Despite the claim that last week's jobs numbers were "better than expected," they were in fact an abysmal indictment of US economic policy over the past two years. The unemployment rate has remained near or above 9 percent for 28 consecutive months, a policy failure not seen since the Great Depression of the 1930s. Unfortunately, our leaders have been in denial about the true nature and magnitude of the problem. The ongoing stock market anxiety surely must wake them up.
Many actions that would be helpful—extension and enlargement of the payroll tax cut, extension of unemployment benefits, extension of aid to the states, and a substantial and accelerated infrastructure program—require Congressional approval. I have no insights as to how to get such actions approved in the face of determined opposition by many members of Congress.
Instead, I propose aggressive actions that can be taken by the Obama Administration and the Federal Reserve without a single vote in Congress. Indeed, to some extent, these are the same actions I proposed nearly two years ago but that were never adopted. The stakes are higher now because of the harmful consequences of allowing long-term unemployment to persist.
First and foremost, the Federal Reserve should announce an additional $2 trillion of asset purchases, including longer-term Treasury bonds, agency mortgage-backed securities (MBS), and foreign exchange. This is more than three times the size of the woefully underpowered quantitative easing of late last year (dubbed QE2) and it should be accompanied by a clear statement that more is forthcoming if the economy continues to underperform. The goals are to push down bond yields and mortgage rates, to push down the value of the dollar in terms of foreign currencies, and to boost stock prices. All of these help households deleverage their balance sheets and encourage consumption, investment, and exports (which would become cheaper for foreign buyers as a result of the dollar's depreciation). Businesses would need to hire more workers to meet the additional demand.
It is important to recognize that $2 trillion of monetary stimulus is not comparable to $2 trillion of fiscal stimulus. In my previous proposal, I estimated that this policy would boost US GDP by an amount comparable to $500 to $800 billion in fiscal stimulus. However, monetary easing reduces rather than increases our national debt. An additional step the Federal Reserve should take is to stop paying interest on reserves held at the Fed. At a rate of 0.25 percent, these interest payments are a small but unnecessary subsidy to banks and a minor disincentive for bank lending.
The Obama Administration can help in two important respects: First, the Administration should use its control of Fannie Mae and Freddie Mac to force them to invite all homeowners whose mortgages are already guaranteed by Fannie and Freddie, and who are not delinquent in their mortgage payments, to refinance their current mortgage balance at the new low rates regardless of loan-to-value ratio. There should be no requirement to gain the approval of the current mortgage servicers, and the Administration should use moral suasion (and a publicity campaign if necessary) to prevent holders of second liens (home equity lines) from blocking the refinancings. Lowering mortgage interest payments on underwater loans would be the best way to prevent future defaults that would harm Fannie, Freddie, the holders of second liens, and US taxpayers. It is a win-win for all involved. In addition, a renewed push on mortgage modifications for homeowners behind on their payments could also yield broad benefits to borrowers and lenders alike at little cost to the government. Low long-term interest rates brought about by Federal Reserve policy would maximize the benefits to US households from resolving the mortgage mess.
Second, the Administration needs to acknowledge that the strong dollar policy, as enunciated for many years, is defunct and opt to embrace moderate further dollar depreciation consistent with monetary easing. Developing economies are spending more than $1 trillion each year manipulating the values of their currencies to subsidize their exports to the United States and Europe. Fiscal austerity in Europe and countervailing currency manipulation in Japan mean that the United States bears most of the cost of this modern mercantilism. As the world's largest net debtor, it is time for the United States to just say no to trade deficits. We need the high-paying jobs that come from exports.
Naysayers will argue that this strategy is a recipe for runaway inflation. Indeed, they have been saying that for nearly three years, but inflation remains extremely low. Inflation will never increase to a significant extent as long as unemployment lingers at this elevated level. But the Federal Reserve could assuage the fears of the inflation hawks by stating clearly that its policy would be rapidly reversed in the unlikely event that core inflation rises above 3 percent on a sustained basis. It is particularly important for policymakers to focus on actual inflation and not measures of expected inflation—that is the mistake made by the Bank of Japan during Japan's slide into deflation. The market has not proved to be a good forecaster of inflation.