Policy Conundrums
Raymond James
By Scott J. Brown
August 29, 2011
In the last few months, some have taken to calling the current economic period, “the Lesser Depression” (instead of “the Great Recession”). There’s no precise definition of “a depression” (and as it is, the definition of “a recession” is rather vague). Most economists would say a depression is a lengthy period of elevated unemployment. That’s exactly what we may be staring out now. Monetary and fiscal policy could provide further support for growth, but there’s a lot of resistance.
Bernanke’s Jackson Hole speech shed a little light into the August 9 FOMC policy meeting. Not surprisingly, the Federal Open Market Committee “marked down its outlook for the likely pace of growth over coming quarters.”Policymakers generally felt that inflation would “settle” at or below 2%, the upper end of the Fed’s comfort range. The inflation outlook, along with expectations of continued excess capacity in production and labor, allowed the Fed to be more explicit about the time period for which short-term interest rates are expected to remain exceptionally low (“through the middle of 2013”).
Short-term measures of core inflation have been trending higher in recent months. Some of this may be related to the pass-through of higher commodity prices. Commodity prices have generally fallen recently and the Fed apparently expects that low rates of resource utilization will put downward pressure on consumer prices. This outlook gives the Fed more leeway to act, but not every member of the Federal Open Market Committee agrees with that assessment.
Bernanke indicated that the Fed considered alternative tools to support growth at the August 9 FOMC meeting and would continue to do so at the September 20-21 meeting (which has now been expanded to two days). The economic data releases for the next two weeks will be critical for the Fed’s decision.
The Fed still has some tools in its kit. However, fiscal policy could do a lot more of the heavy lifting right now. Unfortunately, “stimulus” is a dirty word in Washington.
As a whole, Americans are frustrated with the current size of the federal budget deficit and without a doubt, we are on an unsustainable trajectory. The budget deficit can be reduced over time, but people aren’t going to like how we get there (higher taxes and sharp cuts in discretionary spending). However, reducing the deficit too soon risks damaging the economic recovery. It may be counter intuitive to most people, but the federal government should loosen fiscal policy in the short term and tighten more significantly later on.
ARRA (the American Recovery and Reinvestment Act of 2009) has been criticized from both sides. Some said it shouldn’t have been done – that it would significantly raise the government’s borrowing costs. Well, the 10-year Treasury yield is currently below 2.20%. Others said it wasn’t large enough and was poorly structured. A third of the stimulus was aid to the states. Less than a fifth was infrastructure spending. For the most part, the stimulus prevented the economy from weakening a lot more. It acted like a bridge (providing public-sector support while the private-sector recovers), but the bridge wasn’t long enough.
In a week or so, President Obama will announce proposals to boost job growth and shore up the housing sector. These efforts, even if they could make it through Congress, would help somewhat, but wouldn’t boost economic growth substantially.
Bernanke’s Jackson Hole speech showed that the Fed chairman remains optimistic about the long-term prospects for the economy. Current difficulties are unlikely to affect the long-term growth potential, but he stressed that is “if our country takes the necessary steps to secure that outcome.”
(c) Raymond James
