Bernanke's Cures Are the Economy's Disease

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New jobs numbers from the Labor Department due out next week will give the Federal Reserve its first clue as to how the economy performed in May, and signal whether the Fed might start reducing its accommodative monetary policy.

In testimony last week before the Joint Economic Committee, Fed Chairman Ben Bernanke once again defended his agency's record. He said that the Federal Open Market Committee recognized the disadvantages of low interest rates, and sought "economic conditions consistent with sustainably higher interest rates."

However, he continued, that does not mean that he can let interest rates rise. "A
premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further."

Four years after the beginning of the recovery, Bernanke reports that the Fed is unable to allow interest rates to rise closer to historical levels. Might it be possible that the Fed's cure is worsening economy's disease?

After all, no country ever devalued its way to prosperity. If that were possible, then all countries would have to do to become rich would be to let their currencies depreciate. But this doesn't happen. Rather, weak currencies drive up prices of commodities and discourage saving and investment.

The Fed spends $85 billion a month purchasing Treasury bonds and mortgage-backed securities. Its record-low interest rates, caused by quantitative easing and purchases of bonds, encourage investors to take risks to get higher yields.

Older people, many of whom rely on income from savings and investments, have no choice but to move into riskier assets in order to be able keep up their standards of living. The low interest rates discourage savings and encourage people to take high risks, as well as dampening bank lending, making the economy sicker.

This is a bubble waiting to burst, and it will burst when interest rates rise to more normal levels. At that point the value of these risky investments will decline, and these older investors will be hurt. Plus, interest payments on the public debt will rise, increasing the budget deficit, which has been a trillion dollars a year for the past four years.

Other countries are following the Fed's example. On Monday the Korean won declined, as Korea tries to keep exports competitive. The European Central Bank is lowering rates to bail out Europe. Japan is expanding its currency because it is suffering from the devaluation of the dollar and the euro.

How high will interest rates have to go to head off future inflation? No one knows, and the Fed isn't inclined to start raising rates anytime soon, as Bernanke told the Joint Economic Committee.

In closing, the Fed Chairman said, "Because only a healthy economy can deliver sustainably high real rates of return to savers and investors, the best way to achieve higher returns in the medium term and beyond is for the Federal Reserve--consistent with its congressional mandate--to provide policy accommodation as needed to foster maximum employment and price stability."

That means that the Fed has to keep rates low in order to make the economy healthy so that interest rates can rise. Readers of Alice in Wonderland should feel quite at home.

Governments by nature are more concerned about what happens today than what happens in the future. So there is little pressure on the Fed to unwind its positions and raise rates. When rates are low, no one will blame Bernanke, because he appears to be doing all he can.

Perhaps Bernanke is waiting for Congress and the administration to make some sensible pro-growth decisions that will allow him to raise rates.

For instance, House Ways and Means Committee Chairman Dave Camp, a Republican, and Senate Finance Committee Max Baucus, a Democrat, could come together and craft a corporate tax reform bill. Both recognize that America's corporate tax rates are the highest in the industrialized world, and that America is one of the few countries that taxes corporations on worldwide income.

About $1.7 trillion in earnings are held by American multinationals offshore, because these funds would be taxed at 35 percent if repatriated. As Senate hearings showed last week, corporations such as Apple can legally avoid paying taxes by keeping funds out of the country.

Or, President Obama could approve the Keystone XL pipeline, sending an important signal that he supports America's new energy revolution. Not only would the pipeline's approval create construction jobs, but Canadian oil would flow to refineries in the Gulf of Mexico, increasing economic activity in that region.

With evidence that the Affordable Care Act is causing employers to reduce employment and substitute part-time for full-time workers, Congress could eliminate the Act's employer requirement to offer health insurance and fund the program out of general revenues.

Employers do not have to provide food, housing, and clothing to employees, all arguably more important than health insurance. There is no reason that they should be required to offer health insurance, nor should we be surprised when this mandate results in lower hiring.

Chairman Bernanke needs to allow interest rates to begin rising to historical norms. Some positive policy action by Congress and the administration might improve the economy and nudge him in the right direction.

Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter: @FurchtgottRoth.   

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