With a smaller demand “pull” from shrinking demographic growth, a slower economy is hardly surprising. If we recall that the real, long-term growth of wealth is a function of increases in population and production, then the fact of slower U.S. population growth in the twenty-first century suggests that we will also see more modest growth in GDP. Under such circumstances, what is normal? More important, with nominal GDP growth in the 2–3 percent range absent shocks from external factors, and the Fed targeting similar levels of price inflation, will Americans see any improvement in their real inflation-adjusted income or wealth?

Sadly, you will never hear Federal Reserve chair Janet Yellen and the members of the FOMC admit that the real, long-term growth rate for wealth or GDP is just 2 percent. Because of the dual mandate given to the U.S. central bank of encouraging employment and ensuring price stability, the FOMC has tended to focus policy on trying to encourage job growth while pretending that inflation is not a problem. Indeed, over the past two decades, as real growth prospects have waned, the FOMC has used progressively lower interest rates to both stimulate growth and rescue the economy from the aftereffects of the latest Fed-inspired boom. Whatever concerns the Fed still harbors regarding long-term price stability have been overwhelmed by the political imperative to achieve short-term job growth.

Economists in both private and public life make a living by talking about levels of potential growth that are far above the long-term average increase in real wealth. One reason for this is that suggesting that the long-term average growth rate will not exceed 2 percent implies a future of limited job opportunities, something that’s hardly popular with voters or elected officials. The remarkable growth rates claimed by China’s authoritarian regime illustrate the political imperative behind such efforts. As a result of the one-child policy, China’s population is growing at just 0.5 percent annually, according to the World Bank. When you see official Chinese GDP growth rates of more than ten times the rate of population increase, the one thing you can be sure about is that the claimed rate of “growth” is unsustainable and driven by politically motivated government spending.

 

OVER THE past several years, members of the FOMC have maintained ultralow interest rates, ostensibly to boost economic activity in such areas as housing and job growth. But despite low interest rates and massive purchases of government debt and mortgage securities by the FOMC, volumes of residential mortgage lending have plummeted down to decade-low levels, and job growth remains anemic and of poor quality. Instead of stimulating a recovery in the real economy, the policies followed by the FOMC under first Ben Bernanke and now Janet Yellen have only created new asset bubbles in sectors like real estate, public equities and the corporate bond market. With interest rates and commodity prices now falling around the world and the dollar soaring against other currencies, the FOMC seems to have created a “deflation trap” whereby investors are unwilling to put capital at risk as they await higher interest rates. Meanwhile, job creation and spending suffer due to a lack of investment.

Some Fed officials are increasingly uncomfortable with the Fed’s policies. Richard Fisher, president of the Federal Reserve Bank of Dallas, dissented from his colleagues on the FOMC, saying he’d like to see rates begin to go up in 2015. Philadelphia Fed chief Charles Plosser also dissented on similar grounds. But both Fisher and Plosser no longer vote on the FOMC. A decidedly left-wing majority on the Fed’s policy-making body continues to support the extraordinary low-rate policies in an effort to boost job growth. In the European Union, the European Central Bank is pursuing a similar policy.

But the sad fact remains that the use of interest rates or fiscal policy to stimulate nominal growth is of limited utility today. In the 1970s and 1980s, when the children of the post–World War II baby boom were starting families of their own, a little bit of push in the form of low interest rates or increased government spending resulted in a substantial increase in job creation and economic activity—along with higher inflation. Today, with lower population growth rates and relatively high levels of public debt in most industrial nations, the utility of fiscal or monetary policy in boosting growth rates is very limited—but inflation remains a problem that affects all consumers, rich and poor.

In the Fed’s most recent report to Congress, Yellen repeated the Fed’s explicit embrace of a 2 percent inflation rate, in order to help the employment picture, all the while paying lip service to the Fed’s responsibility to ensure stable prices. She stated:

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate.

What Yellen is saying explicitly is that it is not possible for the FOMC to achieve the legal mandate of “maximum employment” without tolerating a 2 percent inflation rate. But a 2 percent rate of inflation, compounded over twenty years, will rob American consumers of half of the purchasing power of their wages and savings. Not only do the Fed’s publicly stated policies doom many Americans to poverty in the future, but they are also an explicit admission that the Fed’s dual legal mandate set by Congress in 1978 is unworkable. The Fed cannot both pursue “maximum employment” and safeguard against inflation. Indeed, there is a growing doubt that the Fed can truly change the employment picture. But the political attraction of promising people higher wage and job growth, it seems, is so powerful that members of the FOMC and central bankers around the world cannot help themselves. Ultimately, using low interest rates in an attempt to boost demand and job creation will fail.

Christopher Whalen is senior managing director and head of research at Kroll Bond Rating Agency. He is the author of Inflated: How Money and Debt Built the American Dream (Wiley, 2010) and the coauthor, with Frederick Feldkamp, of Financial Stability: Fraud, Confidence, and the Wealth of Nations (Wiley, 2014).

Image: Flickr/Ervins Strauhmanis/CC by 2.0