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The president and CEO of the Federal Reserve Bank of Chicago said that the lingering effects of the recession – high unemployment, a low inflation rate and reduced spending – call for further action.
In a speech at the Evanston Hilton Garden Inn on Oct. 19, Charles Evans said he believes two measures would help stimulate the economy, but added that his speech covered his “personal views, not necessarily those of my colleagues.”
The country, Mr. Evans said, is in a “liquidity trap,” such as has not been seen since the Great Depression nearly 80 years ago. He said he advocates implementing measures that in other circumstances might seem counterintuitive – a “large-scale asset purchase” and an inflation rate increased to about 2 percent, about twice the current rate. The government’s purchase of treasury bills, bonds and other government-issued paper is a procedure known as quantitative easing – a way to supply cash to the market.
Mr. Evans said that these are “entirely appropriate paths,” and added, “The Fed traditionally loathes inflation. Current circumstances require that we fight a different battle.”
Craig Furfine, a professor of research in finance at Northwestern’s Kellogg School of Management, and a former colleague of Mr. Evans, gave the introduction. In other times, Professor Furfine said, the Federal Reserve would lower the federal funds rate to stimulate the economy, but at present that rate is zero. “The unemployment rate is stubbornly high, and the target [federal funds] rate is zero. What can the fed do? Some say, ‘Nothing.’ Others say, ‘The Fed must continue to act aggressively.’”
Mr. Evans appeared to favor action.
A ‘Liquidity Trap’
Mr. Evans presented evidence of a liquidity trap – a condition in which available money is not generating economic growth: Neither businesses nor consumers are spending money. “Businesses aren’t interested in increased spending. They appear to be content with top-line revenues and cost-cutting. … With the exception of replacing some IT equipment … firms are sitting on cash.”
Consumers, too, are saving rather than spending, he said. “Consumers are showing an elevated risk aversion” and prefer to save rather than spend. “If this state of affairs continues it could stifle a robust recovery,” he said.
Liquidity traps are “rare occasions,” he said, and they “require unique monetary response.”
Unemployment and Inflation
“[The u]nemployment [rate] will not go below 8 percent in the next two years,” Mr. Evans said, “and this is symptomatic of a weak economy. …”To bring down the unemployment rate we need to grow the economy.”
Mr. Evans advocates allowing the inflation rate to “catch up” to about 2 percent, a “price-level target.” To do this, he said, “We need careful advance planning.” Once the measure is implemented, he said, the inflation must be closely monitored to ensure that inflation does not increase unchecked.
As a result, Mr. Evans said, the country should see a loosening of the cash logjam because spending cash will be more enticing than holding cash. The “opportunity costs of holding cash” will be increased, he said. The increased cost, he said, should induce businesses and consumers to spend more money, thereby increasing economic growth.
Addressing the stagnation in cash flow (liquidity trap), together with the high unemployment rate and low rate of inflation, Mr. Evans said, comports with the mission of the Federal Reserve.
Reaction from business leaders varied.
Robert Yohanan, chief executive officer of First Bank & Trust, told the RoundTable, “Mr. Evans is a first-rate economist. … [His] argument is to get the long-term spending rate as low as possible to stimulate spending – the only measure left the Fed can use.”
There is a downside to targeting the inflation rate at 2 percent, he said. “The downside would be if the [inflation rate] is uncontrolled and not measured. The action taken in additional quantitative easing could inadvertently move the inflation rate beyond 2 percent. Mr. Evans is saying, ‘You’ve got to be very careful.’”
Even with the downside risk, Mr. Yohanan says, “there’s not a long history of quantitative easing. I would be on the side of giving it a try, but let’s watch it very carefully. There is a fair chance of its having a good impact on the economy.”
Richard Romano, founder and CEO of Romano Brothers & Co., said he did not agree with Mr. Evans’s proposals. “It’s more of the same of something that has been ineffective to this point,” Mr. Romano told the RoundTable. “The new proposal is to lower interest rates at the longer end. … It is not really clear to me how that stimulates consumer spending or borrowing. … I don’t believe this is the answer to the liquidity trap.”
The downside, as Mr. Romano sees it, has three aspects: the potential negative effect on the dollar, the possible loss of credibility of the Federal Reserve “if this doesn’t work,” and the fact that “it is somewhat speculative.”
On the positive side, Mr. Romano said, “the goal is laudable. We’ve got to do something about getting this economy going – getting people back to work.”
Assistant City Manager Martin Lyons told the RoundTable, “Mr. Evans’ speech highlights many of the activities/provisions included in the current and future budgets for the City.
“We continue to tighten our belt on the operations side of our activities and also continue to look for opportunities to work with the financial community to stimulate economic development. This development goal is focused more on jobs and long-term employer growth than on revenue growth from sales tax. Similar to Mr. Evans’ statements, we want to support job growth that will consistently, if not quickly, bring unemployment down in our community.”