Yesterday’s big Ben Bernanke press conference made one thing abundantly clear: the Fed is not about to embark on any aggressive program to bring down the level of joblessness.
Why not? With unemployment at nearly nine percent, there can be little doubt that we are currently experiencing a jobs crisis. Shouldn’t the Fed be doing more?
I suspect the answer is that Bernanke doesn’t believe the Fed can do more. He likely understands that if the Fed were to continue to engage in aggressive monetary easing—stoking fears of inflation—joblessness would actually increase.
This is the key statement from Bernanke: “I think that even purely from an employment perspective, that if inflation were to become unmoored and inflation expectations were to rise significantly, that the cost of that in terms of employment loss in the future as we had to respond to that would be quite significant.”
The problem Bernanke was alluding to is monetary easing may lead to increased expectations of rising prices—even in an economic environment where core inflation remains low. And when inflation expectations get out of sync with actual inflation, this can have a devastating impact on jobs and the economy.
The mechanism for this is fairly straightforward. Say the Fed launches a third round of quantitative easing, injecting more money into the economy by purchasing securities. This new money is mildly inflationary—but, like previous rounds of easing, the Fed makes sure that it doesn’t inject so much money into the economy that prices rapidly shoot upward.
The public, however, might come to the conclusion that the Fed has gone too far and is creating the conditions for inflation. Workers anticipating higher prices will demand higher wages to compensate. If the rise in the price of labor exceeds the actual rise in the supply of money, businesses will be forced to lay workers off.
This is not just a theoretical possibility. It actually occurred in the 1970s in Brazil. Inflation was running at a rate of around 75 percent.
Workers, naturally, were demanding steep wage increases just to keep up with rising prices. When policy-makers sought to bring down inflation to around 45 percent, unemployment sharply rose. This was the totally predictable consequence of a monetary policy that attempts to keep inflation below the level widely anticipated.
And we're already seeing some of this thanks to earlier rounds of easing. Many people are convinced that prices are rising much faster than government statistics reveal.
What Bernanke wants to avoid is any policy that will raise expectations of inflation. Think about what would happen if inflation expectations rise beyond those justified by monetary policy. In that circumstance, the Fed would have to adopt one of two bad policies.
1. Increase the level of monetary easing to allow actual inflation to catch up with inflation expectations. But this might not be possible.
More easing could further heighten inflation expectations—requiring even more actual inflation. This is how central bankers can trap themselves into an inflationary spiral.
2. The alternative is to refuse to inflate to meet expectations—producing the Brazilian problem of rising wages and rising unemployment.
Far better—in Bernanke’s view—to keep inflation expectations from rising than to have to engineer a monetary policy in an economy that anticipates rapidly rising prices. And, right now, that means that the Fed can’t do more to fight unemployment.
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