Today, Federal Reserve Chairman Ben Bernanke is testifying before the Senate Banking Committee in order to argue that he should be confirmed for another four-year term. Even though there are some extremists on the right and left who would like to see his confirmation denied, I think it's safe to say that pretty much everyone would be shocked if the Senate refuses his second term. The Fed's creativity in stabilizing the financial industry after the crisis will be talked about for decades by macroeconomists. As a result, I only consider there to be a few legitimate criticisms for the job Bernanke has done. One complaint that I've been hearing lately is that the Fed hasn't done enough to curb unemployment. Should Bernanke have done more?
First of all, is it part of the Fed's job description to worry about unemployment? Yes. According to the Federal Reserve Act, the Fed should seek:
to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
Yet, the monetary policy statement (.pdf) on the Fed's website follows up that blurb by saying:
Stable prices in the long run are a precondition for maximum sustainable output growth and employment as well as moderate long-term interest rates. When prices are stable and believed likely to remain so, the prices of goods, services, materials, and labor are undistorted by inflation and serve as clearer signals and guides to the efficient allocation of resources and thus contribute to higher standards of living. Moreover, stable prices foster saving and capital formation, because when the risk of erosion of asset values resulting from inflation--and the need to guard against such losses--are minimized, households are encouraged to save more and businesses are encouraged to invest more.
So it's pretty clear that price stability is the Fed's first priority, and it believes that when this goal is satisfied the others will follow. Of course, at a time like now, that isn't working out too well. Unemployment has climbed into double-digits while inflation is hardly a worry in the near-term. So what about that maximum employment goal now?
In fact, this is the first question that Wall Street Journal economics editor David Wessel asks in a piece about Bernanke's confirmation hearing today. He anticipates Bernanke answering that the Fed has done as much as it can to curb unemployment -- it stabilized the financial industry, created programs to help support the housing market and consumer credit availability. It also has interest rates as low as possible. Regarding this potential response, Wessel says:
If the Fed has done all it can, then should Congress and the president do more on the tax and spending side? That isn't Mr. Bernanke's job, but Fed chairmen inevitably are seen as economic wise men. So, Mr. Bernanke, was the Obama stimulus, which you favored, too big or too small? Well designed? Would another dose help by boosting demand or hurt by widening the budget deficit and risking higher bond-market interest rates? Would a payroll-tax holiday encourage hiring?
Here's where I start getting uneasy. The Fed is supposed to remain independent from politics. If the only way for it to help reduce unemployment is to try to drum up public support for Congressional spending or the like, I'm not sure I'm on board. That's fiscal policy, not monetary policy. Leave the politics to the politicians.
That's not to say that the Fed can't give the Treasury or other government officials its expert economic opinion. But it should only do so privately, and not in order to sway the political winds. I just don't think that's appropriate.
The next year or two will be very interesting. Unemployment is expected to remain quite high during that time, but towards the end of this period, inflation might become more of a worry if the Fed fails to begin shrinking its balance sheet. At that time it might be faced with a very tough dilemma: should it worry more about inflation or unemployment. Tightening monetary supply certainly won't help employment prospects, which would go against one of its central goals.
No one can predict exactly how this will play out, but surely Bernanke and company understand the risk of withdrawing monetary support too soon: it could cause a nasty double-dip recession. So I'd be shocked -- shocked -- if he wasn't willing to stomach a little bit more inflation than he'd normally like to see in order to ensure that unemployment doesn't begin creeping back up after it began to decline. With that said, I also don't think he'll want to endure anything like double-digit inflation, so he won't allow loose monetary policy forever. I think we'll see a balanced approach, which may anger some who worry more about unemployment. But ultimately, the Fed might believe it's wise for unemployment to decline a little more slowly rather than risk more drastic inflation.