Morning Must Reads: Monetary Policy Cage Match Duncan Black vs. Charles Plosser

The Associated Press this morning attributes Tuesday's drop in The Standard & Poor's 500 index and The Dow Jones Industrial Average to comments on current monetary policy by Federal Reserve Bank of Philadelphia President Charles Plosser. In The Philadelphia Inquirer, reporter Joseph DiStefano asks a good question:

Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia...said in a speech to investment analysts today that he opposes Fed chairman Ben Bernanke's latest low-interest-rate policy. 

Plosser is more worried by possible inflation, the growing federal deficit, and the Fed's "credibility," than by high unemployment, which he says is slowly coming down. Read his speech here. Highlights: 

"... While unemployment is expected to remain above FOMC participants’ range of estimates of its longer-run level for some time, it is not at all clear that monetary policy can speed up that transition ..."

As in the rest of the commonwealth, the decline in unemployment in Philadelphia has stopped recently. Last July, the unemployment rate in the City of Philadelphia was 11.1%; this July, it is essentially unchanged at 11.2%. High unemployment in the City of Philadelphia will have devastating long-term consequences as John Irons of the Economic Policy Institute explains.

Economic recessions are often portrayed as short-term events. However, as a substantial body of economic literature shows, the consequences of high unemployment, falling incomes, and reduced economic activity can have lasting consequences. For example, job loss and falling incomes can force families to delay or forgo a college education for their children. Frozen credit markets and depressed consumer spending can stop the creation of otherwise vibrant small businesses. Larger companies may delay or reduce spending on R&D.

In each of these cases, an economic recession can lead to “scarring”—that is, long-lasting damage to individuals’ economic situations and the economy more broadly. This report examines some of the evidence demonstrating the long-run consequences of recessions.

In contrast to Plosser, Philadelphia's Duncan Black has an op-ed making the case that there is more the Federal Reserve can do.

The Federal Reserve should give people free money. People would spend this money, increasing demand for goods and services, causing employers to hire additional workers to meet this increased demand and reducing unemployment in the economy overall. 

This probably sounds like a crazy idea, but it isn't. People are a bit uncomfortable with the notion that the Fed can simply create money, but that is what the Fed does. Currently, under a program dubbed "QEIII" (Quantitative Easing III), the Fed is creating money and, instead of simply giving it to people, is using that money to purchase mortgage backed securities in order keep mortgage rates low and increase the supply of money in the economy. This also boosts the prices of these financial assets, providing a windfall to those who own them...

Alternatively, the Fed could finance increased government spending on such things as infrastructure and education, leading to more construction workers and teachers being hired without any need to increase borrowing or taxes. 

Traditionally the Fed has relied on bank shot monetary policy. Expansionary monetary policy involves purchasing US Treasuries from banks, reducing interest rates in hopes of encouraging increased lending for business investment and home purchases. But the ability to encourage increased business investment in the middle of an extended recession is limited, and the demand for new houses has been slow to recover in the aftermath of the collapse of the housing price bubble. Purchasing mortgaged backed securities, instead of Treasuries, targets mortgage interest rates more directly, but with those rates at historic lows already it's unclear that this will have a significant impact.

Charles Plosser has been saying one thing for the last five years — runaway inflation is coming. In fact, in the summer of 2008, before the bottom fell out of the labor market, Plosser was making speeches similar to those he made Tuesday warning about the need to raise interest rates sooner rather than later. Plosser, whose chief argument currently is the Federal Reserve risks its credibility, would be well advised to revisit Aesop's Fable, The Shepherd's Boy and the Wolf.

Duncan Black is equally doubtful that Quantitative Easing III, as announced by the Federal Reserve, will have much impact on the economy. But unlike Plosser, Black understands that our chief problem right now is unemployment and that there is a way the Federal Reserve could do better job addressing it.


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