Politics & Policy

The Bernanke Difference

Why the U.S. isn’t Europe

The mild May jobs report should serve as yet another reminder to President Obama and Congress that the U.S. labor market is suffering a Long Emergency. A smaller share of the adult male population has a job than at any time since the Great Depression. And there’s still a job shortfall of nearly 12 million between current employment levels and the pre–Great Recession job-growth trend. It’s long past time for Washington to launch a full-spectrum response — including cutting investment tax rates and modifying unemployment insurance to support work sharing and relocation to areas of lower unemployment.

But things could be so much worse. For instance: The euro zone is suffering a double-dip recession. The region’s economy has contracted for six straight quarters through the first three months of this year. And euro zone unemployment has risen for 24 straight months and stands at 12.2 percent. “It still looks highly probable that the [jobless] rate will reach 12.5 percent in the latter months of 2013, and there is a grave danger that it could continue rising into 2014,” consultancy IHS Global Insight predicts.

So we have an intriguing natural economic experiment. Two large, advanced economies are both undergoing fiscal austerity from spending cuts and tax increases. But one is recovering, though glacially, from a previous downturn; the other is deteriorating.

The likely difference: monetary policy. Not only did the Federal Reserve slash short-term interest rates to nearly zero way back in 2008, but it has also embarked upon a massive bond-buying program known as quantitative easing. The European Central Bank, however, only last month cut its key interest rate to 0.5 percent, still higher than the Fed-funds rate. And the ECB’s “unconventional” monetary policy has been far more modest, with bond purchases less than a tenth the size of the Fed’s. Its goals have also been more limited: stabilizing southern Europe’s debt markets and avoiding a financial crisis. At a recent speech in Frankfurt, Germany, St. Louis Fed president James Bullard said that unless Europe adopts an aggressive bond-buying program, it risks an extended period of low growth and deflation like what Japan has experienced since the 1980s.

The results of this natural experiment make a powerful case that some very smart, center-right economists, including John Taylor and Alan Meltzer, are mistaken in arguing that the U.S. recovery would be stronger if the Fed had not engaged in quantitative easing — and that the Central Bank should immediately cease and desist. “At some point, the Fed must realize that its current policy is not working,” Meltzer wrote recently. But how would the U.S. economy be doing without the Fed’s massive monetary expansion? That unemployment has not fallen further does not suggest monetary policy has been unsuccessful. “To assess that question, we need to have the counterfactual,” says University of Mississippi economist and Everyday Economist blogger Josh Hendrickson. JP Morgan economist James Glassman made a similar point in a research note last week: “Assertions that large-scale asset purchases have done little for the economy, or at best suffered from diminishing returns, have no credibility because they make no attempt to assess what would have occurred in their absence.”

The counterfactual? How about Europe, its inflation-hawk Central Bank, and its never-ending recession? And even a cursory look at the data shows each of the Fed’s bond-buying episodes correlates with higher interest rates and stock prices, reflecting increased economic optimism. So the Fed has outperformed the ECB — which is, strangely, the model central bank for some Republicans — though it could be doing more by making it crystal clear that it will not scale back its bond-buying until the economy returns to a pre-recession nominal-GDP trajectory. Indeed, that message alone might do more to change consumer and investor and business expectations than the bond-buying itself. “The fact that the economy continues to modestly plod along . . . is a testament to what the Fed is doing with QE3 and what it could be doing — fostering a robust recovery — if it truly unloaded both barrels of the gun,” says Western Kentucky University economist David Beckworth, who blogs at Macro and Other Market Musings.

Please fire away, Mr. Bernanke!

— James Pethokoukis, a columnist, blogs for the American Enterprise Institute.


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