It hasn’t really made the front pages, but the United States recently began carrying out a massive and nearly unprecedented economic experiment, and 2013 looks to be the year when the results come in. The question is straightforward: When the economy is in a deep slump, and the government makes things worse by cutting spending, how much can monetary policy do to help? The answer could reshape the way we argue about economic policy, with profound implications for progressives’ economic priorities — and big opportunities, if they can seize them.
First, a quick refresher. Just like blood carries nutrients to the cells of the body, enabling them to function, the flow of money through an economy enables people to keep buying, selling, and earning incomes. Keeping the supply of money in line with the economy’s changing needs is the job of the Federal Reserve, and normally it does so by adjusting interest rates. Raising them sucks money out of the economy and reins in inflation. Cutting them pumps money into the economy, boosting wages and job growth. And most of the time, most economists agree this is the primary tool for guiding the economy out of its periodic slumps.
But with the 2008 crash the United States entered largely uncharted economic waters, and that agreement blew apart. That’s because the Great Recession was so deep that cutting interest rates all the way to zero still wasn’t enough to boost the economy into a recovery. Economists call it the “zero lower bound.” And while it’s a wall that modern western economies don’t hit often, 2013 will be the fifth year running the United States has been up against it.
So far, progressives have tended to side with economists like Paul Krugman and bloggers like Mike Konczal. They argue that monetary policy is severely weakened at the zero lower bound, when government must take over the job of pumping money into the economy by borrowing and spending. They point out that economic growth was a measly 2.5 percent for 2013’s first quarter, and market data suggests the Fed has failed to convince anyone it’s willing to let inflation get unusually high before it hits the brakes. This despite multiple rounds of “quantitative easing,” an attempt by the Fed to get around the zero lower bound by purchasing huge numbers of financial instruments, thus injecting money into the economy
But economists like David Beckworth and Scott Sumner countered that the economy’s 2.5 percent growth rate stuck around despite blows from multiple rounds of spending cuts, the European crisis, and worries about China. In fact, as Beckworth pointed out, government spending began shrinking by the start of 2010 — yet the economy just kept puttering along at 2.5 percent.
Other points in Beckworth and Sumner’s favor: Before sequestration, the latest round of across-the-board spending cuts, began, the group Macroeconomic Advisors projected growth for the first quarter below 2.5 percent if sequestration didn’t happen. Then the May 3 jobs report, which came out after Konczal’s piece, was so good it was almost shocking. Matt Yglesias and Ryan Avent, two other fans of monetary policy’s salutary effects, pointed to other data sources that suggest the Fed actually has been able to raise long-term inflation expectations.
So this looks like at least a preliminary win for team monetary policy. Granted, the evidence is also very preliminary. Getting economic data in real time is tough, and the full force of sequestration still hasn’t hit. So at a minimum, we won’t have a better idea until at least the second half of this year. But there’s a real possibility monetary policy has put a floor under economic growth — despite the government’s demented insistence on spending cuts and sequestration — and might even be able to do more if the Fed gets more ambitious.
So what if QE3 continues apace, sequestration remains in effect, and economic growth just keeps chugging along around 2.5 percent? What should our take-away be?
Well, Beckworth and Sumner tend to be fans of austerity and small government, for obvious reasons: if fiscal drag can always be offset by monetary policy, why not cut away? But this logic can be turned on its head, because recessions drive up spending and drive down revenues, even when policy itself remains unchanged. Far more than the real-but-modest imbalance between tax and spending left by the Bush presidency, the 2008 crash is what drove the federal government deep into the red. Employment and incomes dropped, so tax receipts dried up. But more people became impoverished and unemployed, thus qualifying for safety net programs, meaning spending automatically increased. Conversely, nothing balances a budget like economic growth. If monetary policy really has the power to guide us back out of even the steepest recession, then that is the way to reduce deficits, not austerity.
Progressives need to make monetary policy something politicians have to answer for. The Fed’s policy is set by the 12 voting members of the Federal Open Market Committee (FOMC), seven of whom are appointed by the president and confirmed by the Senate. This process, and the views on monetary policy of the people who are appointed by it, deserves every bit as much scrutiny from activists, organizations, and politicians as Supreme Court nominations. Republicans and Tea Partiers have relentlessly warn of runaway inflation and denounced quantitative easing, even in the midst of the slump. But outside a rarified group of bloggers, there’s been no serious pushback from the left, or even any real sense that monetary policy is understood as a specific issue worth getting mad about.
Unfortunately, the other five voting members are not vetted by democratically elected officials, and are instead drawn from the Fed’s district banks. That means they come from a social and professional milieu likely to bias them in favor of the worldview of the financial industry, business owners, and the wealthy. Those groups all have vested interests in minimizing inflation while ignoring job growth.
Still, the Fed’s recent announcement — that quantitative easing will be open-ended, with an eye to getting unemployment below 6.5 percent, and allowing inflation to go as high as 2.5 percent — was step in the right direction. But the inflation threshold is too low. Arguably, 4 percent would better balance stable prices with the need for job growth. The Fed is also limiting its purchases to the same amount every month: $85 billion. It’s hinted it might start varying that based on how it reads the economy’s needs, and progressives should pressure it to do so. As Beckworth put it, buying the same amount every month is like putting the same amount of pressure on the gas pedal, no matter what sort of terrain you’re driving over.
Finally, we need a wholesale reform of the way the Fed does business, making the institution more accountable to the needs of everyday working Americans. The simplest way, as Matt Yglesias recommended, would be to cut the five un-appointed members out of the FOMC’s decision-making process. That, or find some other way to bring the entire board under direct accountability to elected officials.
The Fed’s mandate could use a touch up as well. Right now, it merely instructs that inflation be kept down, and employment be kept up. All the Fed’s actual targets are of its own devising, and it can change them as it sees fit. It’s not obvious when economic trends are above or below where the Fed wants them to be, or how it intends to move in response. So Fed watchers pour over its pronouncements in a recurring act of glorified tea leaf reading, parsing the statements for clues of intent or disagreement amongst the FOMC members.
The process is so absurdly vague that, as Konczal noted, the bursts of news from the FOMC’s internal divisions undermine the Fed’s ability to credibly promise sustained monetary stimulus. In the vacuum of certainty, economic players often assume the Fed will put the brakes on the economy as soon as inflation begins to tick up. (There’s that bias in favor of the wealthy again.) The Fed’s targets and its obligation to hit them should be explicitly given to it by law. That could be an explicit inflation target, or a nominal gross domestic product target — which combines the level of inflation and GDP growth — as Sumner and Beckworth have suggested.
Zooming back out to the big picture, the fact is that the political forces pushing for fiscal austerity are the same ones pushing for monetary austerity. Movement in progressives’ favor on one issue is likely to bleed into the other. So while Krugman was wrong to dismiss the case for monetary policy as quickly as he did, his final conclusion was right: we should be throwing every policy tool we’ve got at the economic slump.
It’s just that up until now, progressives haven’t been giving monetary policy the respect it deserves. 2013 is the year they should start.