Economic policy needs common sense, not Fed magic, for long-term growth

By Fareed Zakaria
WashPost
Monday, November 29, 2010

The background noise in the wonk world these days is of furious debates over economic theory and policy. The foreground is the American economy, which appears strikingly unresponsive. The Federal Reserve's much-debated quantitative easing ("QEII") appears, so far, to have had the opposite of its intended effect: It was conceived as a way to push down long-term interest rates so that people would borrow more, but those rates have risen considerably since the Fed switched on its presses. To a non-economist, this is the latest example suggesting the limits of macroeconomic policy and the need for some common sense.

To be fair, economic policy rescued the world from another Great Depression. Having learned from the 1930s, policymakers in the United States and abroad moved in two years ago to strengthen the financial system, offer credit and create demand when none was available elsewhere. But emergency measures that worked to stop systemic collapse are one thing; policies to jump-start real growth are another.

Since the crisis began, the government has responded in a classic Keynesian fashion. It passed three tax cuts (one under George W. Bush and two under Barack Obama), set in motion automatic stabilizers such as unemployment insurance, sent money to state governments to keep their workers employed, and spent on infrastructure and other projects. Above all, the Federal Reserve printed money to make it easier for consumers and businesses to get their hands on cash and thus spend it.

But businesses and consumers are not spending. It is not that the stimulus did not work. The federal government seems to have spent the money reasonably well, with pork and corruption kept to low levels. The problem is that this kind of spending is meant to be a bridge to get the private sector spending again. The theory is that the government would create demand while the private sector cleaned up its balance sheets. But corporate America is flush with profits - yet is not spending.

(More here.)

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