The Federal Reserve, like Procter & Gamble and a host of other icons on the decline, faces a tough new world but appears captive to a failed strategic doctrine and is at wits’ end about how to effectively navigate monetary policy.
Sadly, for all of us, the Fed has no real competition — unlike P&G PG, +1.09% and other private-sector dinosaurs, it can’t lose market share to firms selling generics and boutique brands. If it makes bad policy, we are stuck with it.
At P&G, established management is engaged in a quarrelsome struggle with activist investors about how to cut costs and once again use slick ads to create hot new brands that enable it to put a few common chemicals and a seductive scent into a bottle and sell the concoction for huge multiples of actual production cost.
These days, folks that buy household and personal care products are better educated and more sophisticated than during the 1950s and 1960s. They have a greater intellectual immunity to pitches to pay more for “new and improved” when generic detergents or a Good News razor work as well as Tide or an expensive new shaving system.
Likewise, the Fed appears obsessed with pushing inflation to 2% as if anything less would not stimulate adequate growth. However, the temporary surge in gasoline prices from Harvey notwithstanding, inflation appears stuck below 2%. And with unemployment at pre-financial crisis levels, the Federal Reserve appears as out of touch as the folks that run P&G.
Inflation remains low because labor markets have changed — the decline of unions, rise of the contingent economy, more pervasive federal benefits that permit the semiskilled to work at very low wages, import and immigration policies that make international wage arbitrage pervasive, and breakthroughs in artificial intelligence and robotics that make easier substituting capital for labor.
And the shift from old-line manufacturing to technology products as the fundamental drivers of growth now permit businesses to create a lot more value with existing capacity and smaller investments in physical assets. That reduces the demand for and cost of capital and helps keep down the cost of making goods and services too.
With the industrialized economies growing in sync and at the best pace since before the financial crisis, it is apparent that low inflation is no barrier to economic expansion. And after nearly a decade of easy monetary policy, there is no theoretical or empirical evidence that cheap money can appreciably boost the U.S. growth rate above the 2% rate that was achieved during the Bush and Obama recoveries.
Moreover, very cheap money for long periods of time, as surely as too much inflation, begets speculation and skews reward structures for our brightest young people toward careers in finance away from engineering, with obvious consequences for long-term growth.
Putting the economy on the crutches of cheap credit enables politicians to put off structural measures — like health care and tax reform, streamlining financial regulations, and curbing entitlement abuse.
So why does the Fed cling to easy money?
Too often CEOs and boards — and Janet Yellen and the Fed governors are no exception — are so focused on the execution of established strategies and wedded to old doctrines that they don’t see the world and the imperatives for their success changing around them.
When the Fed meets Tuesday and Wednesday, it should begin the process of unwinding its huge holdings of Treasuries and federal agency securities. That shouldn’t be as big a process as doves like Lael Brainard fear.
The Fed added some $4 billion in the wake of the crisis to boost its portfolio of securities to $4.5 billion. However, changes in Fed operations — such as offering interest-bearing deposits to money-market funds, asset managers and hedge funds — now require that it continue to hold at least $2.5 billion in assets, and Ben Bernanke estimates that figure will rise to $4 billion over the next decade.
It’s time to rethink the 2012 policy statement, which established the Fed’s 2% inflation target, and link interest rate policy to accomplishing 2% GDP growth and reasonable confidence that flight path for the economy can be sustained that over the next year or two.
