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Ben (Bernanke) and the Art of Business Cycle Maintenance

Written by The Two River Times. Posted in Letters & Commentary

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Ben (Bernanke) and the Art of Business Cycle Maintenance

Published on October 19, 2012 with No Comments

By Steven Pressman

Economist John Neville Keynes maintained that while economics was a science, policymaking was an art.

His son, John Maynard Keynes, developed the science of macroeconomics. Due to the work of Maynard Keynes economists know that lower interest rates lead to more borrowing, more spending and more jobs.

The art of monetary policy is much trickier. It involves deciding when to lower interest rates and when to raise them.

Central banks have been given the job of changing interest rates and countering the business cycle, reducing rates to spur growth and create jobs, and raising them to stop inflation.

Although there are no right answers when it comes to policymaking, this does not mean anything goes. Just as there is good art and bad art, there is good and bad policymaking. Central banks can focus too much on inflation when unemployment is the main problem that must be remedied, or vice versa.

Our central bank, the Federal Reserve, appeared stuck the realm of bad policymaking earlier this year.

The U.S. economy is clearly in trouble. Economic growth has slowed to a crawl since early last year, less than 2 percent. Yet 3 percent growth is required just to keep unemployment constant. We must do much better to lower unemployment.

Facing such evidence, Ben Bernanke acted like the proverbial deer caught in a car’s headlights. He blinked a lot as danger approached but did nothing to get out of harms’ way.

There are many reasons for our sluggish economic growth and why unemployment is stuck above 8 percent.

Europe remains mired in recession, suffering double-digit unemployment rates. This keeps us from creating jobs by selling more abroad.

U.S. households, especially homeowners, remain deeply in debt, worried about jobs and losing their homes. They are not about to begin spending anytime soon.

State governments face enormous financial problems. As a result, they are slashing spending, raising taxes or both. This exerts a drag on our economy. Meanwhile, the federal government remains in a state of pre-election gridlock, unable to do anything to help the economy.

Other than the Federal Reserve there is no one around to rescue the economy. Monetary policy is the only game in town.

After hemming and hawing all summer, hinting that they might do something, the Fed finally got things right recently by announcing QE3, or a third round of quantitative easing. This is just a euphemism for printing money, and then using this money to buy bonds and push down interest rates.

After the announcement, there were many naysayers – the same people who opposed a QE3. Larry Kudlow of CNBC and Lou Dobbs of Fox Business News complained that QE3 would generate inflation, would not help the economy, and that it was designed to help get President Obama re-elected.

Taken together, these complaints make no sense. If QE3 will not help the economy and will lead to inflation, it is hard to understand how QE3 will help get President Obama re-elected.

Furthermore, our experience with QE2 belies the main economic grumblings about QE3.

When the Fed announced QE2 in November 2010, critics argued that QE2 would have no impact on economic growth since interest rates were already so low. Others feared sharply rising inflation.

Yet QE2 had exactly the impact predicted by economic science. Lower interest rates reduced the value of the U.S. dollar, increasing our exports. Equity prices rose sharply, raising consumer spending.

Unemployment fell from 9.8 percent in November 2010 to 9 percent in May 2011 when the Fed began winding down the program. All the while inflation remained under control, around 2 percent.

For me, this is a big success.

QE3 has already had a positive impact. In the month after QE3 was announced, the stock market gained nearly 2 percent and the U.S. dollar declined nearly 2 percent against the Euro.

While not the Mona Lisa of economic policies, QE3 will bring a smile to the face of many Americans. Jobs will be easier to find and lower interest rates will reduce the debt burden on US households.

It is hard to understand why anyone would oppose such policies, or what took the Fed so long to do this.

 

Steven Pressman is a professor of economics, finance and real estate at Monmouth University and treasurer of the Eastern Economic Association.

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