People who purport to be concerned about the budget deficit really ought to be spending more time worrying about what the Fed is doing. It’s very difficult, after all, to see how we’re going to stick to PAYGO rules in the medium-term if we have persistent high unemployment. That situation is going to lead to repeated unemployment insurance extensions and increased federal Medicaid spending while also producing considerable pressure to avoid tax increases. That means bigger deficits. But if eight percent of the country is unemployed, what are you going to do?
And that’s what the Fed is projecting. But instead of looking at ways to make monetary policy more accommodating, FOMC members seem obsessed with searching for an “exit strategy” even though their analysis of the situation implies they should keep interest rates at zero at least through the end of 2012.
I’ve had some correspondents suggest that the Fed really does want to be more accommodating but there’s nothing more they can do. That’s certainly not the way recent statements have sounded to me. On the contrary, it seems to me that Ben Bernanke and co. are just flagrantly ignoring their actual legal mandate to balance considerations of employment, growth, and price stability. If we had five percent unemployment and five percent inflation instead of 10 percent unemployment and no inflation, the Fed would be freaking out. So why not freak out at 10 percent unemployment? It’s hard for me to avoid the conclusion that social stratification is driving a weird level of complacency among the country’s political and economic elite. Labor market conditions are much better for college graduates than for those without bachelor’s degrees, and everyone who matters has a college degree and probably associates overwhelmingly with people with college degrees.