Originally published in The New York Times December 8, 2013
Saving the Fed From Itself
By MARTIN FELDSTEINCambridge, Mass.
The Federal Reserve is pursuing a very risky monetary policy. Its leaders
the departing chairman, Ben S. Bernanke, and the vice chairwoman, Janet L.
Yellen, whom President Obama has nominated to succeed him are correct
that the American economy needs more stimulus, and they believe that the
central bank, because of political paralysis, is the only game in town. But
if Congress and the Obama administration could agree on a fiscal stimulus
that goes beyond a short-term budget deal, the Fed would not have to take
such risks.
The Feds strategy has been to stimulate the economy by driving down
long-term interest rates by amassing long-term bonds and pledging to keep
short-term rates near zero. A result has been to increase home and stock
prices and, by lifting household wealth, encourage consumer spending.
But the magnitude of the effect has been too small to raise economic growth
to a healthy rate. Home building has increased rapidly, but from such a low
level that its contribution to gross domestic product has been very small.
And the increase in total consumer spending has slowed, despite the soaring
stock market.
The net result is that the economy has been growing at an annual rate of
less than 2 percent. (The latest estimate, that the economy grew at an
annualized rate of 3.6 percent in the third quarter, overstates the
strength of demand because half of that increase was just because of
inventory accumulation.) Weak growth has also meant weak employment gains.
The decline in unemployment, to 7 percent, as announced on Friday, has
largely reflected the decreasing number of people looking for work. Total
private-sector employment is actually less than it was six years ago.
While doing little to stimulate the economy, the Feds policy of low
long-term interest rates has caused individuals and institutions to take
excessive risks that could destabilize the economy just as it did before
the 2007-9 recession. It has pushed up the values of everything from Iowa
farmland to emerging- market bonds. Banks are lending to lower-quality
commercial borrowers. Households are seeking higher returns by investing in
real estate trusts and other high-risk products.
Although the Fed is expected to taper its bond buying, its promise to
keep long-term interest rates abnormally low means that it is unwittingly
encouraging private investors and institutions to continue to take risks.
A bipartisan House-Senate conference committee on the budget is closing in
on a compromise, before the House adjourns for the year, on Friday, that
would limit the across-the-board budget cuts known as the sequester and
prevent another government shutdown. But even this modest deal would not
produce the kind of long-term fiscal policy needed to achieve strong income
and employment growth.
To get the economy back on track, President Obama should propose, and
Congress should enact, a five-year fiscal package that would move the
growth of gross domestic product to above 3 percent a year and focus on
direct government spending on infrastructure.
Although the mission of the military has been reduced with the end of the
wars in Iraq and Afghanistan, there is also substantial need to replace and
repair the equipment of the armed forces. Some of this aid could also
extend to state and local governments.
The total price tag over five years would have to exceed $1 trillion to
achieve the needed rise in the economic growth rate. The lack of
shovel-ready projects is not an excuse for not pursuing this strategy or
for diverting the funds into income transfers and other low-impact spending
of the kind that made the 2009 stimulus so ineffective. It would be better
to spend a year or two preparing for the right kind of spending.
It would be irresponsible, however, to add another trillion dollars to the
national debt without higher revenues or lower spending. Doing so would
frighten financial markets and business executives, reducing private
spending and offsetting the stimuluss benefits.
The key, therefore, is to combine a major short-term fiscal stimulus with
long-term deficit reductions that would cause the ratio of debt to gross
domestic product to begin declining by the end of this decade. Slowing the
growth of Social Security and Medicare and raising revenue by limiting the
subsidies that are built into the tax code could shrink future deficits to
less than 2 percent of gross domestic product, enough to put the
debt-to-G.D.P. ratio on a path back to the 40 percent level that we had
before the recession. That should be the goal for this Congress or the next
one. And it would allow the Fed to stop trying to shoulder with
increasing futility the burden of saving the economy all by itself.
Martin S. Feldstein, a professor of economics at Harvard, was the chairman
of the Council of Economic Advisers from 1982 to 1984 under President
Ronald Reagan.
Received on Mon Dec 09 2013 - 08:06:24 EST
