Thursday, July 17, 2008

Stronger social safety net could free Fed, says Frank

From today's Wall Street Journal!
July 16, 2008, 2:46 pm

There are many reasons why the Federal Reserve is boxed in on monetary policy, but Rep. Barney Frank Wednesday found a new dimension to the central bank’s dilemma.

It’s a widely held view that Chairman Ben Bernanke and his fellow policy makers are facing a worrisome mix of tepid growth, troubled financial conditions and rising price pressures, with few attractive options for fixing this toxic environment. The weak economy and market tumult call for rate cuts. But the energy-driven price gains and deteriorating expectations for future prices call for rate increases.

That’s left the Fed stuck at its current rate of 2%, very likely for an extended period. But according to Frank, if the U.S. social safety net weren’t so miserly, the Fed might actually have more room to take on inflation.

In response to testimony on the economy by Bernanke Wednesday, the Massachusetts Democrat said current conditions suggest “we have reached a limit” on what the Fed can do with interest rates. He acknowledged arguments on both sides of the rate change calculus. But perhaps more importantly, he reckoned the Fed is now losing some of its ability to get inflation under control because it would cause a politically unpalatable worsening in already bad economic conditions. “The relative insufficiency of our social safety net vis-a-vis what you have in Western Europe constrains monetary policy,” Frank said.

If the U.S. offered more support for the unemployed and displaced, “the Federal Reserve would then be freer…to slow down the economy in the knowledge this would not have a disproportionately negative effect” on the working population. That part of the population is already losing notable ground in economic terms, he said.

Frank’s point went to the short-term trade off that monetary policy makers always face. Rate increases aimed at quelling inflation do the deed by slowing the economy. But growth is already teetering, and the economy has lost half a million jobs thus far this year. Rate increases now come with prospect of real economic pain. But on a longer-term horizon, most policymakers agree that if inflation isn’t controlled, sustainable growth, including job creation, is hard to achieve.

That discomfort has already led to an unusual level of discord in the public comments of officials. Dallas Fed President Richard Fisher has opposed all of the Fed’s rate cuts this year. At the late June policy meeting Fisher thought the Fed should raise rates when the committee as a whole reckoned rates should stay fixed.

In a speech last spring, Fisher flagged the difficult choice that may need to be faced. “Containing inflation is the purpose of the ship I crew for, and if a temporary economic slowdown is what we must endure while we achieve that purpose, then it is, in my opinion, a burden we must bear, however politically inconvenient,” he said on March 4.

Economists are unsure what exactly would have to happen with inflation to change the Fed’s current stance of steady rates. But if things stay as they are, the Fed faces a difficult choice.
–Michael S. Derby


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