Unlike the President and Congress, the Federal Reserve doesn't have to worry about politics. When it says "jump," the money supply asks, "How high?" It has ample autonomy and very little oversight. As a result, it shouldn't be surprising to see people calling for the Fed to do more about high unemployment, since it doesn't have the political concerns of Congress or the President. They feel their ammunition is limited due to deficits. So should the Fed be doing more?
In his New York Times column today, David Leonhardt argues this, saying:
By law, the Fed's mission is to maintain low inflation and maximum employment. Over the last three months, inflation has been zero. Over the last two years, it has risen at the slowest pace in more than 50 years. Meanwhile, 15 million people remain unemployed.
Yet the Fed has taken no recent action to spur the economy -- like buying bonds to reduce long-term borrowing costs for households and businesses, as Joseph Gagnon, a former Fed economist, has urged.
And here's Gagnon's urging Leonhardt writes about. Obviously, the Fed can't do much to directly create jobs. All it can do is try to increase the money supply, so to broaden credit. It has already committed to keep short-term rates near zero for probably the rest of 2010. Leonhardt and others are calling for the Fed to push down long-term interest rates.
First, what would this accomplish? In the case of businesses, they could refinance their debt and have additional free cash flow to spend on hiring or expansion-driven spending. This might help a little, but the reality is that until consumer demand improves, businesses aren't going to begin hiring. It's an insane business decision to take on more employees if there's no additional demand for the products or services they would provide. More cash flow for business would create few jobs in the near-term without a recovery of the American consumer -- who accounts for some 70% of the U.S. economy.
But what about those consumers? How might lower long-term interest rates help them? They could also refinance their long-term debt, which would consist mostly of mortgages. For example, if a person with a $100,000 30-year fixed rate mortgage had a 5% interest rate, then the homeowner pays $537 per month. But if refinanced at a 3% interest rate, the monthly payment would only be $422 per month. The household now has $115 more to spend each month. Instant stimulus!
There are a few problems with this, however. First, the Fed did, in fact, take action to lower mortgage rates when it bought lots of mortgage securities through programs put in place during the credit crisis. They ended this past spring. In doing so, it only got mortgage interest rates down to around 4.81%, according to Freddie Mac. Now they're around 4.89%. Are we sure that more bond purchases could get rates a whole lot lower?
But let's say that the Fed did somehow manage to get 30-year mortgage rates down to 3% or less. It would be a historically unprecedented time in housing finance. Mortgage rates might not get that low again, ever. That would have a very strange effect on the future of the housing market.
Imagine that these ultra-low rates last a year. Home purchases may increase a bit -- but probably not too much. It's pretty clear that home buying fatigue has set in. Despite the current very low interest rates, even though refinancing has risen, purchases have plummeted over the past five weeks.
So what you'll more likely get is virtually every homeowner in the nation refinancing, so they can lock in 3% for 30-years. The Fed's action would have reverberations over that long time period. For decades, those homeowners would fear selling their home, because they don't want a new mortgage at interest rates that would almost certainly exceed 5%.
One negative consequence would be worse labor mobility. Additionally, the housing market would experience an incredibly long period of lackluster sales -- there would be very little housing turnover, with no one wanting to move. Of course, none of this even begins to touch on the potential inflation that such a policy could cause. You can adjust short-term rates quickly to combat a rising price level, but when long-term rates get locked in, they're set.
The question, then, is whether the short-term simulative benefit is worth the long-term consequences. If you don't mind the prospect of the Fed having weaker control over inflation along with three-decades of an ultra slow housing market and very weak labor mobility, then you might think so. But really, direct government stimulus spending would make a lot more sense than contorting the credit market to provide the same end.