Comparing the Federal Reserve’s Reaction to the Financial Crisis Versus the Unemployment Crisis

I never said Kudos to Charles Evans, President of the Federal Reserve Bank of Chicago, for dissenting in the most recent FOMC meeting on behalf of the unemployed: “Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.”  I’m a big fan of the Evans Rule, and am surprised doves haven’t been more forceful on this.  As Goldman Sachs noted, “This was the first ‘dovish’ dissent since December 2007 (President Rosengren).”  Given that unemployment has turned out to be worse than the Fed projected at any moment, it is about time that those who are worried about unemployment inside the Fed start getting loud – else the right-wing dissents make Bernanke look more aggressive than he actually is.

Let’s compare the unemployment response to the financial bailouts.  Bloomberg just released a big story, based on their successful FOIA lawsuits, that tells just how aggressive the Federal Reserve was with its emergency lender-of-last-resort powers.  Kevin DrumMatthew Yglesias and Paul Krugman argue that what is really shocking is how total the rescue and backing of the financial sector was while the real economy was left to rot: “the real scandal isn’t so much that those banks got rescued as that the rest of the population didn’t.”

Part of why the bailouts were packaged the way they were was because the bankruptcy of Lehman Brothers went a lot worse than the Federal Reserve had anticipated.  The Federal Reserve had an expectation of how the collapse of a major investment bank like Lehman would go, and when it went far worse than their expectation they reacted with maximum force.

Is there an equivalent story for unemployment when it comes to expectations?  Let’s try to graph this out.  We’ll use the FRB’s Summary of Economic Projections.  FAQ: “Economic projections are collected from each member of the Board of Governors and each Federal Reserve Bank president four times a year, in connection with the Federal Open Market Committee’s usual two-day meetings (typically held in January, April, June, and November)… The unemployment rate is the average civilian unemployment rate in the fourth quarter of a year.”

Members of the Federal Reserve get together four times a year and projects their expectations of unemployment for several years out.  Let’s take that data and plot it against the unemployment rate.  (Specifically, we are going to plot the average projected unemployment rate from the FRB across the entire year, and we are going to take the average of the core tendencies that are reported as that rate.)  What does that look like against the actual unemployment rate?  Graphing the actual unemployment in bold red and projections from each point going forward in shades of orange (click for larger image):

As you can see, there’s no point in which unemployment has been projected to be worse than it actually turned out to be.  Especially in 2009-2010, we can see that the actual unemployment rate is significantly higher a year or two later than their projections of unemployment.  Let’s zoom in on the 09-11 range (click for larger image):

If we were to replace the FRB with a group of monkeys armed with darts, one would imagine that the second group would get at least a few projections of unemployment above the actual rate of unemployment.  You can see the FRB trying to revise how bad unemployment is, but they don’t revise it anywhere near enough to where the economy actually is.

To recap:  Lehman Brothers goes worse than the Federal Reserve’s projection and the Fed goes to the most extreme lengths it can find to extend emergency lending.  Every single unemployment number turns out to be worse than all of the Federal Reserve’s projections, and the Federal Reserve finds every excuse to look the other way.  Only Charles Evans has the courage to say that we should let inflation go to 3% while unemployment is over 7% to catch up to trend growth.  Amazing.

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21 Responses to Comparing the Federal Reserve’s Reaction to the Financial Crisis Versus the Unemployment Crisis

  1. Steve Roth says:

    Repeating myself, I know. Higher (than expected) inflation would transfer hundreds of billions in buying power — wealth — from creditors to debtors. The fed is run by creditors.

    • Andy says:

      Steve–can you walk me through that concept? It’s in line, I think, with my comment below, “high unemployment=cheap labor”: changing the current economic system doesn’t behoove those with the power to make changes. Is it simply that inflation causes wages to go up? If so, wouldn’t high unemployment mitigate this effect?

      • Steve Roth says:

        Andy: “Is it simply that inflation causes wages to go up?”

        No! It’s not (so much) about the flows, though economists make a big deal of that, saying that in the long run prices and wages go up together. (Currently the very long run…) So money is neutral and inflation worries are “the money illusion.”

        It’s about the *stocks* of debt, credit, and wealth, which they largely ignore. (Run don’t walk to read Steve Keen.)

        If I own a hundred million in bonds, and bananas are going for a dollar a piece, an extra percent of inflation means that if I sell the bonds a year from now I can only buy 99 million bananas. The holders of real assets gain buying power, at the expense of the holders of financial assets .

        Especially fixed-income financial assets; equities [in theory] go up in dollar value with inflation better cause they’re more based on real assets, which go up in dollar value with inflation. (That’s what inflation is.)

        The quantity of bonds/debt outstanding utterly dwarfs the equities market. Traders call the stock market “the bond market’s idiot younger sibling.”

        There’s something like $55 trillion in financial assets out there in the U.S. Assume some of it nets out — some people are both debtors and creditors, so the transfer is from themselves to themselves.

        But still, do the arithmetic: tens of trillions of dollars, times one percent, means hundreds of millions of dollars of buying power transferred from creditors to debtors for every percentage point of extra inflation. *Every year.*

        This hit to the bond-holder’s/creditor’s wealth is massive, immediate, permanent, and one-directional. It utterly dwarfs the relatively paltry, multidirectional, and drawn-out effects on flows.

        And there are far fewer creditors than there are debtors, so the effect on individual creditors is greatly magnified.

        They say financial incentives matter….

        And that’s before you even consider the high-unemployment bonus to business, driving wages down!

        Not hard to understand why the creditors who run the Fed would care more about keeping inflation down than goosing employment.

      • Steve Roth says:

        Oh just thought, the more standard perhaps simpler way to explain it. Inflation means that debtors are paying back their loans in less-valuable dollars. One percent inflation reduces the value of all future debt payments by that amount, so the real value of the bond — in terms of how many yachts or bananas you could buy if you sold it — goes down by one percent.

    • Steve Roth says:

      Oops sorry I meant hundreds of *billions* of dollars. Hard to keep track these days, with all the big numbers flying around. Even given that, half a trillion dollars a year still tends to get people’s attention…

      • Andy says:

        Thanks, Steve, that clears things up well. I’ve always had a hunch that there was more to the heel-dragging than simply keeping labor costs low.

        Also, thanks for pointing me to Steve Keen. I stumbled across him on YouTube several years ago, was intrigued, but didn’t catch his name and was unable to track him down again.

    • Sebastian says:

      Such is the schizophrenic nature of the world economic system that US Bank credit ratings are falling while the Dow is on a holiday tear. The system looks good on the outside, but it’s hiding a cancer:

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  3. Will the Fed or the persons on the Fed get any bad consequences from their decisions? As far as I can tell, the powers that be have been in our face about it. “Look at what we can do, and you can’t do a damn thing about it.”

  4. Ted K says:

    Even for Democrats (of which I consider myself one), I think the idea of rewarding debtors and punishing creditors (not predatory lenders but creditors in general, as inflation is not prejudiced to any type of creditor, and I could argue any person) is not politically palatable. I think nobody wants a system that encourages the average individual to take on debt. If you do, please explain in comments below.

    Also I find myself forced in the uncomfortable position of defending Bernanke to a degree. Yes Evans was good to dissent. Yes the Fed could be doing more to help the poor (although I think a more active role in regulation of large banks, and disallowing exorbitant debit card fees, disallowing exorbitant credit card fees, disallowing exorbitant ATM fees, disallowing predatory ARMs mortgages etc… would be much more useful than rate changes or QE. Bernanke has these tools, unfortunately he only finds these useful during reappointment time or when Ron Paul tries to open Fed books, see here:


    • Peter K. says:


      He can try. I think the Evans rule would work. If it were up to me I’d change to a NGDP level target and say we’d meet trend growth (i.e. not runaway inflation) by any means necessary. If Bernanke believes he needs more fiscal help, he and the governors and Presidents should say so more forcefully.

      Bernanke bailed out the people who got us into this mess and left Main Street to rot. If Obama is re-elected he should replace Bernanke with Evans or Romer asap.

      With Europe about to implode – meaning another downgrade of the Fed’s consistently overly optimistic forecasts – it will be interesting to see if the Fed will act. They’re performing “stress tests” on the banks but will it be enough?

      The WaPo Neil Irwin’s question to Bernanke about whether the Fed has done some sort of internal review over their poor forecasting was spot on and funny b/c it was true. Bernanke was sort of annoyed and said Japan, bad luck, etc. in response, the usual excuses.

  5. Pingback: “Comparing the Federal Reserve’s Reaction to the Financial Crisis Versus the Unemployment Crisis” (LINK) | Punditocracy

  6. Andy says:

    High unemployment = cheap labor

  7. Rosemary Lynch-Kelleher says:

    I agree with you Peter. The Fed needs to do a top-down truly critical review of its forecasting. (I note that the Fed has had many recent job postings for persons with econometric modeling expertise.) I have a second suggestion for the Fed: send some of your employees into neighborhoods and ask people walking their dogs, or playing with their children, how the current economic situation is affecting them. Take a bus or metro ride and ask a couple of people how things are for them, or if they know anyone who’s lost work due to the recession. Drop by one of the area food banks and chat up those standing in line waiting for some vegetables. Ask them. Last week while putting the Thanksgiving groceries into the car, I asked the young man helping me if the store is hiring for the season. “Well yes we are; we’ve already got 4,000 applications.”
    4,000 applications for a handful of good jobs in a grocery store right here in Washington DC. I hope the Federal Reserve System governors read this little story, perhaps it will begin to sink in.

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  11. “Part of why the bailouts were packaged the way they were was because the bankruptcy of Lehman Brothers went a lot worse than the Federal Reserve had anticipated.”

    Part of the reason why the bankruptcy of Lehman went a lot worse than expected was that it was THE ONLY bank not bailed out. Since the Continental Bank bailout of the 1980s (thank you Reagan!), the financial sector had been operating under the assumption they would be bailed out. In that long, simmering summer of 2008, the government seemed poised to rescue/bailout/resolve the issues of companies including Bear Stearns, Fannie & Freddie. Until September, when Paulson let the markets know that Uncle Sam had had enough. Lehman was one troubled asset the Treasury (under Paulson) wanted nothing to do with. And all the other overleveraged companies panicked wildly.

    Which is understandable, since the traditional assumptions about government bailouts had been trashed. But the panic gave the government folks (both Fed & Treasury) the excuse they needed to funnel trillions to the sector. And also to bailout AIG, an insurance company (not a bank.)

    When you read Henry Paulson’s book on the crisis, you realize he recognized the “wheels were coming off the economy.” And you also realize that in his mind, the economy was entirely contained within the financial sector. There is a dangerously insular perspective in any organization so focused on the one sector. And we’re paying a terrible price for that insularity.

    What I wish from economists and policy makers – some analysis as to why our lender of last resort screwed up so terribly in its role as regulator that the only option was to become that lender of last resort. And I wish that the unemployed in America had a Henry Paulson of their own – someone so concerned about their fate that he’d push Congress to the limit to create policy and marshal resources that would help them get back on their feet.

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