All eyes on the Federal Reserve

All eyes are on the U.S. Federal Reserve’s meeting this week of its Open Market Committee, the body that sets interest rates. Until last week, the smart money anticipated a rise in U.S. interest rates, but comments by several board members has dampened such speculation and most observers now expect the Fed to leave rates unchanged, which in turn means that rates may not rise again this year.

A decision to stick with the status quo should not obscure larger, more pressing questions that surround economic policy. The economy of the United States is performing well, but considerable risks persist, not least of which is the prospect of a shock in the November presidential ballot. The biggest concern is the over-reliance on central bankers to run the world economy. Governments — executives and parliaments — have with rare exception taken little responsibility for economic management. Fiscal policy can and should be playing a larger role in stimulating and sustaining economic growth, but it is notable by its absence.

The federal funds rate, the rate at which the Federal Reserve lends money overnight to banks, is the Fed’s benchmark interest rate. Today, that rate stands at 0.5 percent; it was last raised in December, when it increased one-quarter of a percentage point; previously it had hovered around zero for seven years as the Fed ensured that money was available to banks (and the wider economy) in the aftermath of the 2007-2009 Global Financial Crisis.

December’s increase reflected a belief that the U.S. economy was recovering, and that the Fed needed to have some room to influence the economy if there was another downward shock. In other words, if such low interest rates became the new normal, Fed officials worried that they would have little ability to stimulate the economy in the event of another crisis. At the Open Market Committee meeting in June, the governors indicated that they planned to raise rates twice more during the remainder of the year, three times next year, and three more times in 2018.

Those plans were derailed by market gyrations in the first half of the year, some signs that the U.S. economy was slowing, and the United Kingdom’s Brexit vote in June, which introduced an unexpected source of volatility to the global economy. Since then, the U.S. economy has grown steadily, with unemployment dropping under 5 percent, prompting anticipation of a rate increase.

But earlier this month, Fed Gov. Lael Brainard, a dove who was nevertheless thought to be leaning toward a rate increase, gave a speech that revealed doubts about following through on that inclination. She noted that inflation has not only remained stubbornly below the Fed’s 2 percent target rate — as it has for the last four years — but that there is little sign of inflationary pressures. Growth may be steady, but it is sluggish and uneven. Unemployment is down but the labor market is not at full strength, and consumer spending remains weak. Most significantly, there remains the possibility of external shocks, from Europe or even China, forcing her to conclude that “today’s new normal counsels prudence in the removal of policy accommodation” and that “the case to tighten policy preemptively is less compelling.”

That view is not unanimous, however. Some governors are worried about inflationary pressures — they point to tightening labor markets — and insist that the worst overseas shocks have already occurred. The argument that the Fed needs room to be able to eventually lower rates if there is a shock remains persuasive. But low inflation, a steady unemployment rate and sub-normal growth (the U.S. aims for a 3 percent growth; it is currently 1.1 percent) reinforce the dove’s case for putting off any rate increases.

But the Fed debate obscures a larger, more important issue: the failure of governments to do their part and help stimulate growth. Since the financial crisis that hit nearly a decade ago, monetary policy has done most of the work to support the economies that were battered by that shock. Since then, inflation has remained abnormally low — there are fears that deflation is the new normal — as has productivity growth and investment. Governments and international lenders focused on debt levels and embraced austerity, turning their backs on time-tested Keynesian techniques to stimulate demand.

Central bankers have explored radical ideas in response. Japan has been leading the world in such thinking. It was the first to explore massive quantitative easing, it pursued zero or negative interest rates, and it is now discussing “helicopter money,” or having the central bank make transfers directly to the private sector. These policies confound every element of economic orthodoxy, but their spread suggests the traditional policymaking tool box is ineffective.

But fiscal policy must do its part. Governments must do more to stimulate demand, whether by funding public works projects, providing income transfers to low-paid workers or the unemployed, or otherwise prodding spending. While excessive debt is always a concern, it makes no sense not to borrow when interest rates are this low. Central bankers have done their part, it is up to politicians to do theirs.