POLITICS NOVEMBER 3, 2011
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Both the left and the right have been consistently peddling the wrong prescriptions for our economy. Most liberals are focused on the need for additional fiscal stimulus, and dead-set against any premature moves toward what they consider “austerity.” Spending cuts, they say, would weaken the economy. Most conservatives are equally insistent that spending cuts need to begin now—and claim that by reducing expectations of future tax increases these cuts would help the economy. At the same time, they consider monetary policy dangerously inflationary and want the Federal Reserve to tighten it, or at least not loosen it any further.
Both sides are mistaken: the right on monetary policy, the left on budget policy, both on the relationship between them. What the economy needs now, contrary to the right, is a permanent monetary expansion. If the Federal Reserve delivers one, the economy, contrary to the left, won’t need new federal spending—and won’t suffer from spending cuts.
There is a bipartisan misunderstanding in Washington about the important role of the Fed in creating the sharpest recession since the Great Depression. For the 25 years leading up to our current mess—the period economists have come to call “the great moderation”—the Fed did a pretty good job of stabilizing the economy. The result of its monetary policies was that the economy, measured in current-dollar or “nominal” terms, grew at about 5 percent a year, with inflation accounting for 2 percent of the increase and real economic growth 3 percent. Keeping nominal spending and nominal income on a predictable path is important for two reasons. First, most debts, such as mortgages, are contracted in nominal terms, so an unexpected slowdown in nominal income growth increases their burden. Also, the difficulty of adjusting nominal prices makes the business cycle more severe. If workers resist nominal wage cuts during a deflation, for example, mass unemployment results.
During the great moderation, people began to expect spending and incomes to grow at a stable rate and made borrowing decisions based on it. But maintaining this stability requires the Fed to increase the money supply whenever the demand for money balances—people’s preference for cash over other assets—increases. This happened in 2008 when, as a result of the recession and the financial crisis, fearful Americans began to hold their cash. The Federal Reserve, first worried about increased commodity prices as a harbinger of inflation and then focused on saving the financial system, failed to increase the money supply enough to offset this shift in demand and allowed nominal spending to fall through mid-2009.
That drop in nominal spending was the most severe decline since 1938. Since then, none of the Fed’s much-debated moves toward monetary ease have brought nominal spending back to where it would have been had the expected 5 percent growth been maintained all along. Consequently, incomes are lower, debt burdens are higher, and banks are weaker than they should be.
Many liberals believe that the Fed is now “out of ammunition” since interest rates cannot be lowered further. Ron Suskind’s recent book Confidence Men reports that President Obama, for example, told economic adviser Christina Romer that the Fed had “shot its wad.” But as Federal Reserve Chairman Ben Bernanke noted in an analysis of Japan in 1999, the Fed can expand the money supply even when interest rates are very low.
For example, the mere announcement that the Fed will buy assets until nominal spending hits a target could raise expectations for nominal-spending growth. If debtors expect higher nominal income as a result, they will devote fewer resources to deleveraging. If investors expect higher nominal spending, they will rebalance their portfolios away from cash and toward higher-yield assets such as stocks, bidding prices up. Higher asset values then lead to increases in spending on both consumption and investment. The more aggressive the Fed’s announcement, in fact, the fewer assets it will likely have to actually buy.
The Fed has refused to take such steps largely because it fears that a dangerous level of inflation would result. That’s a foolish fear: Inflation has been low for the last few years, and the market for inflation-indexed bonds suggests that investors expect low inflation for years to come.
But the Fed’s fear has an implication that liberals overlook. It means that the current “multiplier” from fiscal stimulus—the amount of extra economic activity new deficit spending will generate—is zero at most. That’s because the more fiscal stimulus Congress provides, the less monetary easing the Fed feels inclined to offer. Liberals feel they are compensating for the Fed’s lack of action, but they are really just encouraging it: the main effect of any current fiscal stimulus is not to expand the economy but to shift economic activity around (and especially to shift it from the private to the public sector). Spending may have an economic payoff if it raises the nation’s productive capacity, but it won’t increase total economic activity in the near term because monetary policy, given the Fed’s predilections, will adjust in response to the stimulus.
Most conservatives, for their part, believe the Fed has done too much already. They look at the growth of the Fed’s balance sheet and see a troubling surge in the amount of dollars. What they don’t see is that the demand for money balances has surged even more, and that the Fed has failed to adequately respond to it. Nor are low interest rates a sign of loose money, as many people believe. As Milton Friedman pointed out in the case of late-1990s Japan, low interest rates can result from a tight-money policy that weakens the economy and reduces the expected returns on investments.
This tight money works against conservatives’ fiscal goals. It increases the deficit both by suppressing revenues and by triggering automatic spending on such programs as unemployment insurance. It also creates political pressure for new discretionary spending to help the economy. Both of the last century’s most pronounced periods of monetary tightness—during the Depression, and during 2008-9—also saw substantial growth in the federal government.
Conservatives have countered liberal fiscal views by pointing to studies suggesting that other countries have cut their budgets while enjoying economic rebounds. But almost all of these success stories featured the accommodative monetary policy that today’s conservatives oppose. This was true of the much-celebrated case of Canada’s fiscal retrenchment in the latter half of the 1990s, and of the emergence of the budget surplus in the U.S. in the same period.
The conservative worry that monetary ease will get out of hand is also overwrought. For one thing, we now have better market indicators of future inflation than we had during the great inflation of the 1960s and 1970s. More important, monetary ease that takes the form of a nominal-spending target would constrain future inflation. The Fed should commit to return to the nominal-spending trendline of the Great Moderation, which requires both a few years of faster-than-5-percent catch-up growth now and then a slowdown to the normal rate.
What the moment calls for, then, is temporarily looser monetary policy to respond to the short-term challenges of the weak economy combined with spending cuts to solve the long-term budget crisis. Each element supports the other. For example, higher nominal incomes will put a lot of homeowners above water again, ending calls for federal intervention. Fiscal stimulus, meanwhile, will not achieve its macroeconomic goals if the Fed remains committed to fighting a non-existent inflation threat and is unnecessary if it adopts a better course. Fiscal stimulus leaves us deeper in debt; monetary expansion reduces the debt burden. It’s a pity that nobody in Washington is advocating the right policy mix.
David Beckworth is an assistant professor of economics at Texas State University. Ramesh Ponnuru is a senior editor at National Review and columnist for Bloomberg View.
16 comments
How would bidding up house and stock prices increase income of workers? What assets will the Federal Reserve buy? Underwater mortgages at their original price? So more bailouts for bankers. Or perhaps just shares of companies on the stock market, great so a bailout for the upper classes. Federal stimulus to build infrastructure would give idle workers income. That's the obvious way to boost income and aggregate demand. Plus it build something useful, instead of having the Fed play more financial games.
- vips73
November 3, 2011 at 12:25am
This article is ridiculous. If high demand for money left unsatisfied by the Fed caused the great recession why did we not see bond prices plummeting and yields going through the roof as investors sought to satisfy their demands for cash balances by dumping other assets?
- dmbrown
November 3, 2011 at 12:30am
What curious logic. The authors deem fiscal stimulus ineffective because the Fed will tighten in response; then they turn around and say that the Fed needs to loosen up. Make up your mind, guys. Either monetary policy is independent of fiscal policy, or it isn't. If it is, then Congress and the President can engage in fiscal stimulus and the Fed can simply refrain from tightening. If it isn't, then asking the Fed to loosen up is futile. I'm not saying the Fed shouldn't pursue NGDP targeting. It absolutely should! But that doesn't mean we ought to give up on fiscal stimulus. Right now, anything that can give the economy more juice is worth trying.
- Dausuul
November 3, 2011 at 12:46am
But how does it play with Narayana Kocherlakota? This is the crucial question. Of course, canonical liberal economists are arguing for a Grand Bargain of marrying expansionary fiscal policy and expansionary monetary policy. At the same time, dogmatic monetarists are pushing expansionary monetary policy and static federal fiscal policy (never mind the contractionary forces at the state level!) The consensus among political economists not currently employed by Republicans or their tentacular, para-university apparatus is that we should do a Grand Bargain of jobs now and deficit later. But three activist regional Fed chairs are (a) screaming about non-existent inflation (b) pushing for a restoration of the single mandate so they don't have to lift a finger to fix the jobs crisis (c) completely ignoring the daily evidence on the economic consequences of austerity and anti-inflation zeal coming from Europe Of course, if you've read this far, you know that Kocherlakota, the Minneapolis Fed chief, takes the multiple choice format very seriously, and shades in all three bubbles. So even a crazed monetarist can't avoid the notion that his party is getting in the way of solving our problems on multiple levels. Because let me tell you, if Ben Bernanke were Fed czar, he would not respond to a second economic stimulus by tightening monetary policy equally to cancel its effects. If you think that, you clearly didn't witness or live through QE I, which was pursued in tandem with the Bush and Obama stimuli. Similarly, if Obama were fiscal policy czar, he would cut issue cost containment reforms in the future and get the economy back on track for the present. That's consistent with everything he's said so far.
- chaitless
November 3, 2011 at 1:23am
What the authors are saying is that the Fed should set a higher inflation target, achieved through monetary easing (i.e., growth in the money supply). And how does the Fed do it? Buying outstanding government debt is one way, but the simple way is to print money and put it in circulation, dropping it from an airplane is one approach (Cohn's suggestion a year or so ago), or just sending it to taxpayers (checks or direct deposits will work fine). By increasing expectations of inflation, and by actually inflating the money supply, people will spend more, create more income, and help the economy recover. A little inflation would have at least two more benefits: it will raise the price of assets including (many underwater) houses and reduce the burden of repayment of outstanding debts both personal and government (monetizing the debt). Of course, this isn't going to happen. Why? The technical objection is that a little inflation is difficult to control and could lead to lots of (hyper) inflation. But as the authors point out, the Fed has gotten much more proficient at closing the spigot. The practical (political) reason this isn't going to happen is that so much of the nation's (and world's) wealth is now invested in bonds, especialy (US) government bonds, whose value would decline with higher inflation; the one thing bondholders abhor is inflation. In other words, we are captives of the bondholders (PK calls them rentiers). My suggestion is to adopt policies that make equity a better (near term) investment than bonds so money will migrate over to equity, whose value is enhanced by a little inflation. Now this suggestion is a chicken and egg issue, because higher inflation in itself will motivate investors to switch to equity. Unfortunately, as I said we are captives of the rentiers.
- rayward
November 3, 2011 at 7:38am
yes rayward, or as Bob Rubin told Bill Clinton in 1993, 'the bond markets rule'. What the authors fail to address is why the Fed's zero interest rates have not flowed through to consumers. A friend called me yesterday because her BoA mortgage has been 'sold' to CapitalOne, and she got two separatee statements for November. She wanted to know if same had happened to my BoA mortgage. No, because mine was originated by Countrywide, and BoA has obviously gone thru a cherry-picking exercise and decided to keep mine because I am profitable at 6.375%, not behind, and not underwater. My friend's mortgage has been sold multiple times since her originating bank got sold and re-sold until somehow it wound up in BoA. Anyway, that conversation made me wish I had the power to sell my own mortgage, without $3500 in new closing costs, to anyone wanting 4% yield, the current rate for a 30-year fixed. Better for the US economy for me to be spending that extra $276 every month than having it go to prop up BoA's profits. So much for 'free markets'
- K2K
November 3, 2011 at 8:04am
k2k, the information I have from lenders is that it costs about 6% to refinance, and that's for somebody with great credit who only wants a lower rate (i.e., no money out). As for BofA, shortly after the crash in 2008, BofA raised my Visa business card rate to 20% (the highest allowed in my state) and put five day holds on checks deposited into my business account (checks from clients). I called BofA about the Visa rate and was told it's the best rate for business (i.e., corporate) cards. They have since relaxed (somewhat) the five days holds, but not lowered the Visa rate. I paid off the card and cancelled it. BofA is not a bank, not in the traditional, retail sense. They only pretend to be a retail bank to capture deposits, especially in places like Florida with all the retirees, and fees. The problem is that small banks have difficulty competing in this environment, many having lost their best people because the small banks aren't lending. Aside from BofA, what's appalling is that the non-bank banks that converted to banks in 2009 to access free money from the government now threaten to convert back to non-banks now that the Dodd-Frank regulations are about to be implemented. These folks have no shame. None. Any wonder that so many people don't trust Obama. I know, with a Republican president it would be much worse (maybe).
- rayward
November 3, 2011 at 9:09am
How bizarre that TNR is electing to publish a piece so plainly wrong. First, it supports, without empirical support, the claim that the current economy is effected by the long term fiscal picture. There is absolutely no support for that claim, not can there be. Secondarily, it argues against further fiscal stimulus based upon a tradeoff with with QE. That's a political argument, not an economic one. It isn't an error on the Left but on the Right, even assuming its accurate as a function of economics
- gator27
November 3, 2011 at 10:20am
"If debtors expect higher nominal income as a result, they will devote fewer resources to deleveraging." That would help in the short-term. However, in the long-term deferring deleveraging would increase vulnerability to future shocks and reduce future capacity to spend. What's needed is to increase income so that they can maintain spending while deleveraging. "Spending may have an economic payoff if it raises the nation’s productive capacity, but it won’t increase total economic activity in the near term because monetary policy, given the Fed’s predilections, will adjust in response to the stimulus." Does that have to be? See chaitless' comment.
- sighthnd
November 3, 2011 at 10:49am
The multiplier for fiscal stimulus in the forms of actual jobs, not unemployment benefits, will NEVER be zero, or even less than 1. That's absurd. Even as people are deleveraging, like I am, there's still plenty of regular economic activity to complete: from gas and groceries, clothes and haircuts, to an inexpensive night out to help me forget how many resources I'm pouring into deleveraging.
At least people who don't have jobs anymore can't be said to be making more than the average income, and so should be able to file bankruptcy fairly easily. I wonder what kind of progress they're making? People are probably holding out hope that something will come along and making things worse in the mean time.
This whole theory sounds a lot like a ponzi scheme to bail out the job creators so they can be free to create jobs, using the notion of inflation as some sort of mystical counterforce to artificially inflate demand. Just another bubble, one that would pop sooner or later, and reveal the massive crater and gaping maw of nothing underneath.
- GSpinks
November 3, 2011 at 11:19am
It means that the current “multiplier” from fiscal stimulus—the amount of extra economic activity new deficit spending will generate—is zero at most. That’s because the more fiscal stimulus Congress provides, the less monetary easing the Fed feels inclined to offer. I agree with Gspinks on what is, remarkably, the secondary rebuttal to this statement. Of course fiscal stimulus doesn't have a zero to negative multiplier. Anyone who says this is an idiot. Even Douglas Holtz-Eakin, hack that he is, recognizes this and points out that the stimulus created no jobs. Interestingly, though , the primary rebuttal to this statement is that the authors have it backwards. I don't know why conservative water-carriers have a pathological tendency to do this kind of thing, but it's pretty prevalent. A conservative says something and either by inverting it or reversing its logic, you can show the opposite notion maintains and perhaps they know this and are cynically attempting to suppress the truth. In this case, it is almost incontrovertible that ever since the stimulus, we have had tight fiscal policy (counter-stimulus) and things like quantitative easing that qualify as monetary stimulus. If anything, the more monetary stimulus the Fed provides, the less fiscal stimulus a Republicans in Congress feels inclined to offer.
- chaitless
November 3, 2011 at 1:54pm
I've had this piece in the back of my mind struggling to make sense out of it, and I can't. There is an equilibrium between supply and demand for deposits that is reflected in the current low deposit rates. As pointed out above, higher short-term Treasury rates imply a demand for cash as the rate goes up until people are not looking to get into cash any longer. Lower short-term rates imply that there is no unmet demand for cash. People aren't spending so they don't want cash and hence there is no pressure on Treasury rates. The flight to safety accounts generally for low rates. They are not passed on to borrowers because loan supply is low. Hence, despite the banks' low costs, the spread is very high. Lenders do better in this environment collecting the spread and not lending. Not an accident. This was the Treasury strategy for recapitalizing the banking sector without doing it explicitly, just fleece consumers for the money. Of course, when lenders don't want to lend, driving down interest rates in this way further adversely affects spending as there are quite a few people who depend in their interest income. But that is all sort of beside the point. We do need more inflation to de-leverage with the least pain. The opposition to that is firmly on the right. Indeed, defense of the rentier class at the expense of everyone else is the main job of the Republican party. It is working just fine for them. Corporate profits and cash are enormous, labor share is down, consumer interest income is down. From their point of view, this isn't a crisis, its a party. If the Fed were more aggressively buying Treasuries, monetizing the debt, perhaps loan rates would really go down, which would help. Inflation might rise. That would deleverage the system and help. But there is no reason at all to believe that monetary policy alone is the way out of the morass. A combination of aggressive fiscal policy and monetary policy is what is needed. If we increase government spending and neither raise taxes nor borrow, but just print money (that is, the Fed monetizing the debt), then we are sure to see a higher multiplier. Even for the crazy rational expectations crowd, the anticipation of inflation will result in people with cash trying to get rid of it. Consumption rises. Asset prices rise. Hoarding cash in the face of expected inflation would not be rational. Is the left supposed to be opposed to this? Is it the left that has not wanted to borrow, to monetize, and to spend? Absolutely not. It is the right, and the rentiers, who oppose all three. So, what, if anything, are these authors trying to say? I suspect that the merely want to sound smart by claiming that everyone else is wrong. But they do, albeit somewhat inadvertently, make something of a case for a much more aggressive Keynesian response. Basically boobs.
- roidubouloi
November 3, 2011 at 2:07pm
Correction: DHE points out that the stimulus did create jobs or did not "create zero jobs".
- chaitless
November 3, 2011 at 4:42pm
What the authors are really doing, it seems to me, is promoting the British approach to debt reduction: restrictive fiscal policy and expansionary monetary policy. This combination is to be used to reduce the debt from both ends by cutting spending on the one hand and inflating away the value of what remains politically impervious (probably much the greater part, e.g. social security, pensions, etc). The fact that taxes are not indexed to inflation has a further, surreptitious revenue-enhancing, debt cutting effect. We don't have to worry about any impetus towards wage inflation as in the 70's, B&P reason, since the unions have been marginalized, and people have now been conditioned to worry about simply getting and retaining a job. B&P are also, therefore, asserting that monetary inflation should be the weapon of choice to consolidate successes from global labor arbitrage in the engineering of labor costs (again e.g. social security, pensions, wages) downward. In selling this to a TNR crowd ("liberals"), they make the case that a monetary "stimulus" is preferable to a fiscal (or at least a spending) stimulus. The key word--in a Pavlovian way--is "stimulus"). In reality, monetary "stimulus" is intended to devalue debt and wage compensation over time with relative discretion. My favorite part is the characterization of the Fed: "Why, those boys are just so dang ornery and independent that they'll offset any fiscal stimulus, so let's do a little judo on 'em and let THEM provide the stimulus that you liberal folks are a-hankerin' for." P&G obviously have a very low opinion of the TNR readership.
- ccarrick@vzavenue.net-old
November 3, 2011 at 6:04pm
K2K - I find it hard to believe it isn't worthwhile (in closing costs) to refinance from 6.75%. I am in the process of refinancing and am saving only about a point and it's worthwhile. Of course it all depends on your loan, what new rate you'd be offered, etc., but you should at least make some inquiries to see what your specific costs would be, rather than relying on what may be "typical," etc. (And going through a mortgage broker was especially helpful; she was able to get a wholesale rate that was better than what the retail banker from the same bank could offer.)
- shellski
November 3, 2011 at 7:03pm
Shell games and smokes screens. This country needs to build for the future, or get left in the dust. Schools and playgrounds, municipal mass transit, improved electrical grids, upgraded port facilities, renovated water and sewer systems, airport improvements, research and development, alternative energy systems---the list is damn near endless. What is holding us back? The fear on the part of the rentiers or plutocrats or moneyed class or "job creators" (i wanna puke everytime i hear that one) that they won't be able to control the unleashed energies of a revitalized national purpose? I don't know, but i know this, its way past time to---at a minimum---reinstitute some sort of fairness doctrine in the media and break up the information cartels that keep the Joe-the-Plumber types thinking that somehow they benefit from the fortunes being piled up by the Daddy Warbucks types.
- bonsaibush
November 3, 2011 at 8:24pm