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Tuesday, August 30, 2011

Bernanke in Jackson Hole

The Federal Reserve long ago was out of economic growth bullets - if it ever had any in its monetary policy gun in the first place. It seems that even Fed Chairman Ben Bernanke is coming to this realization.

In his speech in Jackson Hole, Wyoming, on August 26, Bernanke had nothing to say that staked out new ground on the economy or monetary policy.

For example, despite the recent increase in inflation, and worries among business owners and investors about the threat of future inflation, the Chairman reiterated his unwavering optimism on inflation: "With commodity prices and other import prices moderating and with longer-term inflation expectations remaining stable, we expect inflation to settle, over coming quarters, at levels at or below the rate of 2 percent, or a bit less, that most Committee participants view as being consistent with our dual mandate."

Let's hope Bernanke is right, but unprecedented expansive monetary policy over the past three years indicates otherwise.

Bernanke also renewed his declaration about the Fed standing ready to do more. He said, "In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. We will continue to consider those and other pertinent issues, including of course economic and financial developments, at our meeting in September, which has been scheduled for two days (the 20th and the 21st) instead of one to allow a fuller discussion."

However, a bit of recognition regarding the limits of monetary policy crept into his speech.

He noted that "most of the economic policies that support robust economic growth in the long run are outside the province of the central bank." For good measure, he added: "Fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs. To the fullest extent possible, our nation's tax and spending policies should increase incentives to work and to save, encourage investments in the skills of our workforce, stimulate private capital formation, promote research and development, and provide necessary public infrastructure. We cannot expect our economy to grow its way out of our fiscal imbalances, but a more productive economy will ease the tradeoffs that we face."

Whether in the short term or over the long haul, monetary policy should be focused on price stability. It is ill suited as a tool to generate economic growth. The Fed gets caught in a start-stop game of trying to gin up growth, and then trying to stop inflation.

Bernanke got monetary policy right at one point in his speech: "The Federal Reserve has a role in promoting the longer-term performance of the economy. Most importantly, monetary policy that ensures that inflation remains low and stable over time contributes to long-run macroeconomic and financial stability. Low and stable inflation improves the functioning of markets, making them more effective at allocating resources; and it allows households and businesses to plan for the future without having to be unduly concerned with unpredictable movements in the general level of prices." If only he'd take his own advise in this case.

At the same time, fiscal policy can work to aid economic growth. But it has to be the right policies. More government spending simply winds up hurting the economy by diverting resources form productive private sector ventures. Instead, what's needed is a combination of tax relief, deregulation, reined in government spending, and free trade.

What the economy needs now - and has needed for some time now - are pro-growth fiscal policies and anti-inflation monetary policy, but unfortunately, we have gotten the opposite. And we've paid dearly as a result.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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