Appearing before Congress, Fed Chair Ben Bernacke predicted that the economy would not improve unless Congress addressed looming spending cuts and the expected increase in taxes. In response, Senator Charles Schumer of New York said that because Congress was unable to act it was the Fed's job to stimulate the economy. Therefore, the Fed should get to work. Only a couple of weeks later the Fed announced that it would be offering another stimulus package. And yet it is this passing the buck that is really the problem. For too long Congress and the White House have relied on the Fed to stimulate the economy through monetarism because it effectively absolves the political institutions of responsibility that typically accompanies fiscal policy. Still, each approach by itself is limited, and what is needed is the two together along with another tool, an incomes policy.
Monetary policy is essentially a bottom down approach that assumes that if interest rates can be lowered enough, investment will be stimulated and jobs created. All the Fed can do at the moment is get more money into the economy either through lowering interest rates again and more quantitative easing. Interest rates are already at their lowest level in years, and so far to little effect. The problem with the monetary approach is that it rests on faulty assumptions. Pumping more money into the economy, in and of itself, will not create jobs. Job creation requires a more grassroots approach. In order for there to be jobs creation, there needs to be aggregate demand for goods and services. Therefore, it matters not how much interest rates are lowered. If there is insufficient aggregate demand because individuals lack the financial wherewithal to demand goods and services, nothing is going to happen. To a certain extent, fiscal policy can help in this regard. By lowering taxes, individuals will have more money in their hands and will be able to demand more. But the current debate about extending the Bush era tax cuts is not really a serious discussion of fiscal policy. Extending the tax cuts is not the same as putting more money in people's pockets; rather it simply prevents more money from being taken out of people's pockets. What is needed is lowering taxes in conjunction with monetary policy, which would also require serious tax reform. But this too isn't enough.
need to have incomes that support their demand for goods and services in the
aggregate. This would require some type of incomes policy in conjunction with
monetary and fiscal policy. Milton Friedman, for instance, assumed that wages
would rise, but believed that monetary policy would also serve as a means of
maintaining wage restraint. While advocating roughly a three percent steady
growth in the money supply to maintain stability, it was also assumed that
money wages would also be constrained. In short, wages would increase to match
productivity (which was roughly rising at three percent per year overall), but
faster wage growth would be harder to achieve. His formula simply assumed wage
growth. But a more formal policy to ensure wage growth might be necessary. The
reason is actually quite simple: it really does not matter how many jobs might
be created ether through tax reductions or lowering interest rates if people's
incomes fail to keep up with inflation. It is true that inflation is at an all time
low, but wages have also been stagnant for more than three decades. This was in
part compensated for by people's reliance on credit cards. With the financial
meltdown, however, this too has become more difficult.
market purists will, of course, claim that it is wage rigidity that is the
problem, and that a policy that prevents flexibility will cost jobs. The issue,
however, is not wage rigidity and tax rates. It is insufficient demand for
goods and services because of insufficient incomes. Assuming that an incomes
policy is a set of labor market institutions for the purpose of bolstering
wages, it is critical because without it the erosion in the value of workers'
wages means that they are unable to continue demanding goods and services. An
economy, after all, needs to be built from the bottom-up; not the top-down. At
the end of the day all institutions must work together. This requires
coordination; not passing the buck as Congress attempted to do in response to
Bernacke's bad news.