The Fed Can Help, But Fiscal Policy Is The Key To Job Creation

Last Updated Dec 18, 2009 1:22 PM EST

There are many people currently criticizing the Fed for worrying too much about inflation and not enough about employment. They want the Fed to use quantitative easing - the purchase of financial assets when interest rates are already at zero - as a means of stimulating the economy and creating jobs. I think it's a mistake to focus on the Fed rather than on fiscal policy because the focus on the Fed takes the pressure off congress and the administration to do something about the poor state of the job market.

There's been lots written recently about how the Fed could help to overcome the employment problem with quantitative easing, and maybe it could. I'm not as convinced as many others that this will work, there are some elements of the transmission mechanism for monetary policy that are needed for quantitative easing to work that I don't believe are very reliable, and it could create very bad employment prospects down the road if the program cannot be unwound in a timely way. And even if it does work, the time lags involved in monetary policy are very long, much longer than for fiscal policy (it generally takes longer to put fiscal policy in place, but once it's implemented, its effects are felt faster than monetary policy).

There is much more to be gained much more quickly by implementing a jobs package using fiscal policy measures than by attacking the problem with quantitative easing alone. As I said, perhaps monetary policy could help, I've been in favor of a portfolio approach to policy from the start, but why have people suddenly stopped talking about a jobs package, stopped putting pressure on congress to do something? Just as the voices for another stimulus package began to grow louder and get some attention and political traction, the voices stopped and suddenly turned to the Fed, as though the Fed could solve the employment problem with a wave of its magic QE wand. It can't. Given enough time it can perhaps be part of the solution, so I'm not saying that people shouldn't try to get the Fed to change course. But I am going to continue to focus mainly on fiscal policy because I think it will do the most good. I don't want to give congress the easy out of pointing their fingers at the Fed and saying it's their fault, not ours, but the way is being paved for congress to do just that.

We've been at a similar juncture in the past where some who are now leading the charge for quantitative easing said we should wait to see if monetary policy works before even thinking about fiscal policy. At that time, I felt pretty alone taking the other side and saying that we shouldn't wait because monetary policy wouldn't do nearly enough by itself, and I feel pretty alone again in being pessimistic about the Fed's ability to make a significant difference on the jobs front. But guess what, monetary policy didn't do enough, and by the time enough momentum built to implement fiscal policy, it was much too late to be optimal.

Maybe targeting congress is pointless and another jobs package will never, ever be implemented despite its potential merits and that is the reason people have turned their attention elsewhere. Maybe. But I think the most effective path to job creation goes through congress and fiscal policy, not the Fed, and I'm not ready to give up just yet.