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Home Publications Blogs Beat the Press How the Fed Boosts the Economy: Lessons for George Will

How the Fed Boosts the Economy: Lessons for George Will

Thursday, 13 September 2012 05:03

In his column today George Will notes the Fed's responsibility to maintain price stability and high employment and tells readers: 

"Achieving the former is the best thing the Fed can do for the latter."

Apparently Will has not been following what has happened in the economy recently. While inflation has remained low and relatively stable, unemployment has soared. He also apparently does not recognize how the Fed hopes to boost economic growth through quantitative easing.

The biggest impact from lower interest rates is probably from mortgage refinancing. This both directly generates economic activity through people employed in the process (e.g. banking staff, appraisers etc.) and indirectly by reducing payments and freeing up money for other consumption.

The second biggest impact is on lowering the value of the dollar relative to other currencies, which will reduce the trade deficit. Anyone who does not want a large budget deficit and/or negative private savings (like we had at the peak of the housing bubble) must want to see the trade deficit move closer to balance. This is an accounting identity -- there is no way around it. And, there is no plausible mechanism to get the trade deficit closer to balance except by reducing the value of the dollar.

For some reason Will fails to mention either the impact of quantitative easing on mortgage refinancing or the impact on the trade deficit. There is also zero evidence of the hyper-inflation that he and other opponents of more aggressive Fed actions have been warning about for years.

Comments (8)Add Comment
George Will, Always Late All The Time: Safe and Sorry
written by Last Mover, September 13, 2012 7:06
George Will advocating austerianism via less inflation over more employment under current conditions is like a hypochondriac driving a car who is so worried about getting bad gas mileage from driving faster, he slows down so much he never arrives at the destination.
George Will: penny wise, pound foolish
written by David, September 13, 2012 8:52
George Will advocating austerianism via lower inflation over less unemployment under current circumstances is like the miser who died from starvation when he found out that food costs money.
What He Wants To Say
written by Jeffrey Stewart, September 13, 2012 10:51
Following neoclassical macroeconomics by any name, Mr. Will means that achieving price stability now leads to lower unemployment in the long run. Of course in the long run...
what's the mechanism?
written by joe, September 13, 2012 1:48
What exactly is the mechanism for why QE will affect the trade deficit? Yes yes, weaker dollar, how exactly will it make the dollar weaker? The exact same amount of net financial assets exist after QE..
written by skeptonomist, September 13, 2012 3:32
If the Fed could actually maintain price stability there might be something in Will's claim. But in the 70's and 80's inflation skyrocketed while the Fed is generally credited with causing several recessions and unemployment as high as 10.8% (not exceeded in the current recession). This time there was no inflation to begin with and the Fed made the greatest effort in history to expand the money supply and lower interest rates, but it still did not prevent unemployment from going over 10%. And after two or more rounds of QE unemployment is still over 8%.

Apparently there is no evidence that would convince some economists that the Fed does not control the economy (both inflation and employment). They learned this as students and that was the end of it.
Why the dual mandate?
written by winstongator, September 13, 2012 4:51
It is very simple logically:
If the best way to maintain high employment was through price stability, then the fed would have a single mandate of price stability. There's a reason for the dual mandate.
written by Chris, September 13, 2012 6:50
I understand Will knows a lot about baseball. He knows very little about economics. So of course he makes his living with punditry about economics, etc.
How will this work?
written by john, September 13, 2012 7:47
So other countries in worse shape are going to sit idly by while we devalue our currency?

The people I know that have been able to refinance are fairly wealthy and I do not see their spending patterns changing much after doing a refi from 5.25% to 4.5%. Many of them had to bring cash to closing in order to get their loan to value ratios down. And many also shortened their loan terms from 30 to 15 years which resulted in higher monthly payments. Not sure how this is going to stimulate the economy much. Of course most of those that could refi have done so already. So unless rates go below 3.5% for 30 year mortgages I am not sure what Ben hopes to accomplish.

Those that could really use the help of a refi cannot qualify due to being underwater and/or having inadequate income. Many of these folks have very hefty second mortgages. The smart ones have already walked away from their mortgage(s). Many more are sure to follow.

And lastly I look at my mom and her friends (in their 70s). They are not going back into the stock market after being traumatized in 2008-2009. Much of their money is in CDs. They are cutting back spending as their interest income is reduced every time they roll over their CDs.

I wish Ben luck. His only hope is that housing prices increase rapidly and many of the underwater buyers that have hung onto their homes are able to refi in the near term. I find that a very unlikely scenario.

Obama blew it. He had a chance to restructure our banking system in 2009, but instead he listened to idiots like Summers and Geithner. We will be paying for his lack of courage for a long, long time.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.