February 2, 2016
Over the past several weeks, we’ve once again seen how the Federal Reserve’s stimulus policy has done nothing to help the economy. Fourth quarter growth for 2015 was a disappointing 0.7 percent, and there are no obvious signs of improvement in sight for 2016. Nonetheless, as the U.S. economy continues to smolder, the Fed acts as though pulling levers on interest rates will get us out of this seemingly endless trough.
In December, the Fed thought that the economy was turning around and accordingly raised the federal funds rate from one-quarter to one-half percent, with the prospect of further increases down the road. In January, the Fed let the interest rate remain constant, and there is now an active debate over whether the weak growth numbers will induce the Fed to postpone raising that key rate as widely expected. As usual, the Fed conceives that its mission is to run a delicate balancing act between overall economic activity on the one hand and the job market on the other. Thus the justification offered for the December increase—the first in about seven years—was the “considerable improvement” in the job market, which is in reality far weaker than it appears, given the low labor market participation rate, the rise in part-time employment, and the general stagnation in wages.
Nor is the U.S. exceptional in how it deals with these problems. Labor market problems in Europe are chronic, and the prolonged economic slowdown is of increasing worldwide concern. In late January, nervous central bankers in other major countries adopted stimulus policies more aggressive than the Fed’s. The Bank of Japan, joined by number of European banks, set key short-term interest rates at below zero, in effect charging banks to hold their deposits in order to encourage private lending. Japan’s central bank accomplished this by imposing a 0.1 percent penalty on excess reserves. No longer is there general expectation of a 2 percent inflation rate. Instead the recent central bank decisions presage a new deflationary cycle, which is no recipe for growth.
Read the full article at the Hoover Institution: Why Fiscal Stimulus Fails