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Fed Policy Raising – Rather than Reducing – Unemployment

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Washington’s Blog
May 2, 2013

The Federal Reserve announced that it will keep on engaging in quantitative easing in the amount of $85 billion dollars per month (or more) until unemployment improves.

That is like a medieval doctor bleeding a patient with leeches until his iron deficiency goes away.

Ken Griffin – head of Citadel Capital – noted this week:

As we’ve all learned over the years, if you reduce the cost of capital you increase your use of fixed assets and you take out jobs. Corporate America, seeing an ever increasing cost for its employee base and extraordinarily low interest rates, is taking every step it can possibly take to reduce employment, to build factories abroad and domestically to substitute technology and automated processes for people.

By way of background, Dallas Federal Reserve Bank president Richard Fisher said in 2011:

I firmly believe that the Federal Reserve has already pressed the limits of monetary policy. So-called QE2, to my way of thinking, was of doubtful efficacy, which is why I did not support it to begin with. But even if you believe the costs of QE2 were worth its purported benefits, you would be hard pressed to now say that still more liquidity, or more fuel, is called for given the more than $1.5 trillion in excess bank reserves and the substantial liquid holdings above the normal working capital needs of corporate businesses.

Similarly, former Secretary of Labor Robert Reich pointed out in 2010:

Cheaper money won’t work. Individuals aren’t borrowing because they’re still under a huge debt load. And as their homes drop in value and their jobs and wages continue to disappear, they’re not in a position to borrow. Small businesses aren’t borrowing because they have no reason to expand. Retail business is down, construction is down, even manufacturing suppliers are losing ground.

That leaves large corporations. They’ll be happy to borrow more at even lower rates than now — even though they’re already sitting on mountains of money.

But this big-business borrowing won’t create new jobs. To the contrary, large corporations have been investing their cash to pare back their payrolls.They’ve been buying new factories and facilities abroad (China, Brazil, India), and new labor-replacing software at home.

If Bernanke and company make it even cheaper to borrow, they’ll be unleashing a third corporate strategy for creating more profits but fewer jobs — mergers and acquisitions.

William F. Ford – former president of the Federal Reserve Bank of Atlanta – wrote in 2011:

Table 2 below shows our estimates of the possible losses in spending power, output, and employment generated by the Fed’s artificially low interest rates. Even by our most conservative estimate, which only looks at the $9.9 trillion in assets most directly affected by depressed yields on Treasurys, the losses are impressive. The average yield on Treasurys in June 2010 was 2.14 percent compared to an average of 7.07 percent in the previous nine recoveries, a difference of 4.93 percentage points. The projected annual impact of this loss of interest income on just $9.9 trillion of rate-sensitive assets translates into $256 billion of lost consumption, a 1.75 percent loss of GDP, and about 2.4 million fewer jobs.(Our calculations assume that the recipients of interest income face a 25 percent average income tax rate and consume 70 percent of their after-tax income.)

Fed Policy Raising – Rather than Reducing – Unemployment RR20110704 2

Had these jobs not been lost, the unemployment rate would be 7.5 percent, instead of the current 9.1 percent, and this is the minimal effect we estimate.

***

As the estimate of the total of affected interest-sensitive assets gets bigger, the negative effects of depressed yields becomes even more striking. Using our mid-point estimate of $14.35 trillion of interest-sensitive assets, a 4.93 percentage point reduction in interest rates annually cost the economy $371 billion in spending, 3.5 million jobs, and 2.53 percent of GDP. This is a sizable effect, given that during this time GDP grew by only 2.33 percent and the economy added only 870,000 jobs.

With the additional jobs that might have been created by higher interest income levels, the unemployment rate could fall to 6.8 percent. And output could grow more than twice as fast as it has. The resulting GDP growth rate of 4.86 percent would then be closer to the average second-year growth rate of the past nine recoveries, and the U.S. economy would be well on its way to a vigorous recovery, rather than struggling as it is now.

This midpoint appraisal is our best estimate of the likely effect of the Fed’s policy. It may still be on the low side.

The numbers do not account for any so-called multiplier effects. Additional spending by recipients of interest income creates revenues for businesses, which in turn increases the income of their owners and employees, who themselves spend more. This, in turn, could boost overall spending and employment by more than the gain in interest income alone would suggest.

***

The housing market has not even begun to recover since the QE initiatives were created. U.S. auto sales and the stock market also remain well below pre-recession levels. And the sharp decline of the U.S. dollar has not created an export boom. But it has put upward pressure on the cost of our food and energy imports.

And tens of millions of U.S. savers, largely the elderly, still are facing strained circumstances created by Fed-driven abnormally low interest rates across the entire Treasury yield curve.

The negative impacts on output and employment caused by quantitative easing through the interest income effects shown here are large. In fact, they may outweigh the expected, but hard-to-document, positive effects of the QE program.

John Doukas – founding and managing editor of European Financial Management, a leading journal in European finance, and  Chair in Finance and Eminent Scholar at Old Dominion University, Virginia - wrote this April:

The repeated Quantitative Easing (QE) policies of the US Federal Reserve in the aftermath of the global financial crisis, with similar actions by the Bank of England and the European Central Bank (ECB), have failed miserably to restore growth and reduce unemployment.

***

The practice of expansionary monetary policy leads to capital misallocation as it favours short-term spending at the expense of long-term spending (investing less in long-term projects). That is, it creates a savings-investment gap that reduces the capital formation required for the economy to grow, which renders a high fraction of its existing capital stock obsolete. This, low interest rate policy, an outcome of quantitative easing, in turn, has an adverse effect on productivity forcing capital to migrate in foreign/emerging markets in order to realise higher returns. In other words, excessive money supply fails to increase real economic activity because itraises the labour cost while it lowers the cost of capital. Depressing yields at home, as a result of quantitative easing, in an open economy setting, leads yield-seeking investors into higher-risk investments such as emerging markets.

***

While quantitative easing, like expansionary fiscal policy, may increase aggregate spending, this does not trickle down to the real economy because relative prices (labour vs. capital) work against it. This results in higher rates of unemployment with capital flying to foreign markets. A related effect is that foreign economies, especially those with lower labour costs than western economies, become more attractive places to invest because of these lower costs and promising higher returns to capital. That is, quantitative easing encourages outsourcing, as capital is excessively substituted for overseas labour causing jobs and product innovation to move offshore. Imported goods and services from these countries, then, become more attractive to western consumers because they are cheaper in comparison to the ones locally produced resulting in great outflow of capital, outsourcing and unemployment. This vicious circle exacerbates the disadvantaged position of western economies as they are forced to continue relying on overseas lenders to meet their spending needs, leading to mounting budget deficits and external debt.

Moreover, it is well-documented that quantitative easing increases inequality.  Quantitative easingdoesn’t help Main Street or the average American. It only helps big banks, giant corporations, and big investors.

Too much inequality causes economic downturns and decreases aggregate consumer demand … and companies fire workers when demand decreases.  So quantitative easing also indirectly – but in a veryreal fashion – destroys jobs by destroying consumer demand.

This article was posted: Thursday, May 2, 2013 at 4:52 am





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