Spring Is Not Yet Awakening, Says the Federal Reserve, with Good Reason
The Federal Open Market Committee met this week and as expected left interest rates alone. What is more interesting, however, is the Fed’s insistence that “inflation will remain subdued for some time” and that they continue “to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
A few weeks ago everyone was talking about “green shoots.” But we must be patient. Just because we are weary of so many months of economic malaise does not mean our economy will quickly spring back to life.
There have been some signs that we may be seeing the recession bottoming out. For example, new construction, which typically leads economic growth, has been relatively flat for a couple of months. But that’s the good news. The bad news is that new construction is flattening around a historically low level. This may be a green shoot, but it seems to be more of a dandelion than a daffodil.
And we know that the worst for workers and their families is only yet to come. Unemployment is what economists like to call a “lagging indicator,” meaning that it will continue to rise after other measures of economic well-being, such as new construction or economic growth, have bottomed out. Given the pace of lay-offs—May gave us the single-largest month of mass lay-offs ever recorded—and that unemployed workers have been taking an extraordinary long time to find new work, the ranks of the unemployed are likely to grow for many months to come.
The upshot: Unemployment won’t come back down to normal levels until our economy begins generating jobs, which is likely many quarters—even years—away.
To keep teasing out the spring analogy as far as we can take it, the Bush administration left us with the most expensive weedy, nutrient-poor, clay-soil garden imaginable. In the early 2000s, when the economy began to slow, President George W. Bush told us that tax cuts for the wealthiest among us—the “largest tax cut in a generation”—were “exactly the right action, at the right time” and that “reality is, tax relief is important to make sure our economy grows.”
It is true that our economy grew in the ensuing years, but the pace of growth, the pace of business investment, and the pace of job gains where slower than in any economic recovery in the post-World War II period. Families ended the 2000s economic recovery in 2007 with less income (after adjusting for inflation) than they had in 2000.
Essentially, we went to the garden store, spent more money than we ever had before on new-fangled tools and seeds, but our harvest was unbelievably weak. The vegetables we thought we bought were actually insidious and invasive weeds.
On top of this we can now clearly see that while the financial sector reaped record profits in the first half of the 2000s, it did so at the expense of our economy’s health. In an economy such as ours, the point of a financial industry is to allocate capital to productive endeavors. Investors can pool their money and businesses can tap into these pools and use the funds to produce things of value, making money for everyone in the process.
But this isn’t what our financial system was focused on in recent years. Many investors thought that their funds were being pooled to create products of value and generate profits. But in reality this was not the case. Much of the wealth that Wall Street generated has now evaporated. The collapse of the housing bubble destroyed wealth for homeowners as well as for those who owned the mortgages—in whole or in part. We can now see that investments focused more on generating fees than generating strong, long-term economic growth.
Back to our springtime analogy. Given the mess we’ve made, now we need to get to work and get our hands dirty. But it isn’t going to be easy and it’s not going to be quick.
For nearly two years now the Federal Reserve has been pumping money into the economy. Fed Chairman Ben Bernanke, an ardent student of the Great Depression, has focused on making sure that credit flows so that businesses can access the funds they need to generate production.
But his task has not been easy. The last time our economy faced double-digit unemployment the federal funds rate was above 20 percent. At that time, Fed Chairman Paul Volcker was able to drop interest rates by a large amount and quickly generate a strong recovery. That’s simply not the case this time. At this point we’re in the midst of what is known as a liquidity trap—the federal funds rate is nearly at zero and there’s no more room to encourage investment, yet our economy isn’t growing.
The Fed has accomplished a great deal—the financial markets are behaving more normally than they were a year ago—but we continue to struggle with a significant problem in the real (as opposed to financial) economy. Economic growth remains negative and job losses and foreclosures continue to mount.
This is why the American Recovery and Reinvestment Act is so important. Our economy relies on consumer spending for 7 out of every 10 dollars spent. Yet consumers are strapped—they’re facing high unemployment, record foreclosures, falling home values, and reduced access to credit. Exporting our way out of this crisis may become more likely in the future if the value of the dollar remains at current levels and business interests see a reason to invest in export-oriented production. But so far the global slump is preventing anything like this. The current recession is a global one and our trading partners are also struggling (some much more than us) to find the path toward economic growth.
Business investment has plummeted. The most recent data show a 37-percent decline in nonresidential investments in the first quarter of 2009. Why is this? If a manufacturer or video game maker looks out into the horizon and sees all those strapped consumers with little disposable income, then they will not invest in new plants or equipment or new office buildings. If you build it, they will come might be the stuff of film, but it isn’t the way most people run their businesses.
The goal of the Recovery Act is to fill in that gap and create demand where there currently is none. Through spending the government can help boost consumption and create the conditions for businesses to begin to invest in our economy again.
The challenge is great. If we stop spending before our economy gets back on track, then we risk moving backward. This is exactly what happened in 1937. Politicians shifted their attention to short-term deficits rather than long-term economic growth. But that’s comparable to saving too many seeds. If we don’t spend now, we won’t create growth and our deficits will loom even larger as unemployment and foreclosures continue to pull down tax revenue, creating more deficits and, at the state and local level, a greater need to cut spending.
It all comes down to one thing: A strong economy, like a vibrant garden, needs people to commit to investing long before seeing the fruits of those investments. To see green shoots we need a fertile soil, productive seeds, and careful tending. For our economy to get back on track we need to lay the foundation for long-term economic growth.
The policies laid out by President Barack Obama focus on this task. Reforming health care will generate long-term benefits and limit the health care’s drag on our economy. We spend more per capita on health care than any other nation, yet one in seven Americans go without insurance and our health indicators, such as maternal deaths, infant mortality, and longevity, are not the best in the world. Fixing the health care system and getting a handle on costs will help make our economy more productive in the future.
Similarly, investing in renewable energy and limiting the future damage to the planet through a carbon cap-and-trade program lays the foundation for strong economic growth in the future. If we do it right, it could lead to the development of a vibrant new industry that could employ millions while helping to limit global warming.
Cleaning up our financial house is also on the table. Through taking the time to sort out a structure that protects consumers and focuses Wall Street on its purpose—making capital available for investment—we can recreate a vibrant economy in the months and years to come.
But, back to my (possibly now tiresome) analogy: These investments will not bear fruit overnight. The Recovery Act is only now beginning to pump hundreds of millions of dollars into the economy, and laying the foundation for long-term growth has only just begun. It took many years to create this mess and there’s no quick fix. Green shoots don’t spring out of nowhere.
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