Tags: Fed | monetary | policy | employment

Monetary Policy Has Run its Course

By    |   Friday, 26 September 2014 07:50 AM EDT

Further monetary expansion can actually hinder our economy. The sooner the Federal Reserve realizes this, the better off we will be.

Despite a dramatic decline in long-term interest rates, from 18.4 percent on a 30-year mortgage in 1981 to 4.1 percent today, the turnover of the adjusted monetary base — or monetary velocity — has fallen to 77 percent, a historic low.

The adjusted monetary base represents the currency in circulation and lendable funds held by banks at the Fed.

More alarming, monetary velocity has remained dangerously low in the face of a huge expansion in the Fed's money stock, from $875 billion in September 2008 to $4.1 trillion in September 2014, an increase of nearly 370 percent in six years.

The beginning of this buildup of bank excess reserves coincided with the Lehman Brothers bankruptcy of Sept. 15, 2008, the largest U.S. bankruptcy by far in history. At the time, Lehman had assets of approximately $639 billion and debts of $613 billion. For perspective, the next largest bankruptcy was that of WorldCom in 2002 — it had $104 billion in assets, one-sixth that of Lehman.

Low interest rates and expansive monetary aggregates have not manifested in significant increases in bank lending, employment and income. For some time, it has been readily apparent that more expansionary monetary policy will have little impact on promoting economic growth.

In fact, "these remedies" may further exacerbate the underlying causes by encouraging financial speculation and creating additional wealth inequalities. As wealth disparities rise, consumption and investment as a share of the economy tend to decline, causing greater unemployment and lower incomes.

The Fed is tasked with promoting price stability. However, it does not have the tools to manage unemployment, as dictated by the dual mandate in the late 1970s.

Fed Chairman Janet Yellen correctly assessed the current situation when she said, "There are still too many people who want jobs but cannot find them, too many who are working part time but would prefer full-time work and too many who are not searching for a job but would be if the labor market were stronger," according to The New York Times.

Charles Plosser, president of the Philadelphia Fed, and Richard Fisher, president of the Dallas Fed, also believe the Fed has been too accommodative for too long, which tends to be a recurring problem. Unfortunately, they are scheduled to retire shortly.

Narayana Kocherlakota, president of the Minneapolis Fed and the youngest member of the policy-making Federal Open Market Committee, is perhaps the strongest proponent of expanding the stimulus program of the Fed.

It should be noted that Kocherlakota was quoted as having said the following: "I believe that during the last financial crisis, macroeconomists (and I include myself among them) failed the country, and indeed the world."

He added, "Of course, from a longer view, macroeconomists let policymakers down much earlier, because they did not provide policymakers with rules to avoid the circumstances that led to the global financial meltdown."

The Fed has recently recognized it may have shortcomings in dealing effectively with unemployment, especially since it does not have an accurate and comprehensive understanding of the labor market.

To her credit, Yellen has been recommending more macroprudential regulation before embarking on greater monetary stimulus. This fiscal supervision and regulation would promote greater capital requirements and avoid massive sell-offs to meet obligations.

In my view, much more needs to be done on the fiscal side. Tax reform is front and center in this equation. My proposal would increase investment, employment and income while keeping a lid on inflation and balancing the budget at current spending levels.

Monetary policy has run its course. It's time to turn our focus elsewhere.

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Further monetary expansion can actually hinder our economy. The sooner the Federal Reserve realizes this, the better off we will be.
Fed, monetary, policy, employment
Friday, 26 September 2014 07:50 AM
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