Stephen Foley: America has just abandoned the unemployed

US Outlook: The seven men and three women who sit down in Washington on Tuesday to debate US interest rate policy will almost certainly decide to do nothing. They may well say something, but action – desperately needed action – seems unlikely for the time being.

The Federal Open Market Committee of the Federal Reserve is locked in its own version of the ideological paralysis that has crippled Washington's response to the renewed economic downturn. A minority of inflation hawks has kept the Fed from pursuing its mandate of maintaining full employment. The 9.1 per cent jobless rate in July is an indictment of the Fed's dereliction of duty as much as it is of the political class's abdication of responsibility.

The market rout this week, and the 10 per cent-plus correction in equities prices since May, is a reset to the new expectation for anaemic economic growth in the remainder of this year and beyond. It has become clear that the Fed was wrong to claim the slowdown in the first half of the year was a result of temporary factors such as commodities price rises and the Japanese earthquake. The European debt crisis is hardly temporary; it has become a permanent and terrifying feature for business managers deciding whether to risk making new investments and hiring workers. Most important are the real concerns over final demand, now that high unemployment looks certain to continue for years to come and that consumer spending has gone into reverse in the world's largest economy.

It was the threat of deflation that gave Ben Bernanke, Fed chairman, room to push for a second round of quantitative easing this time last year. The inflation hawks are stronger this time round, because core inflation has ticked higher, and because there are real concerns that a third round of easing will whack the dollar, refire commodities prices and counterproductively raise energy bills for consumers and businesses, cancelling out the benefits of lower interest rates.

But the risks of not acting have risen dramatically, too, because it is clear now that no one else is going to. Congress has managed to extend unemployment benefits to the 13.9 million Americans who are out of work, a Democrat priority, and to extend tax cuts for the rich that Republicans say will trickle through the economy and encourage job creation. But there is no political constituency fighting for direct job creation by government, either through federal aid to prevent lay-offs in local government or through public works projects. These ideas represent the fastest way to lower unemployment, but government is now out of the business of job creation. It is cuts, cuts, cuts all the way from here.

No wonder so many Americans are so discouraged in their search for work that they have left the labour force entirely. Only 58.1 per cent of the country's adults were in work in July, the lowest level for 28 years.

As was clear from yesterday's figures, private sector job growth, though better last month than economists had feared, is notnearly fast enough to undo the effects of the recession, let alone to restore the spending power of America's middle class that has dwindled for a generation.

Until the world's largest economy breaks the back of its unemployment problem, final demand from the US consumer will remain weak. Given the consumer accounts for 70 per cent of the country's GDP, that is a brake on growth not just for the US but for developed and emerging economies that rely on selling to it.

Monetary policy is the one, imperfect tool left. The FOMC shouldn't have this amount of pressure on it, but it must indicate that it will consider additional, innovative ways to manipulate market interest rates to ease the burden on consumers and encourage more lending into productive sectors of the economy.

When historians write the story of the Great Recession, the premature end of expansionary fiscal policy may well be seen as a mistake of Smoot-Hawley proportions. Will Mr Bernanke and his FOMC colleagues emerge with credit for doing all they could to lean against these policy errors? We may well have a clue in the coming week.