actually stimulate the economy. The empirical evidence is that it doesn't work when the economy is weak (or maybe not at all, when you correct for confounding factors). But monetary policy can at least limit the damage to the economy caused by tight fiscal policy. If the central bank aggressively reduces interest rates, it can counteract the effect of reckless budget-cutting. (See the IMF's World Economic Outlook from last fall.)
WHAT THE FED CAN DO
The Federal Reserve can see what Congress is doing to an already weak economy (spending cuts on top of spending cuts), and they should be actively correcting for it. Yes, short-term interest rates are stuck at zero and can't go any lower, but that doesn't rule out another round of "quantitative easing"--buying longer-maturity bonds to reduce long-term interest rates.
The people calling for more aggressive action from the Fed aren't left-wing radicals. They include former Fed official Joseph Gagnon, Reagan administration official and well-known deficit hawk Bruce Bartlett, and former IMF chief economist Kenneth Rogoff, co-author with Carmen Reinhart of the widely-cited This Time Is Different, a history of financial crises. When Reinhart and Rogoff said that bad things would happen if the national debt exceeded 90 percent of GDP, that became the hottest issue in popular economic debates (and was cited by Paul Ryan as a reason for budget-cutting). But when Rogoff says we need more aggressive monetary policy and even higher inflation to recover from the current economic crisis, people change the subject.
The Federal Reserve recently said it "anticipated" keeping short-term interest rates low for the next two years, but that tepid reaction was in marked contrast to Bernanke's extraordinary response to the financial crisis in 2008 and 2009, when he used the Fed's emergency powers to guarantee assets held by Bear Stearns, Citigroup, and Bank of America, made trillions of dollars available to banks to keep them afloat, and launched the first round of quantitative easing to stabilize the market for mortgage-backed securities. He did so not out of any particular love for bankers, but because he believed that a collapse of the financial system would damage the economy.
But today, we are seeing actual damage to the economy, and the Federal Reserve is splitting semantic hairs. As Brad DeLong wrote, "The thing about Bernanke and Geithner is that they believe that bold action is only needed if there is a crisis in which lots of money-center banks are about to fail, otherwise they are status-quo players." But that's not the Ben Bernanke we need. When Congress and the president do stupid things for political reasons, that's precisely when the Fed is supposed to act. That principle shouldn't be confined to cases where elected officials want to stimulate the economy recklessly; it also applies when, as now, they want to strangle the economy recklessly.
Paul Volcker established his legacy by keeping interest rates high to choke off inflation, even while Presidents Carter and Reagan wanted more economic growth. We're now in the exact opposite situation. It's time for Ben Bernanke to think about his legacy and start acting to save it.