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China, debt, Federal Open Market Committee, Federal Reserve, Financial Crisis, Great Recession, inflation, interest rates, Janet Yellen, Jobs, leverage, monetary policy, recovery, unemployment, yield, {What's Left of) Our Economy
Reverberations continue from the Federal Reserve’s decision last Thursday to keep the short-term interest rate directly controlled by the central bank at the so-called zero bound – after strong hints most of the spring and well into the summer that the financial crisis-born policy of super easy money would finally start coming to an end. Most of the commentary has focused on the incredibly convoluted rationale for delay presented by Fed Chair Janet Yellen at a press conference held following the “stand pat” announcement. That’s entirely understandable, as I’ll explain below. What worries me even more, though, is how the kinds of financial stability threats that triggered the 2007-08 crisis have apparently dropped off the Fed’s screen completely.
It’s not necessary to believe that the U.S. economy is performing well to be puzzled by the Fed decision – which was nearly unanimous. That’s because the Fed majority itself clearly believes it’s performing well. Here’s how Yellen described the recovery from the Great Recession:
“The recovery from the Great Recession has advanced sufficiently far, and domestic spending appears sufficiently robust, that an argument can be made for a rise in interest rates at this time. We discussed this possibility at our meeting.” A little later, Yellen emphasized, “You know, I want to emphasize domestic developments have been strong.”
The Chair did spotlight areas of continued economic weakness, including sluggish wage growth that was contributing to overall inflation rates remaining well below the levels characteristic of a truly healthy economy; the stubbornly high number of Americans who remained out of the workforce, which takes much of the sheen off of the major reduction seen in the headline unemployment rate; and weakening economies in China and elsewhere abroad, which roiled stock markets in the United States and overseas in August.
But she persisted in describing weak prices as mainly due to “transitory” factors, like the depressed global energy picture and the strong dollar (which makes imported goods bought by Americans cheaper). More important, Yellen repeatedly emphasized points like “I do not want to overplay the implications of these [and other] recent developments, which have not fundamentally altered our outlook. The economy has been performing well, and we expect it to continue to do so.”
Moreover, and most important, the record makes clear that most of the voting members of the Fed’s leadership – the Open Market Committee – “continue to expect that economic conditions will make it appropriate” to raise interest rates “later this year.” All of which inevitably and justifiably has raised the question of why, if most Fed policymakers remain confident that the U.S. and even world economies will remain on a course encouraging enough to warrant slightly tighter monetary policy by year end (i.e., in three months), all except one decided that the conditions of these economies are too fragile now to withstand rates even the slightest bit higher than their current emergency, mid-crisis levels.
Nor is this question answered adequately by Yellen’s claim that it’s crucial not to raise rates too early because such actions could snuff out the recovery’s momentum. Indeed, the Chair herself stated that she buys one of the most compelling reasons to hike sooner rather than later – because the delay between the approval of a monetary policy decision like a rate hike and the appearance of its effects on the economy means that inflation could overheat if the Fed waits too long to step on the brakes.
As a result of these contradictory messages, it’s hard to avoid the conclusion either that the Fed is genuinely confused about the real state of the economy and how it can strengthen it; or that despite its expressed confidence, it still believes that even the kind of minimal rate hike it’s been telegraphing – which Yellen further has intimated will still leave monetary policy “highly accommodative for quite some time” – could bring the recovery to its knees. No wonder investors are confused, too – and increasingly nervous.
And this is only the set of problems on which the economic and financial chattering classes are concentrating. The problem they’ve overlooked for now is even more disconcerting: The Fed’s latest statements about the future of its super-easy money policies contain no mention of the big reason to be genuinely scared of super-easy money policies: They’ve shown a strong tendency to encourage reckless financial practices that tend to end in oceans of tears.
The reason should be pretty obvious, especially since it played out just a few short years ago and nearly blew up the American and global economies. When money is for all intents and purposes free and in glut conditions, incentives to use it responsibly vanish. After all, by definition, it’s no longer precious: If you lose some in a bad investment, you feel confident that more will be easy to get.
At very best, then, nothing like market forces exist to discipline lending and investing, and thereby increase the odds that credit will be used in productive ways that bring the greatest, most durable benefits to the entire economy and society. In fact, too many investors will view the strongest incentives as those fostering a thirst for yield – which drives them into ever riskier assets simply because safer choices offer so little return. At worst, borrowers take on amounts of debt that become ruinous whenever interest rates do finally rise – and threaten the entire financial system and economy.
The Fed’s reluctance to raise rates may in fact stem in part from fears about that latter scenario. It’s true that the economy is less leveraged these days than it was during the previous bubble decade. But that doesn’t mean there’s not a lot of bad, vulnerable debt out there – including that wracked up by the federal government. Worse, precisely because the longer the Fed waits, the more dubious debt will accumulate, the more painful any rate hikes are bound to be.
What’s genuinely sobering about can-kicking by the Fed is that the central bank is structured to be insulated from politics and its obsession with short-run gratification. If the Fed is so reluctant to bite this bullet, and impose some near-term costs on the economy to place it on a sounder footing, where will America’s adult supervision come from?
