Many of this AM’s Fed stories present the argument as to whether the Fed should do more or less to help the still fragile economy. That’s fine as far as it goes, but one important point seems absent to me: there’s not that much more they can do.
They control interest rates. In fact, they only directly control short term rates. Indirectly, through the “twist” and QE, they can target longer term rates. But that’s almost all she wrote when it comes to what’s under their direct control.
Don’t get me wrong—that ain’t nothin,’ especially in normal times. But the price of capital isn’t so much the issue right now. Borrowing’s cheap, it has been for a while, and corporate cash reserves are flush. The missing ingredient is demand. Without that, the Fed is pushing on a string.
Push, they should, and I think Ben and Co. are doing yeomen’s work (and I’m all for them going further). I especially appreciate his clear-eyed look at the real economy, which he continues to see as slogging towards recovery with clear and present downside risks.
One further point. Note that I said “almost” above re the limits of what the Fed can control right now. The other variable I was thinking about there was inflation. If the Fed could generate more inflation, it is said, that would help by hastening deleveraging (since inflation erodes real debt levels) and perhaps move idle capital off the sidelines.
But two problems here. First, I think the Fed’s ability to increase the rate of inflation exists in general and right now, but it is limited. There are economic contraints—inflation today is more a factor of global commodity markets and (very) tight labor markets—and political constraints. Bernanke doesn’t act alone and while he’s been able to stave off the hawks thus far, that could change if he got too aggressive on pushing past their targeted inflation comfort zone (not to mention that he explicitly rejected this option in his news conference yesterday).
Second, the vast majority of workers are already suffering real wage declines. Faster inflation would erode their paychecks further, and that’s another downside to this idea that’s been given too short shrift by folks espousing this strategy.