The Counterfeiter’s Cry: Trust Me!

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Sarah Bloom Raskin is a member of the Board of Governors of the Federal Reserve System. She is a lawyer. She is a banking lawyer and has earned her living for her entire career as a government banking regulator.

On September 26, she gave a Bernanke-imitating speech on the rotten job market: “Monetary Policy and Job Creation.” Does it come as a surprise that she promotes monetary inflation as the solution to unemployment?

She began: “Today I want to discuss how monetary policy can promote the objective of maximum employment in a context of price stability.” She offered a footnote. Just what we need: speeches with footnotes!

“I will set the stage by reviewing current labor market conditions, and then I will talk about the tools that the Federal Reserve has been deploying to foster job creation and promote a stronger economic recovery.” Just like Bernanke! Tell everyone what they already know, and then defend the FED’s policies that, so far, have not worked.

“I will do my best to make these points in plain English rather than economic jargon, but feel free to correct me if I lapse back into it – my children certainly do.” Clever! As if someone is going to raise his hand and say, “That’s obvious nonsense, and you know it.”

So, I will be raising my hand. Frequently.

Her speech begins as a typical Bernanke speech always does: telling us what we already know.

The global economy began slowing in late 2007 and early 2008 and turned downward sharply in the autumn of 2008 when the financial crisis intensified, resulting in the worst recession in many decades. By the end of 2009, the unemployment rate reached a horrifying 10 percent, corresponding to more than 15 million Americans being out of work, with all of the attendant social consequences, including lost income and wealth, mortgage foreclosures, family strains, health problems, and so on.

The key words: and so on. On and on and on: there have been no solutions.

Officially, the recovery from the recession began in the third quarter of 2009, but the pace of recovery has been modest. We have learned from recent comprehensive revisions of government economic data that the recession was deeper and the recovery weaker than had previously been thought. Indeed, the most recent reading on real gross domestic product (GDP) in the United States – the one for the second quarter of this year – still has not returned to the level that it had attained before the crisis, and the increases in economic activity over the past two years have been at a rate insufficient to achieve any sustained reduction in the unemployment rate.

So, 45 months of Federal Reserve policies have produced . . . nothing much. She’s got that right!

The latest employment report issued by the Bureau of Labor Statistics was bleak. Private-sector employers added only 17,000 nonfarm jobs in August, far fewer than the already weak average monthly gain of about 110,000 recorded over the previous three months. The headline unemployment rate was 9.1 percent, representing about 14 million Americans who were out of work in August.

Bleak. Yes. But it gets worse.

Nonetheless, as many families know, the headline unemployment numbers don’t fully capture the weakness in labor market conditions. Beyond the headline number, an additional 8.8 million workers were classified as “part time for economic reasons” in August because their hours had been cut back or they were unable to find a full-time job. In addition, about 2-1/2 million Americans were classified as “marginally attached” to the labor force because even though they wanted to get a job, they had not searched for one in the past four weeks. And almost half of that group – nearly 1 million individuals – have given up searching for employment altogether, because they do not believe any jobs are available for them.

So it is not just those who are currently classified as unemployed who are excluded from work. The underemployed, the marginally attached, and the discouraged – all of whom are concerned about the security of their livelihood, their housing, and the rising cost of living – can speak powerfully to the weaknesses of the recovery.

Thanks. We needed that!

Here she actually says something relevant:

The economic data in this regard correspond to what I have seen firsthand over the past several years. I have traveled to once-robust manufacturing cities in the Midwest and have observed vacant lots, burnt-out factories, metal scrap heaps, and foreclosed homes. I have visited unemployment insurance offices and job training centers, and I have met lots of people who have been out of work for more than a year or two – out of work for so long that some of them are embarrassed to show their resumes to potential employers.

In short, the statistics don’t lie. There really is a disaster out there.

Now, what to do about it? “These circumstances have called for forceful policy measures.” They certainly have. They still do.

I will now talk about the conventional and unconventional actions that the Federal Reserve, for its part, has taken to foster economic recovery and job creation.

Here we come to the sales pitch. But let us not forget: the recession began in late 2007. The FED has made announcement after announcement about its many “tools.” Result: an ongoing disaster. This is the FED’s huge PR problem. Nothing it has done has worked.

She points to the FED’s most recent actions. But she neglected to explain why over three years of ad hoc measures have not worked.

The conventional tool of monetary policy is to modify the near-term path of interest rates. To be more specific, a reduction in current short-term rates and a corresponding downward shift in private-sector expectations about the future path of such rates will tend to reduce borrowing rates for households and businesses, including auto loan rates, mortgage rates, and other longer-term interest rates. This policy accommodation also tends to raise household wealth by boosting the stock market and prices of other financial assets.

There is that word: “accommodation.” What does the new policy do to accommodate anything? Mortgage rates are lower. The housing market still declines. New houses are not being built: 300,000 a year, down from over 1,000,000 in 2005.

With greater household wealth and cheaper borrowing rates, consumers tend to increase their purchases of houses, cars, and various other goods and services.

Not if they don’t qualify for loans. Not if there is no equity in their homes. Not if they don’t want any more debt, which they don’t.

But that does not faze Mrs. Raskin. She has visions of sugar plumbs dancing in her head. The economy should now take off.

In response, businesses ramp up their production to meet the increased level of sales. Moreover, with lower costs of financing new equipment and structures, businesses may be inclined to increase their own spending on investment projects that they might previously have seen as only marginally profitable. In the near term, firms can meet increased demand by resorting to temporary and part-time workers, but over time they have strong incentives to increase the number of regular full-time employees. Consequently, the monetary accommodation leads to greater job creation, though sometimes with substantial time lags.

I see. Businesses will borrow more, especially small businesses that create most new jobs. Problem: so far, they haven’t, despite three years of falling interest rates. The National Federation of Independent Business keeps saying that small businesses are not hiring, have not been hiring, and do not intend to hire.

Then she attempts a bait-and-switch move. She began talking about long-term rates, which have been falling steadily for a year. She then switches to the federal funds rate, which is at zero, and has been, because banks are not borrowing to cover reserve deficiencies. Why not? Because they have $1.7 trillion in excess reserves. Bankers are in panic mode.

The Federal Reserve has used this policy tool aggressively since the onset of the financial crisis. In particular, the federal funds rate target, which stood at 5-1/4 percent in mid-2007, was subsequently reduced to a range of 0 to 1/4 percentage point by the end of 2008, and that target range has been maintained since then.

Notice the passive voice: “was subsequently reduced” and “has been maintained.” This hints that something reduced it and has maintained it. Something has: terrified bankers. She never mentions this possibility.

Indeed, because currency has an implicit interest rate of exactly zero, economists generally agree that a zero interest rate is the effective lower bound for the federal funds rate because investors could simply choose to hold cash if a central bank tried to drive short-term interest rates significantly below zero. In effect, therefore, the FOMC has been deploying its conventional policy tool to the maximum extent possible since late 2008.

The FED’s policy tool has been the equivalent of pushing on a string. The banks are not lending.

If we attribute falling rates to FED policy, then there why hasn’t it worked? The first section of her speech offers evidence that it has not worked. She knows this. So, she invokes the traditional excuse of every apologist for every failed policy. “What if the policy had not been used? Think of how bad things would be.”

Rather than reviewing the vast academic literature regarding the effect of conventional monetary policy, I will simply pose the counterfactual question: What would have happened to U.S. employment if monetary policy had failed to respond forcefully to the financial crisis and economic downturn?

How do we answer this? Why, by using economic models. What models are these? She did not say. Tested for how long? She did not say. Tested by whom? The FED, presumably. How verified? She did not say.

Economic models – the Fed’s and others – suggest that if the federal funds rate target had been held at a fixed level of 5 percent from the fourth quarter of 2007 until now, rather than being reduced to its actual target range of 0 to 1/4 percent, then the unemployment rate would be several percentage points higher than it is today. In other words, by following our actual policy of keeping the target funds rate at its effective lower bound since late 2008, the Federal Reserve saved millions of jobs that would otherwise have been lost. Of course, substantial uncertainty surrounds various specific estimates, but there should be no doubt that the FOMC’s forceful actions helped mitigate the consequences of the crisis and thereby spared American families and businesses from even greater pain.

What does she mean, “if the federal funds target rate had been held at a fixed level”? Short-term interest rates always fall as a recession escalates. They were close to zero in 1933. She wants us to believe that FED monetary policy forced down rates. The recession forced down rates. It is keeping them low.

Given the magnitude of the global financial crisis and its aftermath, the Federal Reserve clearly needed to provide additional monetary accommodation beyond simply keeping short-term interest rates close to zero. Consequently, like a number of other major central banks around the world, the FOMC has been deploying unconventional policy tools to promote the economic recovery.

Wait a minute! What evidence is there that FED’s monetary policies forced down the FedFunds rate? The FED shrank the monetary base in 2010, and the FedFunds rate stayed at zero. It had already been at zero for over a year at the beginning of 2010.

Conclusion: The FED has had no effect on the FedFunds rate.

In particular, we have provided conditional forward guidance about the likely future path of the federal funds rate, and we have engaged in balance sheet operations that involve changes in the size and composition of our securities holdings. Broadly speaking, these policy tools affect the economy through channels that are similar – though not identical – to those of conventional monetary policy. I’ll now spend a few minutes describing how each form of unconventional policy can be helpful in promoting a stronger economic recovery.

She is a true Bernanke clone. Having failed to show that the FED’s previous policies did what they were intended to do, and having admitted that the economy is still in the tank, she now spends lots of time telling people what existing policies will do.

She promises . . . transparency! Does this mean accepting an audit of the FED by the General Accounting Office? Of course not. But transparency nonetheless.

An essential element of good monetary policy is effective communication. In a democratic society, central banks have the responsibility to clearly and fully explain their policy decisions. Good communication is also essential for strengthening the effectiveness of monetary policy. Expectations about the future play a key role in the decisionmaking of households and firms: how much to spend, save, work, invest, or hire. Moreover, when financial market participants understand how the central bank is likely to react to incoming information, asset prices can adjust in ways that reinforce the central bank’s expected policy actions and thereby support the central bank’s objectives. Finally, clear communication can help anchor the public’s long-term inflation expectations and hence improve the extent to which the central bank can take forceful actions to promote job creation in a context of price stability.

I ask: (1) Why wasn’t the FED transparent before? (2) What has changed? (3) When? (4) Why?

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September 30, 2011

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North