Since the start of the Great Recession in December 2007, the U.S. economy has lost 8 million jobs with the unemployment rate topping 10 percent. Bank failures exploded — 333 banks since 2008, compared with 18 from 2001 to 2007. At the recession’s depth, real GDP fell 4 percent and real economic output declined $1.1 trillion, or 8 percent, back to 2006 levels.
But it could have been worse, much worse.
Speaking last night at the University of Minnesota’s College of Continuing Education, Minneapolis Fed President Narayana Kocherlakota borrowed the plotline from the Christmas chestnut “It’s a Wonderful Life,” where despondent small-town banker George Bailey is given a glimpse of an alternate future if he had never existed.
In a speech titled “It’s a Wonderful Fed,” Kocherlakota, like Clarence the guardian angel in the Frank Capra classic, took the audience on a hypothetical journey into an alternate, hypothetical world.
He posed the question: “Suppose that there were no Fed. What would have happened to the U.S. economy in the past three years?”
“The recession and its subsequent recovery would have been significantly worse in the absence of the actions of the Federal Reserve,” he concluded.
Beginning in the waning days of the Bush administration, the Federal Reserve Bank injected massive amounts of liquidity (read “money”) into the system to shore up financial institutions. It also lowered the Fed funds rate to drive down interest rates for borrowers and lenders.
The size of the problem meant that Fed actions were “to an extent — unprecedented in their scale,” he said. “At their peak, the interventions made up more than a trillion dollars of Federal Reserve assets.”
Had it not acted, Kocherlakota argued that “real GDP would have fallen by even more than 4 percent and unemployment would have been well above 10 percent … Many more solvent financial institutions would have failed during the financial panic.”
While he acknowledged that the unprecedented Fed lending to financial institutions “exposed it — and by extension, the American public — to some risk of loss,” he asserted that “the Fed has not lost a penny on any of these transactions.”
Kocherlakota’s spirited defense of Fed actions coincidentally occurred on the same day that Fed Chairman Ben Bernanke was making a debut appearance at the National Press Club in Washington D.C. The chairman was also defending Fed policy and actions, particularly in the face of Republican-led House efforts to audit Fed decision-making. Bernanke argued that monetary policy needs to remain independent of short-term political considerations.
Kocherlakota also predicted that the economy in 2011 will improve. But his projection that GDP growth “will probably be closer to 3 percent than 4 percent” puts him at the lower end of the range of Fed presidents. He is concerned that both households and banks will continue to shore up their balance sheets, holding back both consumer spending and bank lending activity, thus limiting the impact of these two major drivers of the economy.
Inflation, which was “extraordinarily low” in 2010 is projected to pick up to 1.5 percent in 2011, according to the Minneapolis Fed projections. That is still below the Fed target ceiling of 2 percent.
While unemployment will continue to decline, he predicts that it will remain above 9 percent in 2011 and above 8 percent in 2012. “Employment growth remains disappointingly low,” he said.