Ben Bernanke believes that he and his Federal Reserve colleagues have… “…considerable power to expand aggregate demand and economic activity, even when its accustomed policy rate is at zero,” as it is today. Mr. Bernanke also believes that the economy is growing “not fast enough”… He has predicted that unemployment will remain high for years and that “a lot of people are going to be under financial stress.”
Yet he has been unwilling to use his power to lift growth and reduce joblessness from near a 27-year high… How can this be? How can Mr. Bernanke simultaneously think that growth is too slow and that it shouldn’t be sped up? There is an answer — whether or not you find it persuasive. …
Fed officials are … not so much worried about inflation, the traditional source of Fed angst, as they are about upsetting the markets’ confidence in Washington. Yes, investors remain happy to lend the United States money at rock-bottom interest rates, despite our budget deficit and all of the emergency Fed programs that will eventually need to be unwound. But no one knows how long that confidence will last.
In effect, Mr. Bernanke and his colleagues have decided to accept … high unemployment … for years to come — rather than risk an even worse situation — a market panic, a spike in long-term interest rates and yet higher unemployment. As the last few years have shown, market sentiment can change unexpectedly and sharply.
Still, you have to wonder if the Fed is paying enough attention to the risks of its own approach. … The main historical lesson of financial crises is that governments are usually too passive. They respond in dribs and drabs, as Japan did in the 1990s and Europe did in 2008. Or they remove support too quickly, as Franklin Roosevelt did in 1937, and then the economy struggles to escape its funk.
Look around at the American economy today. Unemployment is 9.7 percent. Inflation … has been zero. States are cutting their budgets. Congress is balking at spending the money to prevent state layoffs. The Fed is standing pat, too. Bond investors, fickle as they may be, show no signs of panicking.
Which seems to be the greater risk: too much action or too little? … In the end, Mr. Bernanke’s … decision comes down to weighing the probabilities and the possible outcomes. Let’s just be clear about the risks and costs that the Fed has chosen. It is … willing to accept a jobless rate of almost 10 percent, with all of the attendant human costs.
“About half of the unemployed have been unemployed for six months or more, which means that they are losing skills, they’re losing contact with the job market,” a prominent economist said at a public dinner in Washington this month. “If things go on and they simply sit at home or work very irregularly, when the economy gets back to a more normal state, they’re not going to be able to find good work.”
That economist happened to be Ben Bernanke, one of the few people with the power to do something about the situation.
I wish I had a better sense why the Fed is so worried about a market panic when there is no evidence indicating that financial markets are near the tipping point. Is there actual evidence that has them worried — if there is, how about sharing it? — or is it just some general sense that we must be getting near the threshold?
I think the economy needs more help, and that fiscal policy is the best choice right now. But given the present inclination toward policy timidity, I’ll take what I can get, and I wish that the Fed would be more aggressive. However it doesn’t look at all likely that monetary or fiscal policy policymakers are going to make any significant moves toward further stimulus, we’ll be lucky if they don’t do the opposite before the economy is ready, so it appears that Bernanke’s forecast that unemployment will remain high for years may come true. But unworried financial markets — and those who benefit the most from them — won’t have to worry about worrying.
Originally published at Economist’s View and reproduced here with the author’s permission.