Fed Failure

Paul Krugman is apoplectic. He is right to be. He even has this nifty ‘cloud’ of the words used in Bernanke’s speech and press conference to back up his assertion that the Fed has taken its eye off the ball. I would give him credit for that cloud had my friend Stephan not brought a similar one to my attention two weeks ago. So kudos to Stephan: you beat Krugman to the punch.

But what of that Bernanke speech? Why is Krugman right to be mad?

Simple: the Fed has two goals in its charter. One is to keep prices within the bounds of reason. This means bottle up inflation when it seems like getting out of hand. Or get rid of it when it is already out of hand in the manner of Paul Volcker’s famous attack that precipitated the 1980 recession. Volcker’s method may have been draconian, but it set the stage for thirty years of quiescence.

The second goal is to foster full employment. Whatever that is.

So. How is the Fed doing with respect to its goals?

Not very well. Badly in fact.

This is the setting within which Bernanke made his views known at his press conference this week: we have around 14 million people unemployed, and millions more underemployed – working part time when they would prefer to be full time. Plus we have core inflation below the Fed’s target range.

So the Fed is failing on both its goals. Having inflation too low is just as bad, in many ways worse, than having it too high. And we all know the economy is a very long way from full employment.

Given this failure, a reasonable guess would suggest plenty of discussion about further efforts to boost the economy, encourage hiring, and even push up inflation.

This would be wrong. Very wrong.

The entire preamble by Bernanke went in that direction, getting our hopes up that he was going to prolong the Fed’s easy money, and perhaps, launch QE3. Then, suddenly and out of nowhere, he vectored off into how urgent it was to watch inflation and begin the exit from easy money. Heck, the only thing he didn’t do was raise rates.

This was, and is, absurd.

The economy is still mired in no-man’s land. Neither strong enough to encourage investment and expansion by business, nor weak enough to stop the hawks from whining about their fears of inflation. We are truly stuck. Because of this, each side in the debate is able to cancel the other out and our policy makers stumble about trying to appease the more vociferous. That would be the hawks. Apparently we need a cataclysm to persuade the Fed to take a look at its charter and to follow through with expansionary policy. Barring such a disaster they are content to appear ‘serious’ by running on about the woes of inflation, and the horrible things the bond markets will do if we don’t act like grown-ups. Which in this case means being stupid and pretending inflation is high enough to cause disruption to our supply of credit. Even if it’s not.

My father had useful words for this kind of nonsense. Unfortunately I cannot use them in public.

One of them describes Bernanke really well.

I have said this before, but it bears repeating: for some reason that is not at all supported by facts known to me, our leadership – in both business and politics – has decided that it is time to move on from solving the problems caused by the crisis, and look to the future. They have begun to squabble aboutsolve longer term problems, whilst leaving the shorter term ones to resolve themselves. They have abandoned the unemployed and have become obsessed over something that has no manifestation here on earth, but which exerts an incredible hold over their imaginations.

Some of them never did care. They are the ideologically driven ones who despise all aspects of government intervention in the economy. They think markets fix themselves, and that we should allow the disease to run its natural course. Even if we have discovered the cure. Next time one of them is sick we should remind them that the human body is also fairly adept at fixing itself, so they should grin and bear all the consequences of fever, and so on. After all, why truncate the full cycle of nature by resorting to man-made palliatives? It’s healthier to avoid intervention. So they say.

That is, of course, hogwash.

It’s actually mean spirited and anti-social.

But what of those who are not motivated by anti-social ideology? They know we have the cure. Why not use it?

Fear. They don’t want to be seen as frivolous, or non-serious. And right now ‘serious people’ know – they just know and don’t ask how – that there are awful consequences lurking around the corner waiting to undermine us. These are the monsters in the closet we all used to fear as children. They go bump in the night. The bump is imagined to be so big that we need to abandon our weak and poor and cave into to the bankers and traders who are sending a very strong message that we need to rein in spending and curb imminent inflation. Or at least the fear crazed think that’s the message.

In truth, the message is so weak, if it exists at all, that it scarcely registers. Standard and Poor’s made some noise about the debt, but it had no effect on interest rates. The markets yawned. If there are fears of inflation out there in the markets they are very well hidden. Besides, the biggest mover of inflation, the thing that can set off the dreaded inflationary spiral we all fear most is wage costs. Not just absolute wages, but wage costs. This morning we heard that the wage cost index rose – roll the drums – 0.6% in the first quarter. Of that paltry number over half came in the form of rising health care costs. Less than half came from actual wages going up. Wages are going nowhere. Hence inflation is going nowhere. Yes, there are concerns over raw materials, food, and oil. But those either form a small part of the overall cost base, or are highly volatile and will ebb once we experience a good harvest or quiet in the Middle East. Those may be big “ifs”, but they are not so permanent as to justify abandoning our poor, weak, or unemployed. Besides, as I have said before, a little burst of inflation, say at about 4%, would do us all good. It would lower real interest rates and ameliorate debt burdens. Two things we need right now. But, no, that’s not being serious.

So the fear factor, the need to appear serious, is now so pervasive that even Bernanke cannot resist the hawks. He is being bullied by superstition and those funny sounds in his closet. He is seeing ghosts and hiding under his pillow.

Too bad. There are a whole lot of real grown-ups who need his help.

Giving the Fed its deserved failing grade is scant compensation for those folks. They need help. They won’t get it. The Fed is acting grown-up. Which in our topsy-turvy world is actually much like a frightened child.

Don’t say “BOO” too loudly, the Fed may raise interest rates.

Fed failure indeed.