The Fed Can't Do It Alone

Yesterday’s FOMC meeting was met with mixed reactions. Some were pleased that the Fed didn’t make any drastic moves like announcing that more quantitative easing was on the way. Others viewed the lack of significant policy as a sign that the Fed was out of bullets and was tired of fighting. Regardless of the consensus (or lack thereof), there is one question that I’m having a hard time understanding:

Why is the entire financial community pointing the finger at the Fed, saying “it’s up to you to fix this?”

While the Fed does have other tools at its disposal that it can use to try and bolster this limping economic recovery, monetary policy can only accomplish so much.

What’s perplexing is why there was so much attention to what was being said at the FOMC, as if they were going to announce a new policy that hasn’t been tried or tested over the past three years that will magically heal this aching economy. In a recent interview with CNBC, Pimco CEO Mohamed El-Erian said that, “[amidst the uncertainty] we are focusing on the wrong thing. The country is facing structural issues and it needs structural solutions… Focusing on the Fed is like sending in a wide receiver to play quarterback. The wide receiver is a good athlete, but he is not a quarterback.”

The economic textbooks tell us that solutions to structural issues are found in fiscal policy, regulation, and the creation of incentives. The problem with the new regulations put in place is that they are not well understood in both cost and implementation (see FinReg, health care), which creates even more uncertainty and hesitancy across multiple markets. While everyone’s attention is focused on the Fed’s monetary policy decision, we seem to be forgetting that effective fiscal policy is equally, if not more, important when solving structural problems. Creating significant, yet vague regulations on entire industries while introducing new taxes would not seem to be the most economically intuitive way to promote growth.

El-Erian also noted that the US is coming to the realization that monetary policy is becoming less and less effective. “Effectiveness is going down. You get less outcomes for the same unit of reaction.” While the Fed was the white knight that called off the US economy’s funeral back in early 2009, it appears that monetary policy simply isn’t the answer in 2010, and is becoming less useful as time passes.

To be fair, one foreseeable problem that IS the Fed’s responsibility is deflation. The Fed reacted by announcing that it would “help support the economic recovery in the context of price stability” by committing to purchase more Treasury securities. El-Erian spoke about how important it is to avoid a deflationary scenario, as deflation can render policy completely ineffective.

El-Erian also said that the Fed letting the Treasury and other agencies “take the lead” would be the correct move, though he doubts that the Treasury would “step up to the plate” with elections looming.

Moving forward, it is becoming apparent that the $787 Billion stimulus bill that the democrats are so proud of wasn’t so simulative, and is not getting the job done. Therefore, it needs to be understood that since the Fed can’t push rates any lower, our current structural “solutions” would seem to be part of the problem.

So, with elections coming quickly, it will be interesting to see what those politicians desperately hoping to keep their jobs can come up with. Because at the current time, the voting population seems to be anxious to “throw the bums out” (regardless of their party affiliations) and get some new thinking in Washington.

 

 

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