Green Shoots and the Fed

Here are some responses to Bernanke's Press conference from The Room for Debate:

• Ducking the Jobs Question: Mark Thoma
• Aiming for One Percent Inflation?: Brad DeLong
• Problems He Can't (or Won't) Solve: Megan McArdle
• Opacity Has Its Uses: Vincent R. Reinhart
• Clarity Helps in a Tough Job: Garett Jones

Here's mine:

The Fed’s dual mandate requires it to pursue both full employment and price stability. Currently, however, the Fed is falling short on both of these goals.

Employment is far below its full employment level, and inflation is running below the Fed’s preferred range of 1.5 to 2.0 percent. Inflation is expected to rise a bit in the short-run due to rising commodity prices, but the Fed says it expects commodity price increases to be transitory.

Thus, none of the Fed’s forecasts show any long-run concern about inflation at all. The main question I wanted to hear Bernanke answer is, given that inflation is expected to remain low, why the Fed isn’t doing more to help with the employment problem? Why not a third round of quantitative easing?

Bernanke was asked this question, but his answer was unsatisfactory. The potential benefit of further policy moves by the Fed is higher growth and lower employment. The potential cost of more quantitative easing is inflation. So the decision on whether to provide more help to labor markets comes down to a comparison of the expected employment benefits to the expected inflation cost.

Even though there is no evidence of a problem in the Fed’s own projections, and the prices of long-term financial assets dependent upon future inflation show no evidence of inflation worries either, Bernanke nonetheless said that he believes the costs have risen relative to the benefits — that is, the Fed’s worry about inflation is standing in the way.

But I think there is something else behind the Fed’s reluctance to continue easing. The Fed first began seeing “green shoots” in April of 2009, a full two years ago. At every step since, the Fed has used the prospect of better times just around the corner as a reason to downplay the benefits of further easing.

But the growth of the green shoots has been stunted, or they have wilted away entirely. In retrospect, more aggressive action by the Fed was warranted in every instance. Perhaps this time is different — I sure hope so — but the recovery has been far too slow to be tolerable. Green shoots require more than hope, they require the nourishment, and with fiscal policy out of the picture it’s up to the Fed to provide it.