Pro-Growth Tools for the Frozen Fed by David Malpass
http://www.wsj.com/articles/pro-growth-tools-for-the-frozen-fed-1444169417
The central bank needs to try something different—and has serious options to get median income rising.
Last week’s dismal jobs report for September will throw an indecisive Federal Reserve deeper into paralysis. For months the central bank hinted that it would end its near-zero interest rate policy, before backing down amid fears of soft growth and opposition from the International Monetary Fund and World Bank. That leaves Fed officials with no plan, as worrying economic news mounts.
After seven years of emergency policies, it is vital that the Fed try something new. If not a rate increase, it should consider other growth-oriented options: tapering its huge bond reinvestment program to free up collateral for credit markets; shifting some of its borrowing away from banks to encourage bank lending; or shortening the maturity of its bond portfolio to relieve some of the illiquidity in bond markets.
The Fed has made preparations for these steps and could start small if it is hesitant. From an economic standpoint, each would be a major policy improvement. When the Fed broke ranks with Wall Street in 2014 to taper its bond purchases, it was warned of disaster but achieved a major success. Bank lending to small businesses surged until the Fed pulled back on normalization, and real GDP growth accelerated above 4% for two quarters. There’s a similar opportunity now.
The Fed says that it is still considering a rate increase in 2015, if the economy and inflation accelerate. That would be welcome. But the economy shows signs of weakening, and the consumer-price index figure for September is expected to show deflation.
On Tuesday the International Monetary Fund further lowered its estimate for world GDP to $73.5 trillion for 2015 and $76.3 trillion for 2016. That’s down a combined $18 trillion from estimates a year ago. The bottom line is that the IMF now believes the world economy will be smaller in dollar terms in 2016 than it was in 2014.
China, Japan and Germany are struggling against slow global trade. The new Trans-Pacific Partnership should eventually help with that, but it won’t come soon enough to offset the drag from years of poor U.S. tax and spending policies and the Fed’s delay in unwinding the emergency measures taken after the 2008 crisis.
The Fed’s theory that extremely low interest rates will someday cause solid growth has been disproved repeatedly. It failed in 2003-06, when the Fed held rates at 1% and then limited rate increases to only 0.25%, which channeled credit into the housing glut. Growth would have been faster and more balanced if rates had been higher. In the current recovery interest rates are even lower, but the results have been worse, with real growth averaging only 2.2%—the slowest recovery on record.
The Fed’s apologists claim the central bank’s policy is helping, citing the large decline in the unemployment rate, now at 5.1%. But that rate excludes millions of people who have given up looking for a job, and it counts as employed the millions of part-time workers who need more hours a week but can’t find them. The Labor Department’s underemployment rate is 10%, almost twice the official unemployment rate. That’s the biggest gap on record in the ratio between the two figures.
Employment as a share of the working-age population stands at only 59.2%, barely above the 2010 trough and four percentage points below normal. This translates into still-falling real median income. With credit growth meager and business formation sluggish, the U.S. economy is suffering from stalled productivity and a year-long decline in business profits. The third quarter slowdown in jobs, manufacturing and capital goods orders adds to the suspicion that the Fed will extend its seven-year monetary experiment into 2016.
In that case, the interbank market, once one of America’s key advantages in the competition with Europe and China, will remain frozen. It used to move funds from banks with extra deposits to those with demand for loans—often community banks attuned to the needs of local businesses. But with interest rates near zero, interbank volumes have shrunk to a fraction of former levels, a problem referenced by St. Louis Fed President Jim Bullard in his Oct. 2 remarks to the Shadow Open Market Committee, an independent monetary policy forum.
Growth in commercial and industrial lending by U.S. banks has slowed sharply in recent months, to a 5.7% annualized rate, according to the Fed’s data through Sept. 23. The Fed has tools that would help. Commercial and industrial loan growth surged to a 20% annualized rate in April 2014 when the Fed was reducing its bond purchases and borrowing more from repo markets instead of banks. Using repos the Fed can borrow more cheaply from money-market funds, as well as Fannie Mae and Freddie Mac, than it can from banks. That saves taxpayers a bundle and returns cash to the banking system for lending to small borrowers and job creators. For example, data from the Securities and Exchange Commission show that at the end of 2014 the Fed was borrowing $450 billion from J.P. Morgan alone, some of which could have been better lent to businesses or other banks.
The Fed’s own data shows that over the last five years, total credit in the economy grew $7.6 trillion. But broken down, credit to government grew $4.7 trillion (by 37%); credit to corporations grew $1.9 trillion (by 32%); and credit to small businesses and households grew $1 trillion (by 6%). The result was a dramatic swing in the allocation toward big, established entities and away from growth. Small-business formation, critical for new jobs, has slowed accordingly.
The post-monetarist policy of near-zero rates combined with direct federal regulation of the quantity of credit doesn’t work. It distorts credit markets, misallocates capital, and—ultimately—slows growth. Wealth becomes concentrated, because the artificially low rates benefit those who already have capital and assets at the expense of those who don’t. The Fed has powerful tools that would help credit flows rebalance and get the real median income rising again. It should find ways to use them.
Mr. Malpass is the president of Encima Global LLC.
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