I Don’t Care Who Replaces Bernanke, I’m Pessimistic

To what degree are the economy’s problems amenable to monetary policy?

The Federal Reserve is at a crossroads. Chairman Ben Bernanke is leaving, but he has indicated it might be time for the central bank to begin reabsorbing some of the capital with which it flooded the economy in response to the recession. Everyone’s talking about who will replace Bernanke (which Ezra Klein argues is idle speculation), and charges of sexism have been leveled at the Obama administration for ignoring Janet Yellen (perhaps with justice).

Obviously, it’s an important decision for the administration, but it really isn’t that important. Monetary policy alone can’t solve our problems, even if the next chair turns on central banking God mode.

Let’s assume that the recovery depends on the restoration of aggregate demand. The Fed’s goal has been to stimulate demand by increasing the money supply, easing access to capital for investors and creating expectations of inflation in the long term. The problem with this strategy is that even with more money available, there persist stubborn obstacles to investment and consumption.

Even though the cost of borrowing for the federal government remains low, we know that Congress isn’t going to start spending much more anytime soon, probably not until the districts are redrawn after the 2020 Census.

That leaves residential consumption and corporate investment. Andrew Paciorek is optimistic that the rate of household formation is likely to begin increasing, meaning that young people will begin marrying again and buying cars and houses. Derek Thompson agrees. “This recovery is different from all others because we just. Aren’t. Selling. Enough. Houses,” he writes.

That is true, but part of the reason we are not selling enough houses (and cars and consumer electronics) has to do with policies that are beyond the control of the chairman of the Federal Reserve. Brad DeLong explains:

The first step is to strike a deal to get the Republicans in the Senate to confirm Mel Watt as head of FHFA, and then for FHFA and the GSEs to offer a conforming loan-rate refi (with equity kickers attached for those underwater) to every mortgage holder in America. That policy to clean out the credit-channel mess created by the housing finance disaster and housing bubble crash of 2004-2008 would have been good policy in 2009. It would have been good policy in 2010. It would have been good policy in 2011. It would have been good policy in 2012. And it would be good policy today. …

Getting all the people who did not move out of their sisters’ basements into houses and apartments of their own over the past five years is economic recovery job #1, and making housing affordable again is the best way to do that.

Low interest rates are not going to result in many people buying houses or anything else for the first time until Fannie and Freddie are resolved or we find an alternative.

Corporations, likewise, aren’t spending. Instead, they’re hoarding cash, despite historically high levels of profitability. Higher inflation would force them to spend the money on something, but as J.W. Mason explains, the disparity between profitability and corporate investment antedates the financial crisis by several decades and points to (dare I use the term?) structural problems in the corporate model.

Henry Blodget argues the disappearance of unions is the explanation. If large numbers of corporate employees were paid better, they would spend some of that surplus money, mobilizing excess capacity and encouraging corporations to invest in a virtuous circle.

I’m all for unions, but the problem with this hypothesis is that corporations seem to be spending less than you’d expect on everything, not just on their employees. Mason argues instead that the neoliberal emphasis on shareholder value since the Reagan administration has blinded executives to opportunities for investment, because the omnipresent threat of a hostile takeover prevents them from considering anything other than quarterly performance.

There is some empirical evidence for that view: private companies invest nearly twice as much relative to their assets as publicly traded ones, suggesting that the pressure of the stock market may discourage investment. As the Financial Times’s Robin Harding asked last month, pointing to two firms with cash burning a whole in their pockets: “If growth companies such as Apple and Amgen cannot or will not deploy capital, then who on earth will?”

The political system’s aversion to deficits, the confusion in the mortgage markets, and the compensation structure for corporate leaders are three of our most serious macroeconomic problems. I hope the next chair, whoever it is, has some ideas for dealing with them. I’m just not sure what those ideas would be.

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Max Ehrenfreund

Max Ehrenfreund is a former Monthly intern and a reporter at The Washington Post. Find him on Twitter: @MaxEhrenfreund