The Fed: A Return to Normalized Policy?

By Deeptanshu Singhvi

The Fed Funds Rate is Zero Bound and interest rates have plummeted to help stimulate a surge in demand. While job growth in the last few quarters has averaged at around 288,000, this quarter there were only a mere 88,000 jobs created. Economists are releasing statements daily regarding the accuracy of such numbers – but no one knows for sure the true cause of this job loss. Is it just an anomaly? Does the Fed have the resources to tackle this economic blow?
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Currently, in order to cope with job growth by population, during each quarter 91,000 jobs need to be created. At 88,000 jobs, the U.S. economy is already below this average, which is negatively impacting the labor participation rate. A large cause for this extreme unemployment is the mediocrity of America’s Educational System – as employed workers are not trained well, structural employment tends to increase. Due to this mismatch between American workers and the skills needed in the jobs sector, the FED is powerless against stimulating job growth. To exacerbate this situation, cyclical unemployment that has made workers inefficient for long periods of time has rid employees of valuable skills, turning into a vicious cycle of unemployment.

Although the United States is spending double its budget than it did in the last decade on education, achievement levels have been outpaced by international competitors. Specifically, United States Fourth Graders are ranked 11th in math, and 7th graders are ranked 8th in science. While these may be relatively high, it offers no optimism for job growth. Firms and companies are outsourcing these jobs to higher qualified individuals in China, India, or Honk Kong where the pay is less but the quality is higher. During the financial crisis of 2008, the Congressional Research Service mapped out a new numerical number measuring the number of experienced unemployed workers divided by job openings. As the recession hit its peak and job growth was at a low, these numbers more than tripled; for example, the ratio for educational job services in 2007 was 0.3, but in 2010 jumped to 2.3. Clearly, even if the job openings existed, comparative business advantage in other nations was keeping jobs away from average Americans. Critics of the Fed have commented that lowering interest rates cannot slow down market forces such as the offshoring of essential jobs.

The clear fallacy between the FED’s goal to target structural unemployment through lowered interest rates poses an imminent threat to the American economy. In fact, due to the separation of the FED and Congress, Bernanke has no power to make Congress invest in the training of human capital. Rather than restructuring the entitlements program of the United States, congressman have passed a sequester cut of 85 billion dollars which severely harms the efficacy of American education. On a more numerical note, the FED previously issued statements saying that it would overlook possible asset purchasing halts. On the contrary, due to these unemployment figures, Bernanke has revised the proposal and plans to continue large scaled asset purchases at a pace of $85 billion dollars per month. Specifically, the Federal Reserve invests 440 billion dollars in short term securities and $45 billon dollars in longer term treasury securities. Stressing the limitations of lower interest rates, Eric S. Rosengren, the Federal Reserve Bank of Boston president, said in a recent interview that, “I think we’re pushing the interest-sensitive sector about as far as we’re going to be able to push it at this time.”

Recently, the Fed’s goal to flatten the yield curve and lower mortgage interest rates has benefitted the housing market. By lowering mortgage interest rates there has been a clear alleviation on refinances and housing starts have increased by 46.7%. Consistent with the famous American Dream, the average middle class family in America invests most in buying a house. As the housing starts indicator shows positive signs, other industries such as construction, furniture, and land continue to grow. While the expansion of the Federal Reserve’s balance sheet has upheld economic recovery in the eyes of the housing market, experts argue that if the FED’s balance sheet gets too large it may lose the credibility of monetary policy. Employees of the Federal Reserve are hoping for normalized policy; a Wall Street Journal study estimates the size of the balance sheet to be so enormous that the newspaper estimates it would take longer than 10 years to normalize.

Also, recently the Federal Reserve’s exit strategy has come into question; in an event of extreme expansion of the balance sheet, the Federal Reserve will slowly have to halt asset purchases. In fact, it will also have to stop the principal payments on interest to make sure that it has tight grip on money supply. To ensure that no trouble is received while pursuing this policy, the FED has been granted a revolutionary new tool, which charges interest on the reserve requirement. By being able to take more capital from banks in exchange for treasury securities, contractionary monetary policy in the future can enable a proper exit strategy. This new tool is necessary as the balance sheet has expanded to 6% of the United States GDP, slightly over 4 trillion dollars. Simple efforts to slow down asset purchases will consume too much time, and make it impossible for a facilitated recovery.

The economy is undergoing vast change and new forces are acting upon the demand side of the financial sector. The Federal Reserve, however, even in these tough circumstances must evaluate the merits of its policy and assess the risks with each course of action. A decision to normalize policy can have a profound impact on economic prosperity and consumer confidence.

1.http://www.nytimes.com/2013/04/30/business/economy/fed-unlikely-to-expand-asset-purchases.html?pagewanted=all&_r=0
2.http://articles.washingtonpost.com/2013-04-24/politics/38772749_1_columbia-schools-chancellor-michelle-rhee-education-policy
3.http://www.forbes.com/fdc/welcome_mjx.shtml
4.http://www.globalpost.com/dispatch/news/afp/130429/fed-set-keep-foot-stimulus-pedal
5.http://blogs.wsj.com/economics/2013/04/23/feds-balance-sheet-could-take-nearly-10-years-to-normalize/
6.http://www.fas.org/sgp/crs/misc/R41785.pdf