No end in sight to US jobless rise
By Hossein Askari and Noureddine Krichene
The unemployment rate in the United States rose to 9.5% in June 2009 from 3.6%
in October 2000 and 4.1% in October 2006. Most puzzling, as indicated in the
chart below, has been the obvious failure of Federal Reserve chairman Ben
Bernanke's unprecedented aggressive monetary policy to produce the quick
economic recovery that he promised at each interest rate cut.
The more he cut interest rates and the more he inflated the balance sheet of
the Fed, the higher unemployment has risen. Unemployment has kept on rising
even though the federal funds rate has been near zero since December 2008. The
unfulfilled promise of Bernanke, a proclaimed expert of the Great Depression,
has been certainly disappointing. However, Bernanke and his supporters have
kept crediting themselves that, without
unorthodox cheap monetary policy, the unemployment rate would have been much
higher.
The climbing unemployment rate has also been puzzling in face of unprecedented
expansionary fiscal policy and gigantic stimuli packages. The George W Bush
administration ran large fiscal deficits which reached US$455 billion in 2008.
House speaker Nancy Pelosi's stimulus package of $165 billion in 2008 was
intended, with announced certainty, to bring recovery in the third quarter of
2008. The Barack Obama administration initiated its own gigantic stimuli
package of $787 billion in February 2009 at a scale touted to be sufficiently
powerful to force a turnaround in the economy.
With the aim of quickening the economic recovery, the Obama administration has
decided to run the largest fiscal deficit in peacetime US history at 13% of
GDP. Yet, in spite of record fiscal deficits, the unemployment has kept on
rising. The Harvard multiplier has seemed to work in reverse, a performance
that would be disappointing to Keynesians who faithfully predict that fiscal
deficits turn stone into bread and multiply income and employment.
It is baffling that such extraordinary expansionary fiscal and monetary
policies and gigantic stimuli have failed to at least arrest job losses. The
job losses have even accelerated from 322,000 in May 2009 to 467,000 in June
2009. It would be very difficult to think of more unorthodox monetary policy or
more expansionary fiscal policy in order to bring about economic recovery.
Despite deepening economic recession, Bernanke and his counterparts on the
Obama team were still faithful to their prescription that unorthodox fiscal and
monetary policies would eventually produce a miracle and set the economy
booming again. Bernanke has recently restated his long standing view that
"final demand should be supported by fiscal and monetary stimulus".
Prominent US policymakers and academicians have related economic recession and
rising unemployment to the housing crisis. For instance, former Fed chairman
Alan Greenspan in a recent Financial Times (FT) article firmly believed that
economy recovery would take place once housing prices stabilize: "I conjectured
over a year ago on these pages that the crisis will end when home prices in the
US stabilize. That still appears right. Such prices largely determine the
amount of equity in homes - the ultimate collateral for the $11,000 billion of
US home mortgage debt, a significant share of which is held in the form of
asset-backed securities outside the US. Prices are currently being suppressed
by a large overhang of vacant houses for sale."
Greenspan rejected pressing calls to stabilize housing prices in 2003-2004. He
let the housing bubble inflate on with cheap fuel from the Fed, inflicting
trillions of dollars in losses on the banking system and triggering millions of
foreclosures. In his recent FT article, he was not explicit how housing prices
could be stabilized when the Fed was injecting $1.5 trillion in mortgage loans.
He was also not explicit about the level at which housing prices should
stabilize.
With the current Fed policy to re-inflate housing prices and the government
policy to prevent foreclosures and subsidize homeowners, it would be difficult
for housing prices to stabilize around a market-determined equilibrium price.
Greenspan was certainly confusing causes and effects. Prices of any good or
service are the result of demand and supply and policies that affect demand and
supply. Hence, prices cannot be stabilized around a market equilibrium level as
long as they are being distorted by monetary and fiscal policies.
Greenspan had certainly a partial view of prices. The US economy has faced not
only distorted housing prices, but also distorted and speculative prices in
other key markets such as food and energy markets and well currency markets.
The US auto industry was hit directly by oil prices and not housing prices.
Auto sales crumbled when oil prices soared to $147 per barrel. Demand for SUVs
and gas-guzzling cars suddenly disappeared with consumers opting for hybrids
and small cars.
In the same vein, when food prices rose by three to fourfold, food riots
erupted and demand for food was squeezed; and although we are in the middle of
a recession, food prices are back up again. Not only housing prices have to
stabilize but all prices have to stabilize. Since housing and commodity prices
are influenced by the same monetary and fiscal policies, these prices will not
be stabilized until these policies are stabilized.
Contrary to Greenspan's narrow view of the recession, Irving Fisher (1933)
forcefully argued that deep recession and large-scale unemployment can only be
explained by, and attributed to, over-indebtedness and overly cheap monetary
policy. The Greenspan-Bernanke excessively aggressive money policy has caused
many distortions in the US economy, pushed the ration of credit to gross
domestic product to unsustainable levels, and saddled banks with trillions of
dollars in toxic assets that finally played havoc with real economy and with
employment.
In other words, the rapid escalation of unemployment to 9.5% in June 2009
cannot be explained except by the aggressive cheap money policy of the
Greenspan-Bernanke era. Such policy pushed trillions of dollars to subprime
markets that melted down and consequently bankrupted the banking system in the
US and Europe. It provided free wealth to borrowers. It set off unparalleled
speculation in housing, stock, and commodity markets.
The collapse of stock prices inflicted trillions of dollars of losses in
pensioners' savings. Excessive mortgage payments and rising property taxes
combined with exorbitant food and energy prices have weighed dramatically on
household budgets and forced real cuts in demand for both essential and
non-essential goods.
The deliberate policy of Bernanke has been to re-inflate housing and asset
prices instead of stabilizing these prices. The June 2009 statement of the
Federal Open Market Committee reads: "In these circumstances, the Federal
Reserve will employ all available tools to promote economic recovery and to
preserve price stability. As previously announced, to provide support to
mortgage lending and housing markets and to improve overall conditions in
private credit markets, the Federal Reserve will purchase a total of up to
$1.25 trillion of agency mortgage-backed securities and up to $200 billion of
agency debt by the end of the year. In addition, the Federal Reserve will buy
up to $300 billion of Treasury securities by autumn."
Besides reducing interest rates to nearly zero, the Fed is mounting the largest
scale long-term liquidity injection under numerous lending facilities, and is
also bearing directly the risk associated with these loans under these Fed
facilities. Hence, with a bid to re-ignite housing speculation and send housing
prices soaring again, the Fed is pushing close to $1.5 trillion in mortgage
loans. Such a re-inflationary attempt cannot succeed unless banks are ready to
"play it again" - making loans to borrowers who cannot service them; and
borrowers put their heads in the sand yet again - taking on forbidden mortgages
they cannot repay.
However, not withstanding the death of securitization, banks continue to suffer
dramatic mortgage losses and homeowners remain unable to service their
mortgages. Hence, banks and homeowners would hardly accept to play the Fed's
game despite the willingness of the Fed to print money and bear all mortgage
losses. The Fed has also established the Term Asset-Backed Securities Loan
Facility (TALF) to inject $1 trillion in consumer (auto and credit card) and
small business loans. The Fed wants to drown consumers in debt and make them
spend out of loans instead of out of earned incomes in order to force an
economic recovery.
Bernanke seems determined to further undermine the safety of the US financial
system in spite of the highest default rates in consumer loans. Cheap monetary
policy will in time turn out to be inflationary and distortionary and will
inflict more financial losses on the banking system and on the government in
form of trillions of dollars in future bailouts.
Bernanke's Fed and the Obama administration are caught in an unsustainable
expansionary fiscal and monetary trap. Politicians would prevent interest rates
from rising above zero or any return to stable macroeconomic policies. The US
Treasury is building the highest US public debt and would oppose any rise in
interest rates. Major reserve central banks would oppose any rise in interest
rates and loose competitive ground relative to other countries.
Hence, the world economy could be stacked at near zero interest rates and
largely negative real interest rates for a long period to come. These low
interest rates will discourage real savings and private investment and
therefore constrain economic growth. They would be propitious to consumption,
speculation in asset and commodity markets, and preclude stability in prices.
Employment is related to real output through a physical relation called the
production function. Demand for labor is a derived physical demand related
directly to the real output of goods and services. Thus a fall in real output
would, in turn, lead to a fall in employment. Although the Fed has all along
denied inflation by considering solely core inflation that excludes food,
energy, and asset prices, real demand in the US has contracted under powerful
inflationary forces in housing, energy, food prices, and substantial
depreciation of the dollar exchange rate.
As wages do not change quickly, pension levels are fixed, and interest income
is low, the real incomes of workers and pensioners have been eroded by high
inflation causing a fall in real personal spending. The latter fell by 2.75% in
2008 Q3 and 2.99% in 2008 Q4. The cooling off of food and energy prices,
however, caused a slight increase at 0.95% in 2009 Q1. Although interest rates
were largely negative in real terms, real private investment showed negative
growth during 2006-2008 and fell dramatically by 8.2% in 2009 Q1. Such a drop
in real private investment caused an interplay of the accelerator-multiplier
effect and depressed real output, falling by 6.3% in 2008 Q4 and 5.5% in 2009
Q1. The record fiscal deficits will squeeze real private savings and crowd out
further real private investment, thus impeding sustained economic recovery.
Milton Friedman argued in 1968 that the central bank cannot control the
unemployment rate nor can it control real interest rates. It can only control
money supply and credit. In turn, he called for a stable monetary policy. The
Fed has so far inflicted heavy financial and economic losses and pushed
unemployment to 7 million. The Fed, with a view to boosting aggregate demand
and reabsorbing unemployment, has decided to inject trillions of dollars in new
long-term liquidity under various lending facilities at a time when the banking
has been overloaded with toxic assets and consumers were over-indebted.
The credit to GDP ratio stood at 350% in 2008 and was obviously unsustainable
as it caused large loan write-downs and bankruptcies. Forcing this ratio
further up will only compromise the safety of the banking system. As the
mountainous liquidity being injected by the Fed will not be hoarded in
mattresses, it will eventually cause runaway inflation, stifling economic
growth and employment as has been the experience since August 2007.
The Fed has created immense distortions in the economy and has pushed private
debt to still higher levels. The Obama administration has decided to push
public debt to levels that would have been unimaginable a year ago.
Unsustainable private and public debt will constrain economic growth for many
years to come. Historically, unsustainable fiscal and monetary policies have
not been conducive to growth and employment. High uncertainties prevail in the
economy and discourage private investment and employment expansion. Unsafe
credit has been a factor in every financial crisis, including the Great
Depression and the recent financial crisis.
Financial crises have called for new regulation, including the Pearl Act in
1844 in the United Kingdom and the Roosevelt administration regulations in
1935. Yet, these regulations did not, and could not, prevent crisis when
central banks deliberately undermined them. Inflationists have taken advantage
of costless money-printing to debase money and push unsafe credit with a view
to boosting aggregate demand and employment. Demand policies are insufficient
to achieve sustainable economic growth; supply side policies are also needed.
It would appear that the US economy is trapped in disorderly fiscal and
monetary policies that could delay recovery and employment creation for some
time to come.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist at the International Monetary Fund and a former advisor, Islamic
Development Bank, Jeddah.
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