Free Market Fundamentalist Opinion

American Monetary Policy Doesn’t Stimulate Job Growth

Unemployment won’t come down as long as the Fed tries to stem the deleveraging process.

In what is deemed (another) unprecedented step on the part of the American central bank to stimulate growth, the Federal Reserve announced on Wednesday that it would hold interest rates near zero and pump money into the economy as long as it takes for unemployment to drop to 6.5 percent.

The Federal Reserve is unique among central banks in that it has a mandate to promote full employment. Still, Wednesday’s announcement is something of a shock because the Fed has never so explicitly linked monetary policy to job growth.

There is one condition: the present policy will be maintained as long as inflation doesn’t go over 2.5 percent. It is unlikely to. Despite the Federal Reserve’s very best efforts, there is a deleveraging process going on — both natural and necessary after financial institutions and homeowners assumed far too much debt in the years preceding the crisis.

The Federal Reserve interprets this deleveraging process as a threat to economic growth, which of course it is, and has pumped some $2 trillion into the economy since the summer of 2007 to stem it. As a result, the process has been weakened and the United States are still waiting for a full recovery.

That recovery cannot happen as long as the banks still have massive debts on their balance sheets which they have no reason to write off because the Fed is giving them virtually free money. The banks don’t use it to invest in businesses, as the central bank would like them to, rather use it to shore up their own balance sheets. As a result, there is no extra economic expansion and therefore no new jobs.

Another natural process that the Federal Reserve has disrupted involves the price of United States Treasury bonds. Not only has the central bank expanded the money supply well beyond what was reasonably required to keep pace with lackluster economic growth; it has aggravated the nation’s debt crisis because the federal government can continue to borrow cheaply and freely to finance high deficit spending which, in all likelihood, it wouldn’t have been able to without the Fed’s help.

In fairness, the sovereign debt crises in the eurozone must also account for the otherwise inexplicable low interest rates on American debt. In the land of the blind, the one eyed man is king. But if assessed dispassionately, the United States’ fiscal crisis is hardly less serious than Europe’s.

Instead of reversing policy, central bank officials this week committed to monthly purchases of $45 billion in Treasuries on top of the $40 billion per month in mortgage backed bonds they started buying in September.

There’s a definition for doing the same thing over and over again and expecting different results.