As Scarecrow pointed out, fiscal policy isn’t changing to reflect the reality of a too-slow recovery and unemployment crisis, no matter how much the economic picture should force a shift in the President’s calculation for 2012. The message may change (from “Morning in America” to “Don’t Change Horses in Mid-Stream”), but the policies will remain the same. Essentially, the message is that we’ve done all we can do, and let’s hope private actors come back and create jobs for us.
That leaves monetary policy as the only avenue left for expansion, and the signals coming from the Federal Reserve herald, at best, the end of quantitative easing and a hold strategy, rather than selling all the Treasury bonds purchased and tightening the policy. The makeup of the Fed Board of Governors doesn’t really offer much for unconventional monetary policy at this time; methods like charging banks for holding Fed reserves, for example, or increasing the expectation for the price level. There was an opportunity to change some of the perspectives on the Fed board, when President Obama had three open slots. Instead, he waited months to nominate anyone. Finally, he put up Sarah Bloom Raskin, Janet Yellen and Peter Diamond. Two of them got through, but Diamond languished for months. And now, in a New York Times op-ed, Diamond, a Nobel Prize winner, offers his withdrawal from the nomination for the position. “It is time for me to withdraw, as I plan to inform the White House,” he writes.
The leading opponent to my appointment, Richard C. Shelby of Alabama, the ranking Republican on the committee, has questioned the relevance of my expertise. “Does Dr. Diamond have any experience in conducting monetary policy? No,” he said in March. “His academic work has been on pensions and labor market theory.”
But understanding the labor market — and the process by which workers and jobs come together and separate — is critical to devising an effective monetary policy. The financial crisis has led to continuing high unemployment. The Fed has to properly assess the nature of that unemployment to be able to lower it as much as possible while avoiding inflation. If much of the unemployment is related to the business cycle — caused by a lack of adequate demand — the Fed can act to reduce it without touching off inflation. If instead the unemployment is primarily structural — caused by mismatches between the skills that companies need and the skills that workers have — aggressive Fed action to reduce it could be misguided.
In my Nobel acceptance speech in December, I discussed in detail the patterns of hiring in the American economy, and concluded that structural unemployment and issues of mismatch were not important in the slow recovery we have been experiencing, and thus not a reason to stop an accommodative monetary policy — a policy of keeping short-term interest rates exceptionally low and buying Treasury securities to keep long-term rates down. Analysis of the labor market is in fact central to monetary policy.
This is the perspective of the person who won’t be joining the Fed board.
In his withdrawal announcement, Diamond laments the “distorted” confirmation process, which caused him to have to be renominated on two separate occasions, and the “little understanding of monetary policy” from those who conduct oversight of it, i.e. the Senate. But the saddest part of this is that Diamond is on point as far as the near-term challenges are concerned. He says that the costs of high unemployment must be primary rather than the low risk of inflation. He says that the risk of fiscal contraction is more pressing than the risk from the long-run national debt. Diamond is hardly a doctrinaire liberal; he’s just allowing the facts to govern his policy insights at this time. That’s what Republicans in the Senate couldn’t abide.
This is pretty sad. The remaining mix of Fed governors will not seek any looser monetary policy in the near future. If past performance is a guide, the President will not nominate a replacement for Diamond for months, and won’t push especially hard for his or her confirmation. So we continue to muddle through. The area of Presidential appointments generally is one where the Administration has shown a shocking lack of vigor, and Diamond’s demise reflects that.