Why is the Fed still in crisis mode …
… when the economy is no longer in crisis?
by James Paulsen, Wells Capital Management
With the release of the FOMC statement today, the Federal Reserve continues to suggest its current accommodative policy approach will be maintained until the unemployment rate reaches 6.5 percent. A good case can be made for continued help from the Fed. After all, real GDP growth is still too slow and the unemployment rate is still too high to consider monetary tightening. However, the most important question isn’t whether the Fed should remain accommodative, but rather why is the Fed still employing an unconventional, crisis-like monetary program in an economy which clearly is no longer in crisis? U.S. household net worth has been almost entirely restored, the household debt service burden has fallen back close to record lows, job creation has recently been persistent, the unemployment rate is declining while the labor force grows, banks are no longer hanging by a thread and weekly bank loans have been trending steadily higher, foreclosures have slowed markedly, housing activity and home prices are finally rising, consumer confidence is near a five-year high, a massive municipal debt failure is no longer anticipated, corporate profits are at an all-time high, and the U.S. stock market is nearing a new record. Where’s the crisis?
In what was widely perceived as the worst recession in post-war history, the initial policy response to the 2008 economic crisis was understandable and seemed appropriate. Today, however, when the economic crisis has ended, continuing an unprecedented “shock & awe” monetary policy appears increasingly absurd. Despite being in the fourth year of a (subpar perhaps but still) recovery, the Federal Reserve continues to employ policies never before used and which normally would be reserved only for times of national economic emergencies (including maintaining a zero short-term interest rate, massive $85 billion monthly bond purchases of both Treasuries and of alternative mortgage assets, and an uncommon verbal commitment to keep interest rates low into the future).
Most everything has moved on from the crisis except for the Fed. Today, while challenges still exist, the economic reality is far better than it was in 2008 or 2009 when the crisis first began and yet monetary policy is more unconventional and more aggressive than ever. Is this really the best posture for the Fed? We think it is fine for the Fed to maintain an accommodative stance until real GDP quickens and until the unemployment rate declines to a more acceptable level. But it also seems appropriate for the Fed to “normalize” policy in line with an economic recovery which has already somewhat normalized from its earlier crisis. By persisting with a monetary policy based on a “crisis-mentality” in a recovery no longer in crisis, isn’t the Fed perhaps risking the likelihood of starting yet another crisis—perhaps an inflationary crisis?
We think investors and private economic players would respond favorably to a show of “confidence by the Fed” if they announced the beginning of a process of “normalizing monetary policy.” They could maintain a healthy growth in the U.S. money supply and reassure investors they would not allow interest rates to surge higher, but they also could begin to drain excess bank reserves and support some rise in money market interest rates back towards normal.
While problems and risks still exist throughout the economy and the performance of the overall recovery is still not acceptable, U.S. banks are no longer in a crisis, nor is the U.S. auto industry, most municipalities, most households, the business community, or the financial markets. If the overall economy is no longer in a crisis, isn’t it time for the Fed to also employ a “non-crisis” policy? Just a thought for Fed Day!?!
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