The Federal Reserve has multiple options going forward in regards to policies that can help the economy grow and create more and better jobs. These option range from delaying the current tapering of quantitative easing (QE) to a regime change where NGDP or price level targeting are implemented to fulfill the Fed mandate of maximum employment, stable prices and moderate long-term interest rates.
There has been deserved criticism of the FOMC over their tapering and eventual lift-off (raising the interest rate). The FOMC has not addressed its mandate for promoting full employment and has erred by focusing on the threat of future inflation. Money has been and is too tight (i.e. there is not enough moneta available in the market which keeps unemployment high and inflation low). Tim Duy, a former economist for the Treasury Department and Professor at the University of Oregon laments that the Federal Reserve is putting the US economy on a slower growth path. In regards to employment he states that, “To be sure, arguably there still remains substantial slack. The failure of wage gains to accelerate is consistent with that story. But the Fed seems content to use that story only to justify its current policy path rather than justify an even easier policy to more quickly reduce slack.” Scott Sumner cites Tim Duy and his conclusion as being similar to his argument that money is tight and Milton Friedman’s assessment of Japan in 1998 that had a similar economic situation that the United States has today.
Japan has learned from its mistakes and has heeded Milton Friedman’s advice more than the Federal Reserve. As of the first quarter 2014, Japan’s GDP grew 1.6 percent from the previous quarter which annualizes a growth rate of 6.7 percent. While Japan grows the Eurozone grew only 0.9 percent in the first quarter and the United States struggles even more with an estimated decline of 1.9 percent. The weak first quarter has caused the IMF and Federal Reserve to revise downward America’s projected annual GDP growth between 2.0 to 2.3 percent from 2.8 to 3.0 percent. Japan’s rapid growth has shown that Abenomics—with the Bank of Japan implementing more aggressive QE—can indeed spark more rapid growth when sufficiently committed to. Japan began its current QE policy in April 2013 and has set a goal of reaching their 2 percent inflation target in two years (2015). This is much more aggressive than the Federal Reserve that set a 2 percent inflation target in 2012 and has treated the target as a ceiling rather than a goal. Chair Janet Yellen’s statement from June 18, 2014 shows the Fed’s position stating:
“Inflation has continued to run below the Committee’s 2 percent objective, and the Committee remains mindful that inflation running persistently below its objective could pose risks to economic performance. Given that longer-term inflation expectations appear to be well anchored, and in light of the ongoing recovery in the United States and in many economies around the world, the Committee continues to expect inflation to move gradually back toward its objective. The Committee will continue to assess incoming data carefully to ensure that policy is consistent with attaining the FOMC’s longer-run objectives of maximum employment and inflation of 2 percent…
FOMC participants continue to see inflation moving only gradually back toward 2 percent over time as the economy expands. The central tendency of the inflation projections is 1.5 to 1.7 percent in 2014, rising to 1.6 to 2.0 percent in 2016.”
These expectations show that the Fed is comfortable taking a much slower approach that means that the US economy will not return to normal until 2016-17 at the earliest and possibly not reach full-employment until late 2019. Taking over a decade to recover from the recession is unacceptable yet the Fed seems resigned to accept such a slow recovery.
Whatever the cause of tight money, it has prevented banks from sufficiently lending to businesses and home buyers to ignite enough growth to rapidly converge on full employment. One policy change that the Federal Reserve has considered is to implement a negative interest rate on overnight deposits. This negative rate would put a penalty on banks that use the overnight market and push banks to lend more of their money rather than hold onto it and take a penalty. As of June 5th the European Central Bank (ECB) is the first of the major central banks to institute a negative interest rate in hopes of preventing deflation and kickstarting the European economy. QE created a larger monetary base and the Fed is trying to find a way to get banks to provide loans with the money they received from the QE purchases. A negative interest rate may be one way to spur more lending and provide the economy the boost it needs to get out of the slow growth path.
Going forward, if the Fed decides, it has multiple options that could make Fed policy more stabilizing and aggressive in dealing with the slow recovery. Two similar options are price level targeting or NGDP targeting rather than the 2 percent inflation targeting that is occurring now. These targeting mechanisms adjust to take into account past fluctuations making future price levels more predictable. This gives the Fed a better chance of achieving a targeted medium to long-run average. For example, if inflation was low last year the Fed would implement stronger policy to push inflation above the expected medium to long-term average to ensure that these targets are met. In the current system the Fed ignores what happened last year and attempts to get inflation to reach the targeted rate. In our current situation, with either of these policies, the Fed would be more willing to increase inflation to reach their goals which would bring down the unemployment rate more rapidly and help the economy grow faster.
The Fed is an institution that is slow to change and rightly so; as changes, if done in a non judicious manner, could crash the economy. Our leaders and the people have a role in influencing the internal debates of the Fed and getting answers for why the policies implemented are the best way forward. The Fed has plenty of options to take on the slow recovery and employment slack yet half of our leaders are too concerned with phantom inflation to even consider these options. Americans need to let their leaders know that the slow recovery is unacceptable and taking another five years to reach full employment is a disaster that will hurt the future of American prosperity while needlessly damaging lives now. With a more vocal electorate and strong alternatives we can work to change the internal debate of the Fed and help fix the jobs.
Photo Via: Federal Reserve Flikr: Federal Open Market Committee (FOMC) participants gather at the Marriner S. Eccles