The Fed's sustained low policy rate, quantitative easing (QE), and forward guidance have stimulated financial markets and boosted asset prices but have failed to stimulate the economy. As planned, the Fed's efforts to lower bond yields and reduce the real cost of capital, encourage risk taking, and lift stock and real estate values have succeeded. But nominal GDP growth has actually decelerated to 2.5 percent in the last year from its subdued 3.9 percent average pace of the prior six years, and real growth has languished.
The most disappointing aspect of the slow economic expansion has been the weak rise in business investment. Consumption and residential investment have grown fairly steadily. But despite lower costs of capital and only modest increases in labor costs, investment has fallen persistently below expectations while employment gains have actually been strong. Labor productivity has risen at a painfully slow 0.5 percent pace in the last six years and has fallen in the last three quarters, a unique trend during modern economic expansions. These trends have far-reaching implications.
In response, estimates of potential growth and the natural rate of interest have been reduced sharply. The Fed has delayed normalizing rates, and bond yields hover near historic lows. Even with mounting evidence that monetary policy is having little stimulative impact on the economy, a constant Fed theme has been that as long as inflation is below its longer-run 2 percent target and inflationary expectations remain well anchored, sustaining monetary ease is appropriate. This theme presumes that the economy is constrained by insufficient demand that may be remedied by monetary policy. Until recently, very few' Fed members have challenged that assessment.
Recent trends make it increasingly clear that economic performance has been constrained by factors that are beyond the scope of monetary policy and that the Fed's policies are contributing to mounting financial distortions with unknown consequences. Such policies are inconsistent with the Fed's macroprudential risk objectives--a point emphasized by Peter Fisher (2016).
Factors Constraining Investment and Growth
Standard explanations of weak investment are that business capital spending has been slowed by the rising share of GDP in less capital-intensive production, particularly in some labor-intensive services, rising investment overseas (that is not measured in GDP), and measurement issues. The largest U.S. companies based on market capitalization are investing less in traditional physical capital than the largest companies in prior decades. Measurement problems center on the challenge of fully capturing information technology, human capital, and intangible capital in the National Income and Product Accounts. These factors likely explain part of the weakness in measured domestic investment and GDP.
Government policies have been a key source of the weak investment and economic growth...