The Federal Reserve has been too glued to theories that haven’t worked to restore robust economic growth since the last recession, says Stephen Stanley, chief economist at Amherst Pierpont Securities.
The central bank’s adherence to the idea that unemployment and weak demand can be cured with policies that encourage consumers, businesses and governments to rack up more debt ignores other problems with the economy, he says.
“For the bulk of this expansion, the Fed has operated as if everything that was wrong with the economy was a cyclical shortfall in demand,” Stanley says in a Sept. 2 report obtained by Newsmax Finance. “The trouble is that it has become increasingly evident that this narrative was wrong.”
The Fed responded to the 2008 financial crisis, which followed the collapse of a massive U.S. housing bubble, by cutting interest rates to a record low of about zero percent in an effort to support a recovery from the worst economic slowdown in 80 years. The Fed also tried several rounds of quantitative easing, a policy of buying government debt and mortgage securities from banks to help drive down borrowing costs.
While the U.S. bounced back from recession and the unemployment rate fell from a 30-year high of 10 percent, growth never exceeded 3 percent a year for the first time since World War II.
Stanley says Fed policymakers are too attached to the ideas of John Maynard Keynes, the hugely influential English economist who argued that deficit spending was necessary during recessions to maintain full employment. Keynesian theories make it difficult to distinguish short-term cyclical trends from long-term structural changes in the economy, Stanley says.
“Keynesians operate exclusively on the demand side of the economy, and much of what is holding the economy back in recent years has been operating on the supply side,” Stanley says, pointing to falling U.S. productivity. “There is also a strong leftward lean in ideology at the Federal Reserve, and it is thus very understandable that they have been very slow to recognize the damage done to growth over the past several years by hikes in marginal tax rates and a stifling regulatory environment.”
The Fed’s fixation on core consumer price inflation also limits its ability to recognize major asset bubbles, such as in tech stocks and home prices, Stanley says.
“Even a casual examination of the financial markets screams easy money, as investors have been reaching for yield for years and even Fed officials are constantly expressing worry that too much risk is being taken in various asset classes,” he says.
Stanley’s report follows last month’s Fed conference in Jackson Hole, Wyoming, where central bank officials and economists from throughout the world met to discuss monetary policy. Investors scrutinized the proceedings for any indication that the Federal Open Market Committee would raise interest rates at its Sept. 20-21 meeting.
The Fed in December hiked rates for the first time in 10 years, but has resisted additional increases amid signs of a weakening global economy and political jolts like the U.K. vote to leave the European Union. Investors don’t expect the Fed to raise rates this month, especially with a presidential election looming on Nov. 8.
“What we are left with is a Fed that seems to take a meeting-by-meeting approach on whether now would be a good time to raise rates with not enough thought given to whether the level of rates, as opposed to the change, is appropriate,” Stanley says. “With this approach, if the Fed happens to get it right, it will be primarily a matter of blind luck.”