“Cautiously optimistic” is kind of a tired phrase, but it appears to be how U.S. Federal Reserve Chair left a group of Democratic senators feeling about the economy after he spoke at a private lunch on Thursday. Bernanke himself didn’t offer any comments to the press, but Democratic policymakers were quick to share his diagnosis of the economic situation.
Not missing a political heartbeat, Senate Majority Leader Harry Reid (D-Nev.) quoted the Fed Chair on the Senate floor. Arguing in favor of extending federally funded unemployment insurance benefits, which expired at the end of December, Senator Reid said that Bernanke “talked about the vibrancy of this economy now. He said it’s not as good as it should be. But he said: ‘With a little bit of help it would be on fire.’”
Reid’s position is clear, and it actually seems to echo an argument that Bernanke has made repeatedly over the past several years. Monetary policy is at full throttle — call it expansionary, or accommodative — and the economy is still running below potential. The stimulus provided by the Fed has been counteracted to a large degree by contractionary fiscal policy, which takes the form of tax increases (or, the expiration of tax holidays) and spending cuts.
Monetary and fiscal policy should not be playing tug of war, but the nation’s enormous debt and a unique and severe financial crisis made the traditional playbook obsolete. The government couldn’t afford to spend freely and slash taxes (goes the conservative argument), ostensibly forcing the Fed’s hand. The result, unpalatable to many but apparently successful in hindsight, was an unconventional monetary strategy — a heavy prescription of stimulants designed to numb the financial markets from both the pains of the financial crisis and contractionary fiscal policy so that the economy could move forward and recover.
You don’t have to be a doctor or an economist, though, to get the feeling that there are some problems with this strategy. For one, there is still the very real concern that markets have become addicted to the medication (that is, easy money), which could complicate the taper. There’s also an ongoing debate about the effectiveness of monetary policy to combat the fundamental issues standing in the way of sustained economic growth.
Philadelphia Reserve Bank President Charles Plosser, a long-time critic of quantitative easing, argued recently that, “Efforts to use monetary policy to offset such permanent shocks and to close what appears to be a gap will likely be ineffective and perhaps even counterproductive.” That is, the Fed’s medicine could end up being toxic if policymakers aren’t prudent.
The next step — as Plosser, Bernanke, Senator Reid, and others may argue — should come from Congress, not from the Fed. The Fed has pretty much run out of ammunition, and incoming Chair Janet Yellen’s first task will be to wind down QE and manage the exit strategy for the Fed’s enormous balance sheet (if there is an exit strategy at all). The last thing that the Fed should do right now is expand policy. In order to successfully return to a normal monetary environment, the U.S. is going to have to get its fiscal house in order, and both the public and private sector need to be willing to make changes. “The real economy must ultimately adjust to such permanent shocks,” said Plosser, earlier. “Monetary policy cannot offset the costs or the necessity of such real adjustments.”
At the beginning of January, Dallas Fed President Richard Fisher voiced his concerns about QE, as well. “I’m very worried about this,” Fisher said of the Fed’s bond-buying program, “and I expect that my own voting behavior will reflect this concern that I just stated. I don’t think these are programs that should be continued, and I worry about the fact that we’ve already painted ourselves into a corner which is going to be very hard to get out of.”