Few shouts for Operation Twist

Operation Twist, the latest attempt by the Fed to stimulate the economy, will not accomplish their objectives, one expert says. Monetary policy alone will not create jobs, which is one of the biggest things this economy needs right now.

Sept. 27, 2011, 12:01 a.m. EDT
By Irwin Kellner, MarketWatch
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PORT WASHINGTON, N.Y. (MarketWatch) — The Federal Reserve’s latest gambit to stimulate the economy by twisting long-term interest rates lower will not accomplish its objective.

Using monetary policy alone, without the aid of fiscal policy to jump-start the economy, is like trying to push on a string. In today’s context, it makes even less sense.

Long rates are already at multi-decade lows, so pushing them even lower is not going to make much difference.

Most people are so worried about their jobs that they are trying to reduce their debts and increase their savings. Those that want to borrow to buy a home are finding that the banks are reluctant to give them a mortgage.

For their part, many businesses have little or no reason to borrow, since they are not seeing enough sales to justify expanding. Besides, a number of firms have socked away big chunks of cash which they will probably draw down first, since in today’s low-interest-rate environment, these liquid funds are earning next to nothing.

What the Fed should have done was to stop paying the banks for keeping excess funds with the central bank and begin charging them instead. Another way to encourage the banks to lend would be to relax the Fed’s new-found scrutiny over bank loans and capital.

At any rate, monetary policy alone is not able to create jobs — much less boost the economy at large. Easy money is a necessary but not a sufficient condition when you want to bolster economic activity.

To ensure a growing economy requires fiscal policy to work in tandem with easy money. In other words, the government should spend more and tax less to boost aggregate purchasing power.

The problem is that fiscal policy is heading in the wrong direction. Instead of loosening, it is tightening; instead of being supportive, it is being restrictive.

Some tax cuts are set to expire next year while the president wants to raise taxes on the “wealthy.” Meanwhile, Washington has already cut spending, forcing many states and local governments, as well as their contractors, to cut staff and thus exacerbate today’s high anxiety over jobs. Why is the government pursuing such a blatantly wrong-headed policy? It is all in the name of reducing Washington’s budget deficit and its outstanding debt.

This is all well and good, except that the pols have our nation’s priorities mixed up. There is a better way to reduce the government’s budget deficit besides the draconian method of cutting spending and/or raising taxes now in vogue.

A growing, healthy economy will achieve this objective too, by producing more tax revenues and requiring less spending on unemployment and other social welfare programs. And I guarantee you that this is a much more satisfactory way to do this for the average worker or business.

Once the economy is on a sound footing, policy makers can then turn to deficit and debt concerns. If needed, spending could be held down while the tax structure can be adjusted in a number of ways to generate more revenues.

It has been done before. A huge deficit in the early 1990s morphed into an even bigger surplus at the end of that decade — thanks to a combination of prolonged growth and the right tax structure.

There is no reason why this can’t be repeated in this decade.

Irwin Kellner is MarketWatch's chief economist.

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