Forget QE3; It's Time for a New WPA

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (BBH FX Strategy) -- With the U.S. economy stalling in the first half of the year and poor survey data, it is hardly surprising that Federal Reserve Chairman Ben Bernanke's Jackson Hole speech on Friday is being awaited anxiously for fresh signals about how the central bank will respond.

Yet, unlike a year ago, the risk of deflation has all but disappeared. The core consumer price index is just below 2%, and core personal consumption expenditures in the second quarter stood at 2.1% (compared with 0.8% in the third quarter of 2010).

Not only is the Fed's preferred (but not sole) inflation gauge elevated, the $600 billion of Treasuries the Fed just finished purchasing and continues to hold appear to have done very little in real economic terms or in rekindling the animal spirits of risk-taking.

Interest rates are considerably lower than a year ago. With the U.S. two-year yield within the federal funds target, the five-year yield less than 1% and the 10-year yield slightly more than 2%, how much lower can yields go?

And will a marginal decline in Treasury yields have much impact ? Will a marginal increase in the Fed's balance sheet have much impact?

It is difficult to know what the market is really expecting from Bernanke at the end of the week. Many banks seem to be playing up the odds of a third round of quantitative easing (QE3) being signaled, but they seem to have a vested interest.

There are a number of other options that Fed officials have cited. These include cutting the interest rate on excess reserves (though no one is really talking about a negative rate or a penalty for holding excess reserves), extending the maturities of the Treasuries the Fed holds and including the size of its balance sheet in guidance about rates remaining low for an extended period of time. At times, the idea of a formal inflation target or a interest rate target for yields further out on the curve have also been suggested.

While Bernanke will want to show that the Fed still has options at its disposal, with various trade-offs associated, perhaps he may want to also underscore the limitations of monetary policy.

With nominal and real interest rates extremely low, banks with ample wherewithal to lend and easing loan conditions (as reflected in the most recent senior loan officer survey), maybe at this juncture there is not much more that monetary policy can do.

If current conditions are somewhat like the Great Depression, then we may need to face the fact that it ultimately was not monetary policy that ended the Depression but fiscal policy.

A couple of weeks ago, the Spanish finance minister was quoted saying that it was more important for Spain to reach its austerity targets than to revive growth. This is seems, well, foreign, to many Americans. It is not that growth is panacea, but it does make seem to make problems easier to deal with.

In the U.S., despite the hand-wringing over the debt-ceiling debate and recognition that the fiscal trajectory is not sustainable, polls suggest jobs are more salient to Americans than immediate deficit/debt reduction.

One of the largest and arguably more successful New Deal efforts was the 1935 Works Progress Administration (which was later renamed the Work Projects Administration). It worked with local and state governments to hire millions of workers to perform a wide range of functions, including the construction of buildings and roads.

In 1935, the federal government spent $1.4 billion, which was 6.7% of that year's GDP. Over the course of the WPA some $13.5 billion was spent, and at the program's peak, 3 million men and women were employed. Between 1935 and the end of the program in 1943, the WPA created some 8 million jobs. It affected almost every community in the nation.

The media are reporting that President Obama is preparing a major speech next month and will unveil a new economic initiative.

A WPA program dovetails nicely with calls for an infrastructure bank. Such an effort, especially if coupled with a medium-term strategy to address the excessive public debt, could make for good politics as well as economics.

As a student of the Great Depression, Bernanke -- viewing the crisis through the monetary lens of Milton Friedman -- has argued that the Federal Reserve exacerbated a "normal" business cycle and turned it into a monumental crisis.

Now at the helm of the Fed, Bernanke has succeeded in turning back the threat of deflation.

Perhaps the necessary heavy lifting our economy needs cannot be done through monetary policy. Perhaps it is time for Bernanke, who helped devise a virtual alphabet soup of facilities to ease the credit crunch during the crisis of the past few years, to remember one more abbreviation: "IMF," for "It is Mostly Fiscal."