Loose monetary policy is not the path to economic growth

Raymond Keating Chief Economist, Small Business & Entrepreneurship Council
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The Federal Open Market Committee released its latest statement on the economy and monetary policy on December 14. In it, the Bernanke Fed reaffirmed its commitment to running loose monetary policy in the hopes that it will somehow juice up economic growth and job creation.

The FOMC statement summed up the far-from-ideal state of business and investment as follows: “Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed.”

The Fed also has declared that it has no concerns on the inflation front. In fact, the FOMC continued its line that “measures of underlying inflation are somewhat low.” As a result, the FOMC reiterated its intention to “purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month,” and “maintain the target range for the federal funds rate at 0 to 1/4 percent.”

Unfortunately, loose monetary policy is not the path to more robust economic growth and job creation. Those are matters meant for fiscal policy, that is, tax, regulatory and spending policies. However, as we know, fiscal policy has been working against entrepreneurship, investment, economic growth and jobs for some time now.

In fact, the tax deal between the president and Republicans in Congress — which would extend much of the Bush-era tax cuts for two years — is the first non-negative to emerge on the fiscal policy front in a very long time. Though to have a substantive and lasting impact on the economy, those tax measures at the very least need to be made permanent.

The only thing guaranteed by the Fed’s actions is increased inflation risk down the road.

Only one FOMC voting member — Thomas Hoenig — voted against the December 14 statement. At the end of the statement, it was noted: “In light of the improving economy, Mr. Hoenig was concerned that a continued high level of monetary accommodation would increase the risks of future economic and financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.”

Hoenig’s concerns are right on target. Eventually loose monetary policy channels its way into a rise in the general price level, i.e., inflation. We’re already seeing signs of the problem in rising commodity prices, such as increases in the prices of gold and oil.

The right policy mix to get the economy on track is tax and regulatory relief, along with spending reductions, to spur growth, and monetary policy focused on maintaining price stability. When it comes to monetary policy, the Bernanke Fed continues to fail to hold up its end of the bargain.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is titled Warrior Monk: A Pastor Stephen Grant Novel.