Not liberal or conservative, just incoherent
IN ITS updated global forecast released this morning, the IMF warns against “premature and incoherent exit” from government support for the economy. “Incoherent” nicely describes the policy debate in Washington. Partisans have aimed their poison at the Federal Reserve and at the government’s fiscal policy choices but what, exactly, do they want? The logical implications of their complaints are contradictory at best and dangerous at worst.
Start with the Fed. On the right, they’re angry about quantitative easing which they say is monetising deficits. On the left, they’re angry about lax regulation of banks. Both are furious at bail-outs of banks and AIG, and both think the Fed created a bubble with its low interest rates. So the Fed, presumably, should shrink its balance sheet, end its asset purchases and liquidity programmes, order banks to raise underwriting standards and raise rates to nip the next bubble in the bud. And this is going to bring unemployment down?
The Fed won’t do any of these things (not this week, anyway). But the intensity of attacks could shape its behaviour, and not for the better. The confirmation circus is surely the last nail in the coffin of any additional quantitative easing (already being wound down in part because of political blowback). As Vincent Reinhart tells the Wall Street Journal, Harry Reid’s endorsement of Mr Bernanke’s confirmation is a “death trap” because it implies he extracted favours from the Fed in return. Yes, such things are tossed around all the time in confirmation hearings, but the circumstances of this one are especially cringe-worthy. Buy more mortgage-backed securities now, and everyone will see payback to Mr Reid. Perversely, to avoid perceptions of political pliability, the Fed may err on the side of less stimulative monetary policy. Meanwhile, to atone for past sins bank regulators are breathing down lenders’ necks and even Mr Bernanke admits“uncertainty attending … regulatory capital standards” is suppressing the supply of credit.
For now, the stand-off on regulatory reform will spare the Fed formal infringement of its independence. But even assuming Ben Bernanke is confirmed, the mud fight has left the institution vulnerable. The administration has two vacancies to fill on the Fed’s seven-member board of governors—more if some of the current governors retire. Could Donald Kohn, whose term as vice-chairman ends in June, be reconfirmed in this atmosphere? This week’s events may tempt the administration to elevate political palatability over technical ability in whom it chooses to nominate. A weakened board means a louder voice for the Fed’s hawkish reserve bank presidents.
On fiscal policy, voters seem equally upset about deficits and high unemployment as if the first has caused the second when the reverse is true. Republicans have certainly fanned this perception by insisting the stimulus did nothing (helped by the administration’s overly optimistic 8% unemployment forecast). Sometimes, though, President Obama feeds the confusion. Last fall he warned that adding to the national debt could lead to a double-dip recession (turning Keynesian economics on its head, ISI Group notes). This week, even as Congress prepares additional stimulus, Mr Obama has begun ringing the fiscal austerity gong, backing a deficit commission (albeit too late to make a difference) and offering a discretionary spending freeze.
Done right, stimulus now and deficit reduction later is good policy. Yet such delicate sequencing is tough enough in rational times, never mind this post-Massachusetts world. Can a Congress in thrall to the extremes of either party really guide the economy safely past the “cliff” when both the stimulus and the Bush tax cuts expire at the end of this fall, and do so without freaking out bond markets on the look-out for an English-speaking Greece? The risk of a policy error, always high, may be rising.