By L. Randall Wray, Senior Scholar at the LEvy Economics Institute of Bard College. Micah Hauptman, Financial Campaign Coordinator for Public Citizen's Congress Watch
Over the past several decades, many people adopted the view that monetary policy, almost alone, could effectively control the economy. Economists, politicians and scholars came to believe that the Federal Reserve was full of neutral technocrats who dutifully fine-tuned the economy. Through their careful orchestration of interest rates, the money supply and inflation, we assumed that they could guarantee a smoothly functioning economy. Fed officials seemed to do so well at their jobs that they were never doubted. But by depending on monetary policy and discounting fiscal policy as an effective way to secure economic stability, we have created a system that is now dysfunctional.
For years, the Fed was considered an apolitical institution. But, in reality, the Federal Reserve is far from apolitical. The Federal Reserve’s lenient regulation and lax supervision of Wall Street – a substantial cause of the recent financial crisis – was a political decision. Likewise, the Fed’s failure to quash speculative asset bubbles in the stock and housing markets was a political choice. While these bubbles led to rapid short-term economic growth, they always burst. These political choices resulted in market failures, injuring ordinary Americans. Even though we know of these failures, we continue to depend on the Fed.
Likewise, when the financial crisis hit, the Fed scrambled to provide emergency support to the economy. The financial crisis led to a catastrophic drop in available credit and consumer spending, and in the absence of any significant fiscal presence, the Fed had to fill the void. It helped avoid a total economic collapse by arranging loans and guarantees for major financial institutions. As the lender of last resort, it had no choice but to act swiftly and vigorously.
But the Fed’s traditional toolkit was limited to temporarily stabilizing, not curing the financial system, and it overestimated its abilities at restoring confidence to the system. The monetary policy tools it employed were mostly limited to dealing directly with banks, which meant that its interventions could only be “top-down.” In other words, the Fed’s actions were aimed at creating incentives for Wall Street to spread the money around the economy so that it would eventually trickle down to Main Street.
The Fed’s expectation was that once sufficient liquidity was pumped into the financial system, banks would return to lending and the economy would become rejuvenated. But as the recession dragged on, lending did not return. Stuck with its limited abilities, the Fed attempted to provide further life support through its ‘quantitative easing’ measures and rock-bottom interest rates, expecting that the increase in banks’ reserves would induce them to lend. However, these measures also didn’t work as the Fed expected. While the big banks that received the Fed’s monetary injections have supposedly recovered, they still haven’t resumed lending, so the money has not spread to small businesses and ordinary Americans, those who need help the most. And still, despite the inadequacies of the Federal Reserve’s “top-down” approach, we continue to depend on monetary policies to get our economy going again.
The Fed recently announced that it will continue its monetary easing measures, given our prolonged economic turmoil. But we must not depend on monetary action alone to restore our economic viability. Fed action will only do so much; we need a long-term and systematic approach for that, one that the American Jobs Act only begins to provide.
For our nation and economy to finally recover, the patient must be given an opportunity to fully heal. It’s time for the new doctors—Congress and President Obama—to take over, put aside the political showmanship and come together for the sake of our country. The patient needs a new course of treatment.
L. Randall Wray is a Senior Scholar at the Levy Economics Institute of
Bard College and Director of the Center for Full Employment and Price
Stability at the University of Missouri, Kansas City. Micah Hauptman is
the Financial Campaign Coordinator for Public Citizen’s Congress Watch