The Fed versus growth

The following editorial is from the Wall Street Journal

The Federal Open Market Committee released its latest monetary policy statement Wednesday afternoon following the government’s morning report that the U.S. economy grew a meager 0.2 per cent in the first quarter. The timing is useful because eventually the Federal Reserve should take some responsibility for subpar economic growth.

Nearly six years into this expansion, the economy once again hit stall speed last quarter. The Fed attributed the slow-down to “transitory factors,” by which it probably meant the cold winter and a strong dollar that hit exports.

The Fed implied that it expects growth to rebound, and there is some reason to wonder about how seasonal factors are being measured. Firstquarter growth has averaged 0.6 per cent in the last five years, which is highly unusual. Economists always blame the cold weather, but it is not news that winters are cold.

Transitory or not, growth sure was lousy. Following the fourth quarter’s slowdown to 2.2 per cent, the firstquarter plunge means the economy entered the spring with little momentum for the second year in a row. In 2014, the economy bounced back with two strong quarters, but growth for the year still registered a disappointing 2.4 per cent — the ninth year in a row without hitting the historic norm of three per cent or higher.

The larger story is that even if it does rebound the economy is still stuck in its two per cent-2.5 per cent slowgrowth mode. The long-promised upside breakout never seems to arrive, which means the growth gap betweenthe Obama expansion and every other modern expansion continues to widen.

Congress’s Joint Economic Committee points out that U.S. GDP would be US$1.7 trillion greater than its current US$17.71 trillion if growth in this recovery had merely met the historical average. That means 5.5 million fewer Americans are working than would be otherwise, and millions who are working have had little or no raise.

Which brings us to the Fed, and the relief in some quarters that at least slower growth means the

The Fed should wonder if its policies haven’t become an impediment to faster

growth

Fedwon’t raise interest rates in June, as everyone once expected, and maybe not at all this year. That’s the message that the Open Market Committee also seemed to be sending.

Yet the great paradox of this expansion is that the monetary policy that is supposed to spur faster growth hasn’t spurred faster growth. The nearby table compares GDP projections from the Fed’s policy makers with actual growth since 2011. (See accompanying table) The Fed has always been too optimistic — to a startling degree.

Economic forecasting isn’t easy, but it’s striking how consistently the Fed has been wrong in a single direction. Our guess is that the Fed gurus have been wrong because like so many in Washington and Wall Street they have overestimated the power of monetary policy to propel the real economy.

The Fed has been able to lift asset prices, but the expectations that this would lead to faster growth in the larger economy have never been realized. Yet the default policy when growth stays slow is always to keep doing more of what isn’t working.

It’s heresy to say so, but maybe after six years of zero-interest rates, and long after the financial crisis ended, the Fed should wonder if its policies haven’t become an impediment to faster growth. Maybe letting markets begin to set interest rates again would lead to a better allocation of capital and less economic uncertainty.

At the very least, the Fed should start analyzing why its forecasts have been so wrong for so long.