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Home Publications Blogs Beat the Press The Washington Post Tells Readers That It Doesn't Understand How Monetary Policy Works

The Washington Post Tells Readers That It Doesn't Understand How Monetary Policy Works

Wednesday, 20 October 2010 04:59

A Washington Post editorial expressing doubts about the Federal Reserve Board's plan to boost the economy with additional quantitative easing told readers:

"it's not clear how the Fed will sop up all the extra liquidity it's creating once growth resumes." 

Actually, it is clear. The Fed has several tools to reduce the money supply and prevent inflation. It can raise the federal funds rate that banks pay for borrowing reserves overnight, it can increase the reserve requirement, forcing banks to hold more reserves, and it can raise the interest rate it pays on reserves encouraging banks to hold more reserves. One would hope that the Post's editors would be familiar with these mechanisms.

The piece then goes on to express its real concern:

"The deeper fear is that QE2 is a cyclical solution to a structural problem. Many corporations are flush with cash already but simply don't see enough opportunities for profitable investment within the United States. The list of reasons include households with too much debt; political and policy uncertainty; a growing mismatch between the skills of unemployed U.S. workers and the available work; and a broader shift in economic dynamism from the developed to emerging markets."

This is an interesting story. All the evidence, including what appears in the Washington Post news section, suggests that we have a cyclical (i.e. not structural) problem. In other words, unemployment as soared because the economy lacks demand.

The problem is that the economy was driven by an $8 trillion housing bubble. Now that this source of demand has disappeared, the economy needs a new source of demand. In the short-term this demand can only come from the government and from very stimulatory monetary policy. In the longer term, a lower dollar is needed to move the trade deficit closer to balance.

There is zero evidence to support the Post's claim of, "a growing mismatch between the skills of unemployed U.S. workers and the available work." It would be an important news item if it uncovers any evidence of this phenomenon.

Comments (12)Add Comment
written by izzatzo, October 20, 2010 6:46
From the WAPO article, this quote:
The case for QE2 is straightforward. By bidding up the price, and thus lowering the yield, of Treasuries and other safe debt instruments, the Fed encourages investors to put their money into different, potentially higher-yielding investments such as stocks. This reduces the cost of capital for businesses, which enables them to expand, which creates jobs.

This makes the cost of capital from the government with less risk, less attractive than a private source with a higher cost of capital.

Investors may prefer a higher rate of return over nothing or near zero, but if demand has collapsed and investment remains inelastic to the cost of capital over the relevant range due to flagging sales, it won't increase aggregate spending.

If it did, it's the same as claiming that tax breaks would increase spending, which they have not. If someone is satiated and not hungry, dropping the price of bananas to encourage a switch from apples doesn't work.

Otherwise Baker is correct. Sopping up liquidity by the Fed is as easy as dishing it out.
written by Eleanor, October 20, 2010 8:13
I suspect this is the key line: "Many corporations are flush with cash already but simply don't see enough opportunities for profitable investment within the United States." I don't think it's lack of skill in the US, but rather higher labor costs and lower profit margins. The corporate desire to off-shore might be called 'structural,' I guess.
retired professor of economics, Western Illinois University
written by Dr. Richard Hattwick, October 20, 2010 8:16
Dean Baker is performing a wonderful public service with his periodic explanations of how the Fed can support fiscal policy and successfully manage monetary policy. His periodic examples of the Fed purchasing Treasury debt and returning interest payments to the Treasury is knowledge that is shockingly absent from public discussions of a new federal government stimulus. This posting on using the reserve requirement to sop up excess liquidity is also sadly lacking from most discussions of public policy actions. Congratulations, Dean, on your somewhat lonely contribution to economic literacy.
burying the body
written by pete, October 20, 2010 9:34
In commodities manipulation, unlike monetary manipulation, the phrase is called burying the body...Say, buying a lot of silver to drive up the price and make previously established long silver futures positions profitable, then trying to sell the silver (bury the body) and not lose too much money. Same principal is at work here. In currency manipulations, trying to peg a currency rate away from equilibrium, for example, central banks usually lose a lot of money. Here, the issue is GDP growth vs money growth. If GDP never really takes off, the Fed will have nowhere to bury the body other than through inflation.
How can there be a shortage of qualified labor?
written by diesel, October 20, 2010 11:11
Since the invention of the steam engine, power looms, interchangeable parts, and division of labor, any particular manufacturing job has been stripped down to the barest of simple tasks. In a factory, the ability to endure tedium is the most valuable asset an employee can have . Early attempts to create a compliant workforce met indifferent success when highly skilled master tradesmen simply walked away from their factory jobs in the middle of a shift. Accustomed to work that engaged their creative faculties, they found the hollowed-out routine imposed by the production line intolerable--an eminently sensible response, but doomed in the long run. How can lack of skills be the limiting factor in an economy that doesn't generally depend on skill? The brighter ones--the industrial engineers and so on--are well paid to design it that way.

This is a fabrication designed to distract us from the simple truth about labor costs and draw attention away from the disloyalty of our manufacturers. When you look at it from their perspective, it makes sense. I mean, they can hardly say "Look, we don't give a damn about you. We'll outsource your job to wherever provides the cheapest labor, lowest taxes and fewest environmental regulations. The only reason we even operate in the USA is because of historical precedent. As long as the US provides a stable currency, safe banking system (relatively), a compliant, easily-manipulated government, an imposing army and an effective internal police backed up by a pervasive internal spy agency, we'll continue to do business and keep our corporate headquarters here. "Business friendly" we like to call it. For three years, you will loan us your children so we can teach them to kill people around the globe in order to enforce the sacred honor of our business contracts. Obey the law and show up to work on time. That's all you have to do. Oh, and root for your home team, (the professional franchise in your area that we also own). Show your loyalty by wearing an official team issue cap (another franchise we own)."
written by James Hogan, October 20, 2010 11:55
Based on my reading of the Washington Post, including it's editorials and columnists, it is very apparent that the WaPo has a political agenda and all writings are constructed to conform to this agenda.

It doesn't matter what the facts are, for they are sliced and diced to produce the message that the WaPo wants to project. No better example of this trait can be found than in the writings of Steve Pearlstein, who claims to have found the "truth" about economics and can't understand why others find him both wrong and boring, to boot.
Just a note of thanks
written by Tim Fuller, October 20, 2010 11:56
Your weblog is a public service. It's readable and educational about the most important topics out there. I pass on your insights whenever relevant.
some can become musicians?!
written by frankenduf, October 20, 2010 12:10
yo deez- u could probably set that last paragraph to music and let it go viral- most people would assume it's a new system of a down song
written by Matt, October 20, 2010 3:24
The problem is structural. The "structure" is one of leveraged rent-seeking. Now that the main avenue of rent-seeking (land) is closed, no one knows what to do. Invest in actual production of wealth? Are you mad?! It's just not done in these parts.
Not so sure
written by Jay, October 20, 2010 7:42
"The list of reasons include households with too much debt..." The US isn't the only country with households drowning in debt. It would be nice to have that reflected in the article.

"political and policy uncertainty..."
Seriously? There are countries much more unstable that are receiving floods of cash without any concern about their political uncertainty.

"a growing mismatch between the skills of unemployed U.S. workers and the available work"

What is the mismatch? You have college educated people willing to work at Starbucks just to get a salary and experienced people changing careers after companies lost faith in demand not skills. The skill is there. It seems employers want independent contractors that can be controlled like employees so they can attempt to avoid the obligations and burdens of having an employer-employee relationship.

"and a broader shift in economic dynamism from the developed to emerging markets."

Haven't we been hearing this for at least 20 years? There is so much social inequality in many emerging markets it makes me wonder whether these countries will provide much long term demand after the initial hype has worn off.
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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.