The Federal Reserve announced twist #2 yesterday and the reaction from markets, Fed watchers, and pretty much everyone else paying attention was…meh. Even Fed chair Ben Bernanke himself sounded a bit unenthused, noting, as he often has, that monetary stimulus can't do it all, and practically begging lawmakers to give him a hand in jolting the economy.
“Monetary policy is not a panacea,” he declared. “Monetary policy by itself is not going to solve our economic problems. We welcome help and support from any other part of the government, from other economic policy makers. Collaboration would be great.”
Which actually makes a lot of sense. Let me explain.
Monetary policy as implemented by the Federal Reserve is all about interest rates. Their usual operations involve lowering the short-term rate they control when they want to goose economic growth, and raising it when they're worried abut the economy overheating. But they’ve already jammed that rate down to zero a while ago, so now they’ve taken to so-called “unconventional” policies to push down longer term interest rates.
The “twist” is one of those deals. With that move, the Fed swaps out some of their short-term holdings for longer-term debt, which helps to lower longer-term interest rates a bit.
They’ve been at this for a while now and while it’s helped, it has clearly failed to provide the booster-rocket jolt the economy needs to regain full orbit. Fed officials admitted as much themselves yesterday, publishing their scaled-back forecasts for where the think the near-term economy is headed, which is nowhere fast.
Why isn't a policy focused on interest rates having much impact? Because what’s holding back the US economy is not the cost of capital, i.e., the interest rate. Borrowing costs on most types of American debt have been very low for quite a while, in part because of the Fed’s actions, though lately it’s the safe haven of American debt over that of most Eurozone nations that been pushing bond yields down (they move inversely to the price of the debt).
And anyway, U.S. firms are sitting on scads of potential investment income, over $1.5 trillion. Ben can do anything he wants to make borrowing even cheaper, but without healthy consumer demand, it's not going to have much effect. No one’s going to jump into a new project, launch a venture, break out on their own with a new idea if they don’t think they’ll have any customers for it, no matter how cheap you make the loan. Demand, in other words, is the missing piece.
What we need, then, is fiscal stimulus to give Ben’s monetary stimulus some traction. If folks could see a better jobs outlook, if paychecks were a bit more buff, if state and local layoffs would abate, if we could get a couple of months with 200,000 jobs added instead of less than half that—then you’d see businesses popping out of the woodwork, eager to use Ben’s cheap money to capture some of that new demand.
Conservatives have argued that we tried the fiscal stimulus approach back when Obama first took office, and it didn't work. In fact, most independent studies suggest that without it, we'd have been in even worse shape, and that the problem was that the stimulus wasn't big enough.
It’s austerity, both here and abroad—fighting economic weakness with spending cuts instead of temporary increases---that’s strongly dampening the impact of the Fed’s efforts to help.
So Ben can twist all he wants, but without some jobs measures from the Congress, I’m afraid he’s going to be dancing alone.
Jared Bernstein served from 2009 to 2011 as chief economist to Vice President Joe Biden, and as a member of President Obama's economic team. He is currently a Senior Fellow at the Center on Budget and Policy Priorities, and an MSNBC contributor.
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