By GENE EPSTEIN
The Fed’s mandate to maximize employment will undermine its other mandate, to keep inflation at bay. Seduced by what can only be called low teaser rates, the U.S. Treasury is piling up staggering debt that does not cost much to finance right now, but will ultimately bust the budget.
You may have heard by now of the Federal Reserve’s “dual mandate.” Not content to merely protect us against the ravages of price inflation (mandate No. 1), our fearless Fed is equally committed to fostering “maximum employment” (No. 2). And right now, with the unemployment rate still at 8.3%—far too high to meet anyone’s definition of full employment—the central bank understandably favors No. 2 over No. 1.
That was again made clear in the release last week from the Federal Open Market Committee—Chairman Ben Bernanke’s group of Fed governors and presidents empowered to set short-term interest rates. The FOMC statement declared that the target range for the interest rate on federal funds would be kept at 0% to 0.25%. It also reiterated the somewhat astonishing commitment that these “exceptionally low levels for the federal funds rate” would be maintained “at least through late 2014.”
Set aside for the moment the potential distortions that such a regime might introduce into the structure of the economy. As CEO Peter Schiff of Euro Pacific Capital has pointed out, the Fed’s interest-rate policy has mortgaged the economy at an “adjustable rate” that will eventually cause damage once the rebound in rates inevitably occurs. Among other profligate borrowers seduced by what can fairly be called low teaser rates, our own U.S. Treasury is piling up staggering debt that does not cost very much to finance right now, but whose financing costs might ultimately bust the budget once rates climb.
NOT TO WORRY, HOWEVER; between now and late 2014, soaring financing costs of the federal debt probably won’t be a problem. Nor do I agree with the other objection about the intermediate term frequently raised by the Fed’s critics: that over the next year or two, the central bank’s pursuit of the employment mandate will undermine its other mandate, the need to keep inflation at bay.
As I’ve argued before (“Inflated Inflation Worries,” Feb. 21, 2011), the Fed’s current monetary expansion is a necessary, but not sufficient, condition for a sustained rise in prices. Also required is a sustained rise in the price of labor, which I doubt will occur with the slack labor markets implied by the 8.3% jobless rate. The great inflation of the 1970s began in a state of low unemployment—although, of course, it ultimately resulted in the stagflation of high unemployment and double-digit inflation.
The Fed clearly shares my complacency. Mindful of the threat of high prices at the pump, last week’s FOMC statement acknowledged that the “recent increase in oil and gasoline prices will push up inflation temporarily,” but that “subsequently inflation will run at or below the rate” the committee judges “most consistent with its dual mandate.”
Friday’s release of the February consumer-price index offered some vindication of that outlook. The 12-month rise in the all-items CPI ran 2.9%, but excluding the price of energy, the rise was a tamer 2.4%. Also, the Fed prefers to focus not on the consumer-price index, but on the index for personal-consumption expenditures, which almost always runs a few tenths of a percentage point lower than the CPI. So when the February PCE index becomes available, it will probably show an even lower inflation reading.
IF THE NEXT COUPLE OF YEARS ARE a not-to-worry, and if we forget about long-term distortions from today’s low interest rates, what else is there to object to? Well, for one thing, there is the central bank’s hubris in assuming that it can handle the potential contradictions of the dual mandate, as evidenced by the stagflation of the 1970s.
In his recent testimony before Congress, Bernanke candidly acknowledged that “dual objectives of price stability and maximum employment” are not always “complementary.” But in those difficult cases, he assured the gullible legislators, in somewhat obscure prose, the Fed “follows a balanced approach…taking into account the magnitudes of the deviations of inflation and employment from levels judged to be consistent with the dual mandate, as well as the potentially different time horizons over which employment and inflation are projected to return to such levels.”
Now, that kind of prescience is quite a magic trick for the Bernanke Fed, which, based on evidence that recently came to light, completely missed the coming of the 2007-08 mortgage meltdown that brought soaring unemployment; or for an FOMC that, based on a track record that I recently ran, generally fails to forecast inflation and unemployment accurately even in the same year.
In his book The Age of Turbulence, Bernanke’s predecessor, Alan Greenspan, foresees serious price inflation beginning around 2030. He points out, first, that the benign “disinflationary pressures” from economies like that of China will have played out by then. And at the same time, inflationary forces will be intensified by the fiscal “tsunami” brought on by retiring baby boomers. By then, if not sooner, the Fed will probably fumble its dual mandate.