Thursday, 16 May 2013

Should central bankers be concerned with unemployment

In a recent speech Ben Bernanke, head of the US Federal Reserve told us that the stagnation of the labour market is a “grave concern” because of “the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years”. This is pretty strong language for a banker?  On our side of the pond Mark Carney arrives to take the reins at the Bank of England in a couple of months and he has hinted that the Central Banks should have wider concerns than interest rates and inflation.
There are two question that are prompted by this loose banker talk, firstly what monetary policies might they have up their sleeves to save the world from high unemployment and secondly,  should they have these wider concerns anyway. 
Central Bankers have limited options for reflating an economy and all of these techniques have been tested over the last 5 years in different markets.  Britain has led the way in balancing mild austerity with a reflationary monetary policy, which has included large doses of (plain vanilla) quantitative easing.  They have supplemented this QE with negative real interest rates, and a more direct “funding for lending” scheme that attempts to force that banks to lend more to business.
Bernanke takes control
Bernanke gave us a detailed assessment of the costs and benefits of unconventional policy easing by the Fed. He believes that bond purchases by the central bank had reduced long term interest rates by 0.8-1.2% points, which has increased output by about 3 per cent, and employment by about 2 million jobs. These are significant benefits and well worth the costs, which were fairly minor.  There is no doubt that the initial exercise to pump liquidity into the banking system was absolutely critical and saved us from a 1930 style banking crisis, where banks rushed to improve liquidity by for-closing on distressed debt.
Similar to a sick patient who requires a blood transfusion to solve an immunity problem, the first doses is always the most important, subsequent transfusions make an incrementally smaller and small difference.  These subsequent injections of new blood may have some psychological effect but they probably don’t have much physiological impact.  In the case of QE further doses will remind investors and borrowers that there is a medium term intention to keep rates low but that’s about it.
This issue of communication and managing people's medium term expectations on the costs of money (whatever the inflationary outlook) seems to have got the whole economics fraternity’s attention.  Bankers are now thinking that by aggressively managing creditor expectations they can govern growth rates, employment rates and probably the timing of the “second coming”!
The problem here is common among bankers, once you give them some credibility they want to take over the whole world;  misunderstanding that the real economy depends on markets for goods and services and these are the markets that provide jobs and sustain lasting growth.  What many of these markets need is structural reform and more competition, and QE is likely to work in the opposite direction, propping up failing business, reducing the need to raise productivity and generally penalising depositors whilst rewarding creditors.  As central bankers around the world search for better ways of communicating their intention to keep real interest rates at a negative or very low value what the real world economy need is an assurance that the value of money will be restored.

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