The Fed Must Act

As the economy continues to face falling prices and high unemployment, the Federal Reserve is failing to fulfill its mandate to pursue the goals of price stability and maximum employment. It is currently doing far too little to strengthen the economy, and its inaction is both inexplicable and unacceptable. Ben Bernanke has signaled that he will pursue further actions if the economy worsens, but the time to act is now: The economy is already in horrible shape for the average American and has been for quite some time. Through a program of inflation targeting and quantitative easing, the Federal Reserve can avoid deflation and increase aggregate demand, both of which will lead to stable prices and higher employment.

After haltingly climbing out of the Great Recession with the help of the stimulus bill, the American economy stands at a precipice. Unemployment remains staggeringly high at 9.5 percent, and just as discouraging as the dearth of jobs are slowing manufacturing growth and horribly weak home sales. Inflation rates have fallen well below the stated target of two percent. The recession has not ended for many Americans, and the economy stands the risk of worsening again if Congress or the Federal Reserve fails to act immediately to bolster aggregate demand. Congress has shown itself incapable of taking meaningful action due to the nihilistic filibustering of Senate Republicans, and thus the Federal Reserve is left with the responsibility of getting our recovery on track.

Luckily, the Federal Reserve is more than capable of doing so. Joseph E. Gagnon ’81, a former Federal Reserve staffer who is now at the Peterson Institute for International Economics, has argued that creating a program of asset purchases to lower interest rates on bank reserves and Treasury notes as well as establishing a low-interest borrowing facility for banks, would, “according to the Federal Reserve's own economic model…reduce unemployment roughly as much as a two-year, $500 billion fiscal package.” Such a plan is called “quantitative easing,” and it would work because the Federal Reserve would be pumping more money into the economy, making it easier for businesses to borrow. In addition to these actions, the Federal Reserve should establish a higher inflation target, at three or four percent, meaningfully impacting business plans by signifying that the Federal Reserve will continue monetary expansion until inflation reaches its target.

It is not easy to understand the technical aspects behind monetary policy. But the main thing to understand is that right now, not enough spending is taking place in the economy. Businesses are not taking risks to expand, and consumers are not spending. By pumping large amounts of money into the economy through quantitative easing and telling businesses that this will be the case for the foreseeable future through inflation targeting, the Federal Reserve can create strong incentives for businesses to borrow and expand economic activity.

Opponents of such a plan have argued that much of today’s unemployment is structural, and thus Federal Reserve actions can’t do much to increase employment. This common argument claims that the economy has changed, there will be less jobs in certain industries such as manufacturing and construction in the future, and it is impossible to immediately train workers for the new industries to which demand will shift.

Such an argument is intellectually appealing, but fortunately, there’s no proof to back up such a claim. J. Bradford DeLong ’82, the former chair of the Council of Economic Advisers under President William J. Clinton, recently showed that, with the exception of logging, internet, and healthcare, employment has declined significantly over 18 major industries during the recession. DeLong points out that if most of the problem was a “structural mismatch,” then there would be huge declines in the “old” employment areas and booms in the “new” employment areas. But the widespread problem shows that, instead, the employment issue is due to an economy-wide lack of demand, which the Federal Reserve has ample tools to fight. However, if the Fed continues to wait on aggressive action, people who could go back to work right now will lose their skills, and our cyclical employment problem could become a far more intractable structural issue.

Other economists, such as Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City, are, puzzlingly, still anxious about the risks of high inflation, despite the fact that prices have fallen. We are far, far away from rapid inflation that would put savings and the economy at risk, and if expansionary monetary policy does eventually cause rapid inflation, something that definitely isn’t happening right now, the Federal Reserve can reverse course at a moment’s notice.

Finally, many are worried that more aggressive monetary policy might not work. After all, such unconventional monetary policy has rarely been attempted before. But, as Paul R. Krugman has recently noted, no less an authority than Ben S. Bernanke ’75, the chairman of the Federal Reserve, has called out the Bank of Japan for their lack of action during Japan’s lost decade. Bernanke said that “Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.” Now is the time for Bernanke to experiment, be aggressive, and act to get the economy going again. The futures of millions of Americans, people who are struggling to find a job, stay in their homes, or pay for educations, lie in their hands.

Ravi N. Mulani ’12, a Crimson editorial writer, is an applied mathematics concentrator in Winthrop House.

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