Saturday, October 3, 2015

Real Economy, Monetary Economy: Rebuild the Bridge

What has happened to the connections between the real economy, versus the Fed's insistence on a diminished economy? Of late, the bridge between the two is all but broken, as central bankers continue to move the goalposts away from aggregate spending capacity.

Scott Sumner reminds his Econlog readers how the Fed is ignoring signals from the market, and devotes the prior post to some of the misconceptions that make it difficult to discern what should be Fed priorities. While monetary policy depends on what happens in the real economy, the real economy also reflects whether monetary policy is willing to faithfully represent aggregate spending capacity. And since the onset of the Great Recession, the Fed has consistently come up short, in doing so.

There is not enough agreement among economists, for the public to understand how much damage the Fed has done to the real economy. And this is no time to be giving the Fed the benefit of the doubt. Even though the real economy involves multiple factors which do not lend themselves to coordination, the coordination of monetary policy could be a walk in the park, by comparison. Much of the present confusion on the part of the Fed has been self inflicted.

Central bankers have particularly distorted monetary policy because of misplaced financial concerns. In some instances, it is as though all sense of responsibility to the public has been lost. For instance, Marcus Nunes highlighted a recent quote from Loretta Mester, at a Boston Fed conference:
If effective monetary policy means taking away the punch bowl just as the party gets going, then effective financial stability policy might mean taking away the punch bowl before the guests have even arrived.
Where to begin? Her reasoning is so poor, that I can only be glad I wasn't in the audience. She voices the sentiment quite clearly: if you're not already on board with the program - so to speak - there are no more seats waiting. Didn't gain economic access at the very moment when it was needed most? Tough luck. Perhaps for the rest of your life.

Does the Fed overreact to events in the real economy, or is it simply beholden to special interests? Indeed, the poor results matter even more than the answer. The Great Recession should have been a time of national soul searching and structural change. It wasn't just a matter for economists and policy makers, because the public needed to reconsider the economic environment which would belong to future generations. The fact this didn't happen is bad enough. But what is worse is that policy makers not only pretended that nothing needed to happen, they are anxious to get on as if everything is normal, now. Unfortunately this comes across as a blatant lie, and it is a dangerous path for policy makers to take.

Doubtless, some think that my suggestions for the real economy are too radical. But no one wishes more than I, that bridges could be rebuilt without completely starting over. If policy makers had admitted early on that change was needed...if the Fed had remembered the hard won monetary lessons from decades earlier, nothing radical would be necessary now. As things currently stand, there are far too many individuals who cannot participate in an economy where people have decided it is not necessary to include them. That's exactly how Loretta Mester's message comes across. And one can only hope, that sanity will return to monetary policy before too many people get on board with that same mentality.

Even now, were the Fed to adopt a nominal level target, it is questionable that many who lost access in the days of the Great Recession, would find a way to participate on the terms now deemed necessary. The radicalism I hold regarding structural change, never should have been necessary to begin with. Like many, I wish that people did not have to suffer so from the Fed's mistakes. I wish that monetary policy could instead have kept the real economy on a strong course. Because now, the real economy cannot be built back, the same way that it was before.

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