Tags: Roach | Fed | medicine | economy

Stephen Roach: Fed Policy Is Wrong Medicine for an Ailing Economy

Monday, 01 Oct 2012 08:21 AM

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The Federal Reserve’s unorthodox measures to push interest rates as low as possible are the wrong medicines prescribed to a very ailing economy, said Stephen S. Roach, former chairman of Morgan Stanley Asia and current Yale economist.

The Fed recently announced it will buy $40 billion a month in mortgage-backed securities from banks to pump liquidity into the financial system in a way that pushes down interest rates across the broader economy to spur recovery, a monetary policy tool known as quantitative easing.

The move aims to fuel demand for financing and jolt the economy and lower unemployment rates.

Editor's Note:
Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

The Fed has rolled out two rounds of quantitative easing since the downturn, pumping a combined $2.3 trillion into the economy since 2008.

The third round seeks to spark investing and hiring at a time when the country is trying to pay down debts and rebuild savings amid an ongoing sluggish recovery.

Monetary jolts would work if the downturn were cyclical in nature, but they won’t work in the wake of a recession stemming from excessive debts run up during the housing boom that came due.

“[T]he treatment prescribed for this malady has compounded the problem. Steeped in denial, the Federal Reserve is treating the disease as a cyclical problem — deploying the full force of monetary accommodation to compensate for what it believes to be a temporary shortfall in aggregate demand,” Roach writes in a Project Syndicate column.

Other central banks around the world have rolled out similar measures, making matters worse in the process by fueling inflationary pressures at home while disrupting foreign exchange policies in developing countries.

“The developing world is up in arms over the major central banks’ reckless tactics. Emerging economies’ leaders fear spillover effects in commodity markets and distortions of exchange rates and capital flows that may compromise their own focus on financial stability. While it is difficult to track the cross-border flows fueled by quantitative easing in the so-called advanced world, these fears are far from groundless,” Roach wrote.

“As the global economy has gone from crisis to crisis in recent years, the cure has become part of the disease. In an era of zero interest rates and quantitative easing, macroeconomic policy has become unhinged from a tough post-crisis reality,” Roach added.

“Untested medicine is being used to treat the wrong ailment — and the chronically ill patient continues to be neglected.”

Other noted economists point out that once demand picks up and the economy does get moving, the massive levels of liquidity floating around in the financial system will pump up inflation rates, possibly before unemployment rates fall, which would exacerbate the pain of rising consumer prices.

“Although economic weakness now prevents inflationary price increases, these conditions will not last forever. At some point, demand will increase and companies will recover the ability to raise prices,” Harvard economist Martin Feldstein wrote in a Financial Times opinion piece.

”Such price inflation has historically been associated with tight labor markets and rising wages. But this time the unprecedented high level of long-term unemployment could cause the unemployment rate to remain high even when product markets tighten.”

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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