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| Source: Finance Roll |
No country exerted a bigger impact on American monetary policy following the financial crisis than Japan. Ben Bernanke understood the origins of Japan's financial and economic crisis better than anyone, and the actions he took reflected the lessons he learned by observing Japanese policymakers. "Among the more important monetary policy mistakes," Bernanke wrote in 1999, while still a professor at Princeton, "[was] the failure to ease adequately during the 1991-94 period, as asset prices, the banking system, and the economy declined precipitously." The Fed's zero-interest rate policy, quantitative easing, and forward guidance all originated from Bernanke's reading of the Japanese crisis.
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| Source: The Economist |
New Challenges
Today, the challenges facing Chair Yellen are different from those that confronted Bernanke -- but the solution may lie in the same place. Now, inflation -- not its evil twin, deflation -- is the primary risk the Federal Reserve faces. With inflation hovering around 2 percent, Chair Yellen needs to elucidate when she and the FOMC would start normalizing interest rates.
The problem, from her perspective, is that the labor market hasn't completely healed. Unemployment is down for sure, but other metrics remain exceptionally weak. Wages have stagnated (compared to inflation), labor force participation has declined, and long-term unemployment has mutated from a temporary setback to a national crisis (see chart).
The last issue -- long-term unemployment -- resonates with Yellen, a labor economist who has shown an uncommon appreciation for the impact of her decisions on people's lives. As the Wall Street Journal reported, recent surveys show a strong relationship between long-term unemployment and depression.
This unsurprising fact should put the rate hike decision into perspective. On one side, there are 3.3 million Americans who have been unemployed for 27 weeks or more, experiencing increasing psychological distress. On the other are some 38 million Americans over the age of 65, struggling to survive on a fixed income. This is not an academic question; it's a social conundrum.
The Real Problem
America's long-term unemployment problem is, to some extent, structural in nature. Cyclical unemployment declines once the economy recovers, but economies facing structural unemployment need more than growth to put people back to work. Structural unemployment implies a mismatch between the skills workers have and the ones employers demand.
Structural unemployment is not a new concern; Clive Crook wrote about it three years ago. But new data confirm what economists had feared. Using the Beveridge curve, which shows the relationship between job openings and unemployment, we can see the growing mismatch between supply and demand in the labor market. The trend makes Chair Yellen cringe. She knows there's little she can do about it. Monetary medicine cannot cure this disease on its own.
Japanese Lessons
Coincidentally, the solution to Chair Yellen's problem may lie in the same place where Bernanke discovered his. Over the last year, the Japanese government has launched a sweeping campaign to save the economy from deflation once and for all, while raising the potential growth rate of the Japanese economy. It's an ambitious proposal to a longstanding economic challenge, and while results are mixed, it demonstrates the need for coordinated action between fiscal and monetary authorities to resolve structural problems.
In Japan's case, the structural problem has to do with potential output, which has fallen sharply since the property bubble burst in the early 1990s. Bank of Japan governor, Haruhiko Kuroda, contributed to the solution by pumping tremendous liquidity into Japanese financial markets (see chart below, showing the Bank of Japan's balance sheet).
Now, Governor Kuroda is applying pressure on Prime Minister Shinzo Abe to shoulder his side of the burden. Last year, Abe promised to implement structural reforms to encourage capital investment, increase competition, and expand the Japanese workforce. This week, he unveiled the reforms. And while Wall Street has expressed plenty of concerns about the feasibility and specificity of Abe's proposals, the message from Tokyo is clear: Japan's fiscal and monetary authorities both understand the need for coordinated action to achieve their goals.
Take Charge, Madame Chair!
I have no doubt that Chair Yellen recognizes the same economic truth. Bernanke leaned on Congress to do more all the time, and the same political obstacles that prevented coordinated action remain in place today. But Yellen has less time. Inflationary pressures are building, and the market currently expects the first rate hike to occur sometime next spring. The window for resolving our long-term unemployment problem through coordinated action is closing rapidly.
Like Governor Kuroda, Chair Yellen should use her next public appearances to emphasize the need for structural reform, focusing on retraining American workers for jobs in growing fields like healthcare. Other FOMC members could articulate the same message without raising as many concerns about the sacred division between the Federal Reserve and Congress. Either way, the Fed needs to communicate the same point to markets and the public as the BOJ: monetary policy is not a panacea.
Applying monetary policy to a structural problem is like wrapping an Ace bandage around a wound. Chair Yellen and her FOMC colleagues must find the courage and creativity to catalyze the same action from Congress as Governor Kuroda has stimulated from his fiscal policy counterparts. Millions on Americans deserve bold action.
Today, the challenges facing Chair Yellen are different from those that confronted Bernanke -- but the solution may lie in the same place. Now, inflation -- not its evil twin, deflation -- is the primary risk the Federal Reserve faces. With inflation hovering around 2 percent, Chair Yellen needs to elucidate when she and the FOMC would start normalizing interest rates.
The problem, from her perspective, is that the labor market hasn't completely healed. Unemployment is down for sure, but other metrics remain exceptionally weak. Wages have stagnated (compared to inflation), labor force participation has declined, and long-term unemployment has mutated from a temporary setback to a national crisis (see chart).
 |
| Source: Federal Reserve Bank of St. Louis |
The last issue -- long-term unemployment -- resonates with Yellen, a labor economist who has shown an uncommon appreciation for the impact of her decisions on people's lives. As the Wall Street Journal reported, recent surveys show a strong relationship between long-term unemployment and depression.
 |
| Source: Wall Street Journal |
The Real Problem
America's long-term unemployment problem is, to some extent, structural in nature. Cyclical unemployment declines once the economy recovers, but economies facing structural unemployment need more than growth to put people back to work. Structural unemployment implies a mismatch between the skills workers have and the ones employers demand.
Structural unemployment is not a new concern; Clive Crook wrote about it three years ago. But new data confirm what economists had feared. Using the Beveridge curve, which shows the relationship between job openings and unemployment, we can see the growing mismatch between supply and demand in the labor market. The trend makes Chair Yellen cringe. She knows there's little she can do about it. Monetary medicine cannot cure this disease on its own.
 |
| Source: Wall Street Journal |
Coincidentally, the solution to Chair Yellen's problem may lie in the same place where Bernanke discovered his. Over the last year, the Japanese government has launched a sweeping campaign to save the economy from deflation once and for all, while raising the potential growth rate of the Japanese economy. It's an ambitious proposal to a longstanding economic challenge, and while results are mixed, it demonstrates the need for coordinated action between fiscal and monetary authorities to resolve structural problems.
In Japan's case, the structural problem has to do with potential output, which has fallen sharply since the property bubble burst in the early 1990s. Bank of Japan governor, Haruhiko Kuroda, contributed to the solution by pumping tremendous liquidity into Japanese financial markets (see chart below, showing the Bank of Japan's balance sheet).
 |
| Source: Yardeni Research, Inc. |
Now, Governor Kuroda is applying pressure on Prime Minister Shinzo Abe to shoulder his side of the burden. Last year, Abe promised to implement structural reforms to encourage capital investment, increase competition, and expand the Japanese workforce. This week, he unveiled the reforms. And while Wall Street has expressed plenty of concerns about the feasibility and specificity of Abe's proposals, the message from Tokyo is clear: Japan's fiscal and monetary authorities both understand the need for coordinated action to achieve their goals.
Take Charge, Madame Chair!
I have no doubt that Chair Yellen recognizes the same economic truth. Bernanke leaned on Congress to do more all the time, and the same political obstacles that prevented coordinated action remain in place today. But Yellen has less time. Inflationary pressures are building, and the market currently expects the first rate hike to occur sometime next spring. The window for resolving our long-term unemployment problem through coordinated action is closing rapidly.
Like Governor Kuroda, Chair Yellen should use her next public appearances to emphasize the need for structural reform, focusing on retraining American workers for jobs in growing fields like healthcare. Other FOMC members could articulate the same message without raising as many concerns about the sacred division between the Federal Reserve and Congress. Either way, the Fed needs to communicate the same point to markets and the public as the BOJ: monetary policy is not a panacea.
Applying monetary policy to a structural problem is like wrapping an Ace bandage around a wound. Chair Yellen and her FOMC colleagues must find the courage and creativity to catalyze the same action from Congress as Governor Kuroda has stimulated from his fiscal policy counterparts. Millions on Americans deserve bold action.
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