Central bankers can be hard to understand.
For one, they speak their own language, littered with words like "modest" and "moderate" or "a number" and "a few." For another, why aren't they doing even more with job growth stagnating and inflation falling? And just how does Ben Bernanke manage to keep his beard so meticulous-looking? (Okay, that last one isn't such a mystery anymore). But there's one thing about the Fed that's not hard to understand: Like 87 percent of the rest of America, it does not approve of Congress.
We certainly are not all Keynesians now, except for the Fed. The past few years, Bernanke & Co. have been in the unusual position, for a central banker, of rooting for Congress to run bigger deficits to keep the recovery on track. Now, in normal times, it doesn't much matter what Congress does. If it pumps more money than the Fed wants into the economy, then the Fed will suck it out by raising short-term interest rates; if it pumps just as much money as the Fed wants into the economy, then the Fed won't do so itself by cutting short-term interest rates. In either case, the economy isn't much better off with fiscal stimulus than it would have been without.
But these are not normal times. Short-term interest rates, the Fed's main tool, have been stuck at zero since late 2008. That's left the Fed to experiment with unconventional easing: promising to keep rates at zero even after the recovery picks up, and bond-buying to make those promises credible. In other words, the Fed says it will keep rates low in the future even if inflation is high then, and buys long-term bonds to convince markets that it means what it says. The idea is to reduce inflation-adjusted borrowing costs by pushing up inflation expectations. It's worked. At least, as Ryan Avent points out, at preventing deflation -- which is toxic to over-leveraged households and businesses.
In other words, the Fed has prevented a real depression, but hasn't been able, or willing, to start a real recovery. The problem is the Fed's bond-buying mostly works through expectations (think of it like a Jedi mind trick), and those expectations are only as stable as the Fed's latest statement. The money the Fed "prints" to buy these bonds has largely gotten stuck in the banks, because of the collapse in lending. Banks only want to lend to the most creditworthy borrowers, but the most creditworthy borrowers don't want to take out new loans. Now, back in 2002, Bernanke suggested a central bank could get around this problem with "helicopter money" -- that is, by printing money and sending it to people. But the Fed can't send money to people. Only Congress can do that -- with tax cuts. As Oregon professor Tim Duy emphasizes, Bernanke thought a central bank could only get out of a liquidity trap if the rest of the government helps it.
In econospeak, unconventional monetary stimulus works best with fiscal stimulus.
The Fed has tried to tell Congress this. As I pointed out a few months ago, the Evans rule -- which says the Fed won't raise rates before unemployment falls below 6.5 percent or inflation rises above 2.5 percent -- makes the case for fiscal stimulus stronger than ever. It tells Congress exactly how much fiscal stimulus the Fed is willing to tolerate -- and the answer is quite a bit. But rather than putting more money into the economy, Congress has taken money out. Between the expiring payroll tax cut and the fully armed and operational sequester, it's been a heavy dose of austerity (even more than in the past few years). As you can see below in this nifty Wall Street Journal tool that tracks changes in Fed policy statements from month to month, it's been enough that the Fed now says austerity is outright hurting growth.
(Note: The highlighted green sections show what has been added since the last Fed statement).
Now, this is couched in Fedspeak, but "fiscal policy is restraining economic growth" is clear enough: Congress is making the Fed's already difficult job even more so. In plain English, it probably translates as a four-letter word with a "you" appended.
Where does a worse-than-useless Congress leave the Fed? Well, doing more. The Fed is already buying $85 billion of bonds a month, and has promised to keep doing so until the labor market improves "substantially", but it could always up that. Indeed, after talking for months about "tapering" its bond purchases, the Fed is now saying it could increase them, if necessary.
It looks like it will be. Inflation is falling again, and job growth is sputtering again, which gives the Fed a straightforward case to increase its bond-buying. Assuming, of course, that Congress continues to perfect the art of doing nothing.
You don't need to understand Fedspeak to know that's a good bet.