Boiling in a Pot of Tea

Charles Buddeke
Class of 2013
College of Arts and Science

Last week was notable for two major developments. First and most headline grabbing, the Republican Party experienced a historic revival after being completely broken in the 2008 election. However, it is not wholly accurate to call this a resurgence of the party. The main driving force behind these electoral results was the enigmatic Tea Party, who rode general discontent with the economy in to office. However, the great irony is that the Tea Party is the single greatest hindrance to economic recovery.
The second important development last week was the announcement by the Federal Reserve of its intent to purchase 600 billion dollars worth of US Treasuries (also known as quantitative easing.) The goal of this program is to incentivize the purchase of assets by making the costs of holding on to capital higher and lowering long-term interest rates to facilitate business borrowing for investment. As soon as this was announced, condemnation came from many high profile Tea Party members.
Sarah Palin, the figurehead of the movement, implored Federal Reserve Chairman Ben Bernanke to “cease and desist” this policy. Not only is Mrs. Palin lecturing a PhD of economics on economics, she is doing so without grasping the complexities of the situation. Mrs. Palin cited international condemnation of these policies as additional evidence to her usual rant about government excess. Since Germany “knows a thing or two about the dangers of inflation,” Mrs. Palin reasons the Federal Reserve should listen to them.
In reality, the international outcry is not out of concern for the world economy, but rather their own dependence on U.S. consumption as the engine of growth for their economies, which is a flaw in the workings of the world economy. The German economy and most developing economies are based largely on exports, the recovery of which would be severely hurt by a weakened dollar. A strong dollar would make US exports more competitive, and it would reduce US demand for foreign products due to higher cost. Just because she fails to capture this detail does not mean, however, that Mrs. Palin is wrong. She is right in that there are serious dangers to the U.S. if these policies cause inflation to take off, and Mrs. Palin doesn’t even touch on the possible danger to the world economy due to the currency wars resulting from methods like quantitative easing.
Why then is Mr. Bernanke using these potentially risky policies? Ironically, it is the Tea Party that forced Mr. Bernanke’s hand. This group has made any fiscal stimulus (government spending) beyond politically toxic. Adding to the already considerable irony, fiscal stimulus would have a much greater effect due to the already low interest rates in the U.S. However, the Tea Party’s campaign against government spending has prevented and will continue to prevent Congress from enacting any additional spending to spur economic growth.
This is incredibly dangerous. The current unemployment rate is in danger of becoming structural if rates of economic growth do not pick up, and this risk is several orders of magnitude more dangerous than the one posed by the short term deficit spending. Therefore, something must be done to drive demand. Enter Mr. Bernanke. Since the Federal Reserve is currently the only body both capable and willing to stimulate the economy, albeit in an usual way, it must be done despite the dangers. The Tea Party would do well to ignore the short term deficit in favor of stimulating the economy. Instead, it should focus on putting in place plans to reduce, if not eliminate, the medium term deficit, which is where the real danger from fiscal policy exists.

References:

http://online.wsj.com/article/SB10001424052748703514904575603023040162294.html?mod=WSJ_hps_sections_news