Underpaid Genius

The Fed — supposedly about the fray of partisan politics — is as ideologically divided as everything else in America society, and as a result, an upcoming meeting is likely to expose the deepening split over Fed policies, especially with regard to attacking unemployment:

It’s the Fed’s Time to Step Up - Christina Romer via NYTimes.com

The argument for additional monetary action is straightforward. By law, the Fed is supposed to aim for maximum employment and stable prices. But the unemployment rate is 8.2 percent — a good two percentage points above what even the most pessimistic members say is its sustainable level. Moreover, the spate of disappointing data and the deepening crisis in Europe make continued weakness all too likely.

What about the arguments against further action? I don’t think they are convincing enough to win the debate.

Some Fed members contend that monetary policy has already done its share. Other policy makers, they say, need to step up. Both the Fed’s chairman and its vice chairwoman have talked about the need for additional near-term fiscal stimulus as part of a gradual deficit-reduction plan. And many Fed committee members have called for a more aggressive housing policy. Indeed, the Fed raised some hackles in January when it sent an unbidden white paper to Congress, outlining possible administrative and legislative initiatives to deal with problems like foreclosures and underwater homeowners.

I agree that we need more effective fiscal and housing policies. But neither is likely to happen, at least not before the presidential election. As a result, the Fed is the only plausible source of immediate help for the American economy. It was set up as an independent body precisely so that somebody can do what’s right when politicians can’t or won’t.

I find a related argument even more frustrating: that the Fed shouldn’t act because Congress wouldn’t like it and might retaliate. This argument exposes the important truth that the Fed is only as independent as Congress lets it be.

But it also raises a key question: what are Fed policy makers saving their independence for? If rescuing millions of Americans from the torment of unemployment isn’t a reason to risk their independence, what is?

Yes, what indeed?

Christina Romer is dead on when she points out that tax policies of the US Government are not causing businesses and consumers uncertainty about the economy, it’s the economy itself that is causing it.

Christina Romer, Uncertainty Over Bush Tax Cuts Is Not Hindering Recovery

One sign of heightened macroeconomic uncertainty is that the forecasts of respected analysts are all over the map. According to the Survey of Professional Forecasters conducted by the Federal Reserve Bank of Philadelphia, the difference between the highest and the lowest forecasts of unemployment a year from now is about twice as large as it was before the crisis. And forecasters’ reported uncertainty about their longer-run forecasts has shown no sign of improving over the last year. If professional forecasters are unsure of the future, businesses and consumers certainly are as well.

Such uncertainty about future economic conditions can make people hold off on any spending that is difficult to undo. Companies may hesitate to build factories or hire permanent employees until they have a better sense of whether the markets for their products will be strong or weak. Consumers may not buy new cars or build additions to their homes until they are more certain about future employment.

In a paper I wrote many years ago, I found that such macroeconomic uncertainty helped start the Great Depression. The stock market crash in October 1929 didn’t destroy a particularly large amount of wealth or make people highly pessimistic. Rather, it made companies and consumers very unsure about future income, and so led them to stop spending as they waited for more information.

How do we resolve uncertainty about future growth? The Federal Reserve, Congress and the president need to reaffirm that they will do whatever it takes to restore the economy to full health. They could take a lesson from President Franklin D. Roosevelt, who declared in his 1933 inaugural address that he would treat the task of putting people back to work “as we would treat the emergency of a war.”

They should follow up with powerful fiscal and monetary actions to create jobs — coupled with a concrete plan for tackling our long-run budget problems. We are at a critical moment. With many in Congress opposed to further jobs measures and tax increases of any kind, the chances of prolonged gridlock are high.

But such policy paralysis would be a disaster. It would make uncertainty more acute by leaving us to the unpredictable forces of natural recovery and with no prospect of resolving our unsustainable deficits. Aggressive action to restore growth and face up to our long-run challenges is the only true and lasting solution.

Hmmm. I agree we should boost jobs, and more stimulus is needed. The problem is we lack a vision of what the new normal is going to be for America and the world. We aren’t going to get back to 1995, or the earlier post-war boom.

We are moving quickly into a very different world, and so the notion of ‘restoring’ what we had should be dropped. We have to start actively building what we need for 2020, now.