Let’s talk good ole’ monetary policy today, or more to the point, the limits of monetary policy effectiveness.
I have thought about this topic several times over the past months, but it wasn’t until I read a profile of Jeffrey Lacker, president of the Richmond Federal Reserve Bank, that I found a kindred spirit.
He fears the path the Fed is walking by keeping both short-term and long-term rates at historic lows will only fuel the fires of inflation when, in his words: “We are at the limits of our understanding of how monetary policy affects the economy.”
Well put. There is no GPS to guide us through the darkness.
The Fed has a dual mandate: Job creation on the one hand and price stability on the other. Simply put, job creation means keeping interest rates low so employers will borrow to invest in their businesses and hire more people.
The other hand means raising interest rates to prevent the economy from being stressed to the point that wage hikes and price hikes push the cost of goods and services to such an unmanageable point that producers are squeezed out of business and the economy crashes.
That is Mr. Lacker’s fear.
I do not necessarily subscribe to Mr. Lacker’s pessimism. I do feel the Fed will have the ability to foresee inflationary pressure from many data sets and move quickly enough to control it. The move by no means will be perfect, and the media will wax hysterically enough to scare the public, as usual.
The bigger issue today is the first hand — job creation. Have lower interest rates really worked to create more jobs? I think the answer is yes, but…
In my experience as an observer of monetary policy since the late 1960s, the economy has never been as slow to respond to stimulus. Unquestionably, others have noticed this, as evidenced by Mr. Lacker’s misgivings. No doubt bond traders have as well.
Simply put, monetary policy appears to have hit a point of diminishing returns. Short-term rates cannot go lower, and long-term rates, already held low by the Fed’s bond and mortgage-buying program, are focused on making housing attractive.
For the latter to go lower still would be entering Mr. Lacker’s realm of the unknown, and to that I would agree — there is a significant danger. This lingering feeling of recession then is all about a housing recovery and, in particular, new construction.
It has crossed my mind that the Fed is now just putting on a good face, pretending that additional stimulus in its tool chest will work, if only to contain the level of uncertainty about which businesses and markets are already concerned.
I wonder if some of the governors and other bank presidents, who sit on the Federal Open Market Committee, aren’t already resigned to the prospect that they must keep a steady foot on the gas, try not to allow things to get worse and just hang on until the residential construction ship ever so slowly rights itself.
If you have ever wondered why the securities markets have done well, corporate earnings have been good so far and yet unemployment numbers remain frustratingly high, housing is most of the answer. However, when a universally healthy construction industry finally comes, I would bet against expectations of a return to 4 to 5 percent unemployment rates for the foreseeable future.
In hindsight, by 2007 the swollen housing sector was an accident looking for a place to happen, and I would be remiss to suggest that we can hit such intense construction levels again.
At the bottom of this entire recession was a massive correction in housing prices, more than just disequilibrium between supply and demand.
Here then is something the Fed appears unable to influence. Even fiscal policy, now impotent and reeling under the weight of debt ceiling, deficit spending and debt levels approaching GDP, has had little effect. =Putting a little money in the hands of the public has hopefully helped, but five years on the correction is still painfully slow.
Free-market purists clearly have a poster child. The housing market is on its own; it is a process of time.
Russ Wigh is a professor of business. Email him at rdwigh@bellsouth.net.