The Fed is Ready to Throw in the Towel

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The Fed appears to be backing away from further attempts to use monetary policy to stimulate the economy. They have reinforced what many economists believe about the use of monetary policy in a balance sheet recession. In the first place, the inflation predicted by some economists did not happen. Its hard to get inflation when there is high unemployment. In the second place, the Fed may have kept us out of a deflationary spiral, but low interest rates only kept the housing market from getting much worse. Unlike previous recessions, in which low interest rates stimulated the housing market, and led us out of recession, the hangover from the bubble burst is still impacted the housing market. We should be worried about what happens next in the housing market when the Fed stops purchasing mortgage securities and mortgage rates rise.

We also learned that business investment is not primarily driven by interest rates. High levels of household debt, and deleveraging, along with high unemployment, has kept consumer demand from rising. Business investment depends upon expectations of consumer demand growth.

What happens next is dependent upon fiscal policy which is in the hands of politicians who are more focused on developing talking points for the 2012 election than they are on dealing with high unemployment. That will have to wait until after the election and it could get worse.