The economy is recovering — but it isn’t. This is essentially the Federal Reserve Bank of San Francisco’s (FRBSF) most recent mixed message on the state of the economic recovery.
A rather stale and well-tread outlook on the economy and monetary policy is offered in the FRBSF’s July Economic Letter, as sound and reasonable as it is. Essentially, the economy is recovering, but at a snail’s pace. Here are the reasons why:
- government fiscal policy (raising taxes, cutting spending) is threatening continued growth; and
- instability in the Eurozone, coupled with stagnating austerity measures, continue to put the brakes on the U.S. economic recovery.
While the FRBSF insists the economy is growing, inflation is stable and near target and GDP is set to grow around 2%, they also admit that this growth is not robust enough to meet their mandate of full employment and stable pricing.
What’s to be done? A continuation of Operation Twist, the Fed’s creative bond buying program designed to lower long-term interest rates, and another possible round of quantitative easing to inject more cheap cash into the banking system and encourage consumer lending.
first tuesday take
This all sounds very reasonable. Perhaps we are beginning to accept it because we have been hearing it for years now. Yes, fiscal policy is a problem that needs to be worked out in order to create confidence both for institutional investors and for the average consumer and homebuyer.
We know the Eurozone is an austerity-inflicted mess; it will continue to be a mess for quite some time, years even. We also generally agree that keeping long- and short-term interest rates low (read: zero) is a matter of helplessness, as they most likely need to be at negative rates as is now the case in Denmark.
However, it just so happens that all of this has added up to where we are now — the economy is recovering, but it isn’t.
We have said it before and we will say it again — it’s the demand stupid! Rather than maintaining its heretofore stalwart focus on keeping inflation at 2%, the Fed needs to let irrational inflationary fears slide for now and keep pumping until they have fully stimulated demand.
Job creation is their primary task, tempered in its enthusiasm only by rising inflation. The disinflation the Fed has now engineered suggests they feel pressure to appear apolitical, which in itself is politically motivated inaction.
It can be done; and it can be done without waiting on Congress to get its act together, irrespective of the 2012 presidential election and notwithstanding how much Europeans hate Germany’s forced austerity program. For the Fed it means print, baby, print! and perhaps even considering going negative on short-term rates for a pre-determined period to force lenders to lend.
Lenders, it seems, are still unable to realize a sufficient profit margin on their free cash from the Fed. Maybe if the Fed pays them to lend, they will open the liquidity floodgates. This is a tough pill to swallow, to be sure, but it must be done.
The fact is, the Fed isn’t doing enough to create jobs and Ben Bernanke, being the bearded scholar on Japan that he is, knows this better than anyone.
re: “The Outlook and Monetary Policy Challenges” from the FRBSF