What Bernanke Should Say About Unemployment: David Leonhardt Gets It Wrong

Dave Leonhardt has a piece in today’s New York Times (“Holding Bernanke Accountable,” no link due to paywall). I’m sad about this piece because Leonhardt is a very knowledgeable guy whom I always enjoy reading. But I find that he has a tendency to fall back on conventional wisdom. At times I feel that his research is limited to what he reads in his own newspaper.

Most of the piece is a recital of stuff that everyone already knows. Leonhardt does touch on the fact that Bernanke will start giving news conferences today, but doesn’t go into what makes this interesting. (There is some new-ish monetary theory out there which holds that public explanations of policy are key to making it work, and for non-obvious reasons.)

Also, we know very well the horrible social and economic consequences of prolonged high unemployment. And, we know the Fed believes inflation is well-controlled. (It is, even if much of the lay commentary on the subject violently disagrees.)

And it’s a very serious misreading of both Bernanke’s personal character and of the nature of his job to suggest that he can (let alone should) steamroll the dissenters on the Fed’s policy-making board, and just step up to be a big-time unemployment fighter.

But forget about all that. The real problem is that Leonhardt assumes there’s something the Fed can do about high unemployment. That’s the part I really wanted him to go into some chewy detail about. But he didn’t.

He says (without links or direct quotes) that Bernanke believes the Fed has the tools to reduce high unemployment. I believe (without proof) that this is a misunderstanding by Leonhardt. Bernanke (and colleagues like Fed vice-chairwoman Yellen) have long insisted that the Fed has the tools to control high monetary inflation, should it appear. But I’ve seldom heard them make a parallel point about unemployment.

Where Leonhardt leaves it is to simply accept the Economics 101 idea that lower interest rates will magically reduce unemployment. That’s not good enough.

Leonhardt suggests that Bernanke could announce a policy of zero policy rates for “several years,” instead of the current formulation (“an extended period,” which has been in place for two and half years with no end in sight). It’s true that a long-duration interest rate is the sum of a series of short-term rates. Making this announcement might have some effect on the middle of the yield curve.

But there are at least three problems with this: first, it would be a minor effect at best. Second, as with QE2, it would have an effect on industrial interest rates only at the high end of the credit-quality scale, where capital is already abundant. This is NOT a solution to the unemployment problem.

And third, the continuation of zero interest rates is creating huge distortions in the normal flow of capital to business and industry. We can’t go even farther in this direction, which is what Dave Leonhardt implicitly suggests. We really have to get off the mat and start into a more normal policy. I do NOT accept that raising the policy rate to, let’s say, 1.25% by the end of this year (the Europeans are already there) will have a significant chilling impact on hiring. I could give you the reasons why I believe this, but that’s another post.

Leonhardt also proposes that the Fed announce a policy of officially tolerating a higher amount of inflation going forward. Trust me, this is not a tiger you want to let out of its cage. You’ll get a big swing in rates in the midcurve and at the long end, with no beneficial impact on economic activity. If Keynesianism is such a good idea, we should be seeing more beneficial effects from all the stimulus we’ve already put on. Instead, we’re getting asset bubbles.

Finally, Leonhardt says that the Fed chairman can simply tell the market that “he considers years of widespread unemployment to be unacceptable.” Let me suppress my true reaction to this idea, and instead ask you how you’d react to that. Would such a statement really cause you to shift your investment and business planning? I didn’t think so.

The bottom line is that the Federal Reserve is not the place to be looking for a way to reduce the extremely serious problem of high unemployment. We should be looking for them to begin a track to normalizing interest rates, congruent with the multi-year goal of allowing the banking system to slowly recapitalize.

And we should be looking to Washington’s other policymakers, in Congress and the Administration, to stop creating the most anti-business tax and regulatory climate that we’ve ever had in this country.



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