As the Federal Reserve continues the so-called taper, winding down the bond-buying program that was among its extraordinary responses to the Great Recession, it’s time to take stock.
Overall, I’d give the central bank a B+, with lost points for failing to see the magnitude of the disaster earlier and for leaving questions as to how much it will really regulate the Too Big To Fail Banks in the future.
To the extent that the economy remains stuck in second gear, I put the biggest blame on fiscal austerity from Washington, D.C., the hollowing out and consolidation of many industries, rising inequality, a purblind trade policy and “rent seeking” rather than job creation from Wall Street and many major corporations.
Some economists call our situation “secular stagnation” or “the lesser depression.” I call it part of the Great Disruption.
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To be sure, it has also witnessed a bull stock market and record corporate profits. This tide at the top has not, however, lifted all boats. But that’s not the Fed’s fault.
Mark Thoma, University of Oregon economics professor, wrote that the Fed’s response was “clearly a success” in a nuanced assessment in Fiscal Times.
Not everyone agrees. For example, a reader sent me an email saying he was skeptical that the Fed’s near zero interest rates were working. Yet they were hurting investors in such fixed-income investments as money-market funds and short-term certificates of deposit.
This echoes a popular article on the site Bankrate.com, “Six ways Federal Reserve policy hurts retirees.” For example, “paltry return on savings.”
The reader implied that the Fed should be raising rates. “It is hard to believe that an increase of hundreds of billions of dollars in disposable income among those retired and others in the short term, fixed-income investment marketplace would not give a significant boost to the economy — not to mention the enhancement of the quality of life for millions of those retired.”
It’s true that the safest fixed-income investments are making a lousy return. This is not merely the downside of Fed policy but the price of safety. You won’t lose your principal in a CD or money-market account. Also, the FDIC insures qualified CDs up to $250,000.
Safety was highly prized during the crisis and the jitters still haven’t completely eased.
Jennifer Vail, the Portland-based head of fixed-income research for U.S. Bank Wealth Management, told me that “from an asset-flow standpoint, investors are nowhere near more normal levels of equity and fixed-income exposure.”
But unless an investor is in an unusual situation — such as the terms of a will, irrevocable trust or lawsuit settlement — most are free to pursue higher returns elsewhere.
Many moved into the stock market (equities). Vail said investors seeking a steady stream of income are allocating more of their portfolios to municipal bonds, investment-grade credit, high-yield bonds, emerging debt and preferred securities.
Also, while the future for many baby boomers is bleak, a historic number of retirees who faced the recession were better off than other age groups, according to a Pew Research Center study. This was the generation that enjoyed steadily rising incomes, secure jobs and pensions.
We don’t need to engage in counterfactual history to wonder what might have happened had the Fed responded differently to the crisis of 2008. We have the example of the Great Depression.
The Fed was one of the major causes of the 1929 stock crash when it substantially raised interest rates. Afterward, it helped turn contraction into depression by tightening the money supply and refusing to act as lender of last resort for most banks.
This was the great insight of Nobel Laureate Milton Friedman and Anna Schwartz. In 2002, Ben Bernanke promised them that the central bank wouldn’t repeat those mistakes and it didn’t.
Had rates not been driven to zero and kept there, along with other extraordinary measures, the economy would have faced Depression-like deflation.
What if the Fed had raised rates once the economy began recovering in 2010? We would have slid back into recession or worse.
History and numerous studies also show that savers would have held onto their money rather than spending it.
Now, with the economy nearing its fifth year of recovery, unemployment is still very high and growth is slow. Also, inflation is low. So the Fed can be in no hurry to raise interest rates.
I want to address one other issue raised in the email, lest it become one more false meme on the Internet: that pensions are calculated based on interest rates.
Vail said this is “shocking(ly) … way off base.”
“This period of low rates and multiyear equity-market strength has allowed companies to not only get closer to fully funded status,” she said, “but corporations are also sitting on record levels of cash. In other words, the more conservative curve’s future liability assumption impact has not been the catalyst for the lack of job creation.”
Indeed, the stock market’s rise had led to a substantial improvement in funding of pension plans of S&P 1500 companies, with 2013 being the best year on record, according to the compensation consultants at Mercer.
So the Fed made mistakes. But faced with the greatest crisis since the Great Recession, it did far more right than wrong.
You may reach Jon Talton at email@example.com