Whither the Fed?

As the economy changes, the central bank's tools are becoming less effective.

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Last month, the Federal Reserve announced it would begin to taper the bond-buying program it launched to stimulate the economy. Its decision reflects a gradual decrease in the unemployment rate, now down below 7 percent.

But recent improvements in the economy, while welcome, are hardly a cause for celebration. The rate of new job creation barely keeps up with the natural growth of the population. It is not enough to re-hire the workers laid off in the Great Recession. While the unemployment rate is falling, most of what passes for progress results not from new jobs but from the fact that millions of workers have quit the labor force due to discouragement. The percentage of Americans of working age who hold jobs has barely budged since 2008.

Clearly the Fed's stimulus program has not benefited all parts of the economy equally. The stimulus has helped banks repair their tattered balance sheets by letting them borrow from the government at unrealistically cheap rates. It has helped capital intensive industries like airlines, telecommunications and oil refining. It has helped raise profits in general for U.S. businesses. It has helped boost stock markets to record highs. But the Fed's decision to flood the economy with cheap money has not led to sufficient gains in overall employment.

[See a collection of political cartoons on the economy.]

Why not? Why has the tried-and-true method of restoring strong employment after a recession not worked this time?

In essence, the economy has changed, but our methods for stimulating job growth have not kept pace. In the past, cheap money encouraged companies to invest in expanding production. Companies built new plants and hired more workers. There was a direct and rapid relationship between stimulus and job growth.

But today's economy is different in several ways: First, many of today's growth industries don't require much headcount growth as they scale up. Twitter doesn't need to double its headcount to handle twice the tweets. Even mature industries like automobile manufacturing don't require as many people to meet increased demand: Ford buys new robots when demand increases, but it doesn't need as many new workers as it once did.

[Read the U.S. News Debate: Should the Federal Reserve Keep Interest Rates Low?]

Second, headcount growth, when it does occur, often happens overseas. In the information technology services sector, companies that laid off staff in the U.S. are rebuilding elsewhere. A leading company may impress us with reports of 10 percent net headcount growth year over year. But that rosy statistic masks a 20 percent reduction in U.S. headcount followed by a 30 percent increase in headcount in Ireland, Malaysia, the Czech Republic and elsewhere.

As these structural changes in the economy take hold, the Fed's approach to stimulating the economy becomes less and less cost-effective. Relatively more of the money deployed by the Fed goes toward boosting profits and stock prices, and less goes to job creation. The Fed is spending more, but we are getting less as a result.

As we begin to taper off the stimulus, it's time to invent (or reinvent) new kinds of stimulus programs that can boost employment efficiently. Instead of injecting liquidity across the board, we need targeted programs that support job creation, because job creation is the backbone of a robust middle class, and a robust middle class provides the fuel for the economy as a whole. These programs could include:

  • Low cost loans or tax credits for developing or expanding U.S.-based factories.
  • Loans or tax credits that promote new hiring, or expanding the hours of existing workers.
  • Low cost loans for those seeking education and training in STEM fields and other areas where jobs are going unfilled.
  • Direct investment in domestic infrastructure-building projects that employ domestic workers (for example, smart-grid deployment to support renewable fuels.)
  • [Check out 2013: The Year in Cartoons.]

    Another important lever for job growth is our tax policy regarding the repatriation of profits squirrelled away offshore. As long as the potential for tax-free repatriation remains, companies are encouraged to do their growing offshore. But if tax-free repatriation is definitely and permanently closed off, companies will, on the margin, be more inclined to invest in domestic assets and increase domestic employment.

    Unfortunately, the smart and targeted ways of stimulating economic growth require action from Congress. In turn, that requires a Congress whose members can work together and get things done. Without a better Congress that can actually pass legislation, we have no choice but to continue our crude and inefficient ways of promoting job growth. Our current tools, limited as they are, are the only tools within reach.

    David Brodwin is a cofounder and board member of American Sustainable Business Council. Follow him on Twitter at @davidbrodwin.

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