Friday, June 24, 2011

The silver lining in the Federal Reserve’s Open Market Committee Meeting on Wednesday is that quantitative easing seems to be off the table for now. Once the Fed ends its $600 billion bond-buying program at the end of this month, it’s over. The Fed remains committed to maintaining low to near-zero interest rates.

Unfortunately, the good news ends there. The economy is doing far worse than expected, as Fed Chairman Ben S. Bernanke acknowledged. The gross-domestic-product growth rate dropped to 1.8 percent in first quarter of this year, sharply down from 3.1 percent in the fourth quarter of 2010. Unemployment has been climbing steadily, reaching 9.1 percent in May, the second straight increase this year. This slowdown in growth has been accompanied by an increase in inflation. The inflation rate has been rising steadily this entire year. From a trend level of 1.6 percent in January, it jumped 2.7 percent in March and 3.6 percent in May. The increase has been largely driven by two categories that hit tight family budgets hardest: gasoline and food.

High unemployment, low growth and climbing inflation are the definition of stagflation, the scourge of the Carter years. It’s worth examining how close we are coming to reliving the bad days of the late 1970s.

External factors between then and now are similar. Gas prices are high. The ‘70s had supply problems from the Organization of the Petroleum Exporting Countries (OPEC); we have the earthquake and tsunami in Japan and a president putting every domestic source of oil off-limits for drilling. Uncertainty was the dominant theme of the Carter years. Monetary policy was highly volatile, swinging wildly between being expansionary through 1977, moderately accommodating in 1978, and becoming sharply contractionary in late 1979 through early 1980, and then again expansionary in mid-1980. Similarly, fiscal policy swung between being moderately expansionary in 1977, somewhat contractionary in early 1978, and back to expansionary in 1979.

One possible difference is that interest rates were extremely high during the Carter years. Right now, real interest rates are close to zero. Banks have plenty of reserves but they still aren’t lending. Banks won’t lend if it isn’t profitable to do so. Businesses won’t invest if the expected benefit doesn’t exceed the risk. That has to do with uncertainty in the system, and in view of fact that when interest rates are nearly zero, there isn’t much wiggle room there to change the calculus.

Today’s uncertainty runs the gamut from monetary to fiscal policy. Uncertainty about another ineffective “helicopter drop” of money by the Fed does not help the situation. There’s no telling what’s going to happen on the fiscal and regulatory side. Obamacare is in legal limbo, some states are starting implementation, and many employers have no idea what it’s going to mean for them. Congress and the president have no agreement on addressing the debt crisis as we edge up to the point of default. Spending cuts have to be part of the solution because what we have is a spending a problem.

Seventies fashions might be back on the runways, but Carter-era policies should be filed in the same drawer as the disco albums. A return to pro-growth policies is the only thing that will keep full-fledged stagflation a bad memory.

Nita Ghei is a contributing Opinion writer for The Washington Times.

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