The Federal Reserve is virtually certain to cut Fed funds rate in the wake of Friday’s news that the economy is shedding jobs for the first time in four years. But the anticipated easing still comes with risks.
It’s not obvious that more liquidity is the solution for what ails the economy. The return of job losses after four years of gains may simply be the natural ebb and flow of the business cycle. There’s a general sense that such cycles have been banished to the dustbin of economic history, but that’s a premature conclusion. Yes, the Fed has learned how to smooth the business cycle with tactical injections of liquidity. But there’s no free lunch and it’s possible that keeping deep recessions at bay all these years has been a temporary triumph that’s had the unintended effect of letting excesses build up to the point that they’re now set to burst forth.
If the cycle is poised to reassert itself on the downside, the Fed will no doubt intervene in an effort to keep the economy bubbling. The past 20 years have shown that the central bank is inclined to do just that. But at what cost? Has the smoothing of the business cycle in past years dispatched the fallout or simply rolled it into the future?
The economy may be weakening but the cause doesn’t fit neatly into the classic boom-bust story. In the old days, the Fed would choke off rising economic growth by raising interest rates, sometimes by too much. The tightening brought recession, which in turn spurred the Fed to ease to induce growth once more.
This time, however, it’s debatable if the economic slowdown that appears to be in progress is directly caused by excessive monetary tightening in the traditional sense. The Fed funds rate has been at 5.25% since June 2006, but the charge that the price of money’s been too high is exaggerated. Only in recent weeks has the cry for lower rates gained critical mass.