The Fed: The Mismanagement of Millions

         A week ago, the Bureau of Labor Statistics released January’s unemployment data, showing good news regarding our economic recovery: Employment in January rose by 243,000 new jobs and unemployment dropped by .2 percentage points to 8.3%, the lowest level since 2009.  While this seems like a good sign at first glance, other numbers paint a more pessimistic picture. The labor force participation rate, sitting at 63.7%, is the lowest it has been since the early 1980s. This tells us that more people are giving up in their search for employment. Because the unemployment calculations ignore discouraged workers, a genuine economic recovery would include both a drop in the unemployment rate and a non-negative growth in the participation rate.

            Federal Reserve Chairman Ben Bernanke seems to agree. Testifying in front of the Senate Budget Committee on February 7, he stated, “The 8.3 percent no doubt understates the weakness of the labor market in some broad sense.” Barack Obama, on the other hand, took a more blindly optimistic approach to the January jobs report: “In January, American businesses added another 257,000 jobs. The unemployment rate came down, because more people found work. And altogether, we have added 3.7 million jobs over the last 23 months.” Added more jobs? Yes. Are we out of the hole yet? No. Even though Bernanke, unlike Obama, understands that the January Jobs Report is misleading, he is still staying strong in his commitment to keep interest rates between 0 and .25 until late 2014, desperately trying to re-inflate the bubble.

            Ben Bernanke has yet to commit to a QE3, hoping that standard monetary policy manipulation of interest rates will be effective enough to bring us out of recession, but the question remains: will the zero interest rate policy (ZIRP)  bring us out of the recession or backfire and create inflationary pressures that further the devaluation of our currency? Bernanke is willing to take that gamble. In late January, he said, “If the situation continues with inflation below target and unemployment declining at a rate which is very, very slow, then the logic of our framework says we should be looking for ways to do more.” A key problem with Bernanke’s thinking lies in his belief that current inflation levels are indicative of future inflation levels, allowing him to ignore the prospect of runaway inflation.  

            Bernanke’s dismissal of the potential for future inflation is concerning, seeing as many of the factors resulting in our current low inflation level may not be existent in the near future. Inflation always lags behind monetary stimulus, and an impatient Fed may accidentally be slapped with out-of-control inflation before the free market has been given time to correct itself. The current strength of our dollar, for example, has been propped up by uncertainty regarding the Euro following the Eurozone debt crisis. The Euro’s weakness has increased European demand for the dollar, temporarily strengthening the dollar’s purchasing power. As Europe continues to solve their debt crisis, however, the demand for U.S. Treasury Bills will decline while European investors move their investments out of U.S. Treasury Bills.

            Also, much of the money injected by the Federal Reserve has been sitting in the banks as excess reserves, not being circulated through the economy. The Federal Reserve has recently adopted a policy that pays a .25 interest rate on all excess bank reserves. This policy is unprecedented, especially considering the Fed’s public attempt to create easy credit. The chart below shows the amount of excess reserves that have been sitting in banks, not being lent out.

            The interest payment on these excess reserves creates an incentive for depository institutions to keep deposits as reserves rather than lend out the deposited money and increase credit. When the Fed’s ZIRP becomes ineffective, like what happened when Japan’s Central Bank bottomed out interest rates, Bernanke and the other Board Members will look for other tactics to stimulate the economy, possibly resulting in the elimination of the policy that pays interest on excess reserves. If this policy were to end, more money would be dumped into the economy and inflationary pressures would grow even greater.

            Our current economy is in a very delicate and fragile situation. The problem with Bernanke’s solutions lies in the fact that they are his solutions. The economy cannot be manipulated by central bankers or central planners no matter how intelligent they are. As we attempt to pull ourselves out of a mess that was created by too much government intervention in the economy, the only proposed solutions involve even more government intervention in the economy. Bernanke walks a tight rope attempting to balance inflationary pressures and employment, while we all hang on and hope that Bernanke gets it right. There has never been stronger evidence to suggest that the Federal Reserve has too much influence in the economy, and that the free market, a natural coordination of millions of people, would do a better job at engineering an entire economy than one Federal Reserve Chairman.

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