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June 02, 2012 8:34 AM #FedFail?

By Matthew Zeitlin

If you want a detailed argument for how the Federal Reserve has failed the American economy because of its timidity in considering and implementing unconventional policies against a background of rock-bottom interest rates and persistently high unemployment, read Ryan Avent’s passionate, informed screed for the Economist. If you want a more neutral reading on the Fed’s options, read Justin Lahart in the Wall Street Journal.

What’s interesting about Avent’s wonk-and-brimstone and Lahart is that both pieces start from a similar point: the Fed has been willing to step in with an unconventional policy measures when the economic picture has gotten particularly bad. But whereas Avent sees excess caution leading to calamity (“the Fed bears the greatest responsibility for America’s pathetic recovery”), Lahart voices the Fed’s possible concerns with more agressive policy, especially raising expectations of future inflation:

First, take targeting higher inflation. If investors believed the Fed would succeed, 10-year Treasury yields would likely surge, undermining a recovery. Capping yields in such a scenario might require an unfeasibly large expansion of the Fed’s balance sheet and scare off foreign creditors like China

To understand the debate Lahart is rehearsing, you have to understand one proposed unconventional policy measure.

Avent and other Fed-critics often call for using the “expectations channel” in order to stoke the economy. What this means is that the Fed would state that, as a matter of policy, it expects inflation to be a percentage point or two above its current two percent target and will engage in policy actions in order to get inflation to this higher rate. The idea here is that when the Fed is unable to stimulate the economy through cutting interest rates (interest rates directly controlled by the Fed are already basically at zero), it can resort to announcing — and affecting — future inflation. And since you don’t want to bet against the central bank, this gambit may very well work.

Now, the objections Lahart lists out make sense if you don’t see raising inflation expectations as either a policy that is likely to be effective in bringing down unemployment or if you don’t think that a possible decrease in unemployment is not worth the risk of expanding the Fed’s balance sheet (having the Fed buy more bonds) and all the attendant controversies.

What is so frustrating to Avent and many others is that the possible downsides of more agressive Fed action are exactly that, possible downsides. And all the while, unemployment remains stubbornly high and does not appear to be coming down anytime soon. In the eyes of its critics, the Fed has gained credibility, but a kind no one would actually want.

Comments

  • Gandalf on June 02, 2012 10:07 AM:

    Ooooooh my head! It's so complicated and I'm an american and by god all that complicated shit just interferes with my tv watching because I can't concentrate if I have to think.Ooooooooooooooh.

  • DAY on June 02, 2012 10:09 AM:

    Stalin supposedly said, "The death of one is a tragedy, the death of a million is a statistic."
    For someone out of a job, that is a tragedy. And, for him, inflation/deficit/the interest rates on T Bills are statistics.
    -As is that unemployed individual, to those concerned about the trio above. Because that trio of numbers affect the 1%ers livelihood. Besides, "workers" are fungible!

    fungible: goods contracted for without an individual specimen being specified, able to replace or be replaced by another identical item; mutually interchangeable.

  • menthol on June 02, 2012 10:23 AM:

    I agree that the Fed could possibly be (even) more stimulative, but the bottom line is that it's really unfair that all of this falls on Bernanke's head. The MUCH bigger failure is on the fiscal side, due to GOP intransigence and sabotage. Failure to spend on badly needed infrastructure is a mortal sin (and a moral one); meanwhile, the Fed doesn't have nearly the ammo that Congress does and has used many of its bullets already.

  • Neildsmith on June 02, 2012 10:23 AM:

    In my little world there is, thankfully, no recession. No one I know is umemployed - not family or friends. No one is losing their home (really!).

    I get that all the data says there is massive suffering and that, as a result, we must pull out all the stops to deal with it. I really do get it. But the fact that this suffering is invisible to me personally is telling. I'm quite certain there are millions of middle class people just like me who are scratching their heads wondering what all the fuss is about.

    And that, my friends, is why the FED isn't doing anything.

  • stormskies on June 02, 2012 10:27 AM:

    Gandalf is right........this is just way to much for the typical American to even consider .. let alone the corporate media who is invested in the invention of narrative and story lines that serve the corporate/ repiglican's interests and agendas.

    And, of course, those story lines and narratives have zero to do with the actual reality of anything. So the typical American then accepts or 'believes' the corporate generated narratives and story lines which are so much easier to integrate because they are typically one liner slogan making that is repeated over and over till those pathetic slogans become the actual reality of the vast majority of our stupid, bordering on cretinism, fellow citizens.

    Nope, time for another hamburger and watching some stupid tv show ....... now that is what is important.

  • Christiaan on June 02, 2012 1:35 PM:

    And it is not just that possible downsides are indeed just "possible", but it is also true that the (remotely) possible downsides (rising inflation and rising interest rates) are something that the Fed knows very well how to deal with and has a very good track record in dealing with. On the contrary, the downside to the other side (i.e. going on like now or even lowering inflation in a zero-interest regime) is something that the Fed does not really have much confidence and experience in dealing with.