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The Last Liberal Branch of Government

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If you want to appreciate just how conservative the fiscal conventional wisdom is, consider that hotbed of Bolshevism, the Federal Reserve. Yes, the central bank that progressives love to hate is today the most expansionist outfit in town.

Although they are arguing about the details, both President Obama and the Republican Congress have committed to another $1.5 trillion of deficit reduction over the next decade, just about guaranteeing a prolonged period of high unemployment, an under-performing economy, and flat or declining wages for most working people.

Consider this thoughtful speech by the Fed's vice chairman, Janet Yellen, delivered last week at an event jointly sponsored by the AFL-CIO (!) and the German Social Democratic (!) Friedrich Ebert Foundation, titled "A Trans-Atlantic Agenda for Shared Prosperity." It was light years more progressive than the sort of fiscal summits that the White House has blessed.

In the speech, Yellen began by reminding the audience that the Fed's mandate is a society of high employment, not just low inflation, and she made several important points that seem to have eluded President Obama -- all of which are implicit rebukes to the Administration's fiscally deflationary approach to the recovery. Compared to all other postwar downturns, she said, "The Great Recession stands out both for the magnitude of the job losses that attended the downturn and for the weak recovery in employment that occurred after the recession ended."

How come? First, Yellen reports, bad fiscal policy. In every other postwar recession, government helped the recovery along by increasing spending or cutting taxes, or both. But in this recession, the government has been more concerned to rein in deficits.

... [D]iscretionary fiscal policy this time has actually acted to restrain the recovery. State and local governments were cutting spending and, in some cases, raising taxes for much of this period to deal with revenue shortfalls. At the federal level, policymakers have reduced purchases of goods and services, allowed stimulus-related spending to decline, and have put in place further policy actions to reduce deficits.

So people, let's not make things worse by even more belt-tightening while the recovery is still weak.

And in other recoveries, housing led the way. Not in this one.

Tight mortgage credit conditions are continuing to make it difficult for many families to buy homes, despite record-low mortgage interest rates that have helped make housing very affordable... For some households, the collapse in house prices has left them underwater on their mortgages, and thus less able to refinance or sell their homes.

Yellen is too polite to scold Obama for his lame and inadequate mortgage relief program, but the clear implication is that the Administration could be doing a lot more.

She also pointed out the persistence of too high unemployment, with its negative effect on incomes, hopes, and purchasing power. When you accurately count unemployment, to include people who've given up any reasonable hope of funding a job and people in part-time work who can't find fulltime work, the real rate according to Yellen, is not 7.9 percent but 14.4 percent.

Workers' share of the total national income, she reports, is near its all-time low, just over 60 percent, compared to 68 percent during boom times. And long-term unemployment is still near its recession high:

Long-term unemployment is also a great concern because it has the potential to itself become a headwind restraining the economy. Individuals out of work for an extended period can become less employable as they lose the specific skills acquired in their previous jobs and also lose the habits needed to hold down any job. Those out of work for a long time also tend to lose touch with former co-workers in their previous industry or occupation -- contacts that can often help an unemployed worker find a job. Long-term unemployment can make any worker progressively less employable, even after the economy strengthens.

Yellen then took on the center-right's favorite alibi for persistently unemployment--the conceit that the skills demanded by the economy have moved away from the skills that today's workers. Citing an impressive array of scholarly evidence, Yellen was having none of it.

[A] broad-based cyclical shortage of demand is the main cause of today's elevated unemployment rate.....whatever problems there may be today with labor market functioning [i.e, skills shortages] are likely to be substantially resolved as the broader economy improves and bolsters the demand for labor.

Yellen went on to defend the Fed's extraordinary policies of bond purchases to keep interest rates very low, but made clear that monetary policy alone can't levitate the economy when fiscal policy is making things worse and there are inadequate efforts to solve the housing and unemployment problems.

Yellen's Chairman, Ben Bernanke, has said much the same thing, just not quite so bluntly. Today, the most resolute economic progressives in town are the chair and vice chair of the Fed.

Compared to the past stance of the Fed -- priority for cutting inflation, capture by bankers -- this is good news. But it hardly makes them radicals. Her speech was the sort of analysis you'd expect from a middling Democratic president or his top economic advisers. But this Democratic president and his top advisers, despite some brave words about new spending initiatives (for which there is no serious money in the budget), still believe in the austerity cure.

What sort of a topsy-turvy world is it when we have to look to the Federal Reserve, normally the home of inflation hawks and shills for commercial bankers, for ordinary common sense on the economic recovery? It's not that the Reserve has become dangerously left-wing. It's that the rest of Washington has been captured by the deflation delusion.

Robert Kuttner is co-editor of The American Prospect and a senior Fellow at Demos.

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