Fed Prints More Money

A quick look at the Federal Reserve’s balance sheet in terms of assets has led some economist’s to wonder what the Fed is planning to do, while others say there is no plan at all. The lion’s share of assets are tied up in U.S. Treasury securities and mortgage-backed securities, which doesn’t seem like a problem when inflation rates are kept in check as they are now, but when considering the financial turmoil experienced in the last seven years there are some who believe that more quantitative easing may lead to rude awaking in this fragile financial ecosystem. For more on this continue reading the following article from Tim Iacono. 

After catching up a bit on all the commentary related to the Federal Reserve’s ongoing money printing effort such as this item from yesterday and today’s offering from Jim Jubak at MSN Money where it was concluded that “The Fed has no endgame“,  refreshing the simplified graphic of the central bank’s balance sheet below seemed like a good idea, particularly since they are rapidly closing in on the $4 trillion mark.



Of course, there is a growing consensus that this is all benign (or at least irrelevant as long as stock prices are rising) and that argument is lent some credence by the low rates of inflation for consumer prices reported in the West (inflation in developing nations is an entirely different matter). Somehow, it seems the quadrupling of the Fed’s balance sheet (and then some) will prove to be anything but benign.

This article was republished with permission from Tim Iacono.

Economist Skewers Fed’s Expert Outlook

Tim Iacono takes note of Neil Irwin’s recent critique in the Washington Post of U.S. government economists and their prognostications for the last few years, arguing that they basically don’t know what they’re talking about and may even be guessing. He points to their GDP growth predictions for 2011 and 2012 and how they were both similarly inflated. He then points to the outlook for 2013 and suggests the rhetoric could have been cut and pasted from previous years, leaving some to expect the worst when it comes to this year’s economic performance. For more on this continue reading the following article from Iacono Research.

A look at the abysmal track record in recent years in forecasting economic growth by the nation’s top government economists as related by Neil Irwin in this Washington Post story. Also see the related graphic that depicts how poor a job the economy has been doing in getting back to its “potential” growth.

They say that the essence of futility is to keep doing the same thing while expecting a different result. But is that what key government forecasters are doing in determining their outlook for the economy?

Throughout the halting economic recovery that began in 2009, the formal economic projections released by the Congressional Budget Office, White House Council of Economic Advisers, and Federal Reserve have displayed quite a consistent pattern: This year may be one of sluggish growth, they acknowledge. But stronger growth, of perhaps 3.5 percent, is just around the corner, and will arrive next year.

Consider, for example, the Fed’s projections in November of 2009. Sure, growth would be slow in 2010, they held. But 2011 growth, they expected, would be 3.4 to 4.5 percent, and 2012 would 3.5 to 4.8 percent growth. The actual levels of growth were 2 percent in 2011 and 1.5 percent in 2012.

What’s amazing is that the Fed’s newest projections, released in December of 2012, look like they could have been copy and pasted from 2009, just with the years changed: They forecast sluggish growth in 2013, 2.3 to 3 percent, followed by a pickup to 3 to 3.5 percent in 2014 and 3 to 3.7 percent in 2015.

Increasingly, it appears that this is one of those times when “it really is different” in that we’re not about to return to “trend growth” and for good reason – it was artificial, based on a reckless expansion of credit.

Then again, another reckless expansion of credit might just do the trick.

This blog post was republished with permission from Tim Iacono.

CBO Budget Outlook Review

The Congressional Budget Office (CBO) has released its budget forecast for the next ten years and the prognostication is not tethered to reality, according to one critic. Tim Iacono notes that CBO analysts believe the big picture translates into fewer policy decisions in the future to the high level of federal debt, but he argues the real trouble is that an increase in GDP and lower unemployment will have to rely on the inflation of an asset bubble that will make the last 15 years look small by comparison. For more on this continue reading the following article from Iacono Research. 

The first page of The Budget and Economic Outlook: Fiscal Years 2013 to 2023 from the Congressional Budget Office contains the following summary charts that tell you quite a bit about how this group sees our future.

What’s interesting about the first chart is that it’s being interpreted in two very distinct ways. Some say, “See there! The debt is stabilizing. There’s no need to do anything more.” while others (including the CBO) conclude, “This high level of debt will restrict policy choices during any future crisis”.

A small minority (including myself) think that the lower two graphics are the more important parts of this report since, for all the wrangling over taxes, spending, and debt that go into the numerator of the debt-to-GDP equation, the denominator gets far too little attention.

There is clearly no recognition that the U.S. has come to the end of a multi-decade credit boom that has goosed both economic growth and employment. Moreover, about the only way we’ll return to “trend growth” and a 5 percent jobless rate by 2017 is to inflate an even bigger (and, ultimately, more destructive) asset bubble than what we’ve seen over the last 15 years and this is clearly not factored into any of this forecast.

This article was republished with permission from Tim Iacono. 

‘American Dream’ Dead, Economist Says

Economist Joseph Stiglitz makes a compelling argument that the American Dream is a myth during a recent interview for Spiegel. He points out that the political system favors the wealthy and that there are more rich people who attained their wealth through market manipulation and cheating the poor than there are of those who earned it by creating something new that people needed. He argues that there is no other industrialized nation that makes its children more dependent on the wealth and education of their parents to succeed in life, which is the very antithesis of American Dream. For more on this continue reading the following article from Economist’s View.

Spiegel interviews Joe Stiglitz:

'The American Dream Has Become a Myth', Spiegel: ...Spiegel: The US has always thought of itself as a land of opportunity where people can go from rags to riches. What has become of the American dream?

Stiglitz: This belief is still powerful, but the American dream has become a myth. The life chances of a young US citizen are more dependent on the income and education of his parents than in any other advanced industrial country... The belief in the American dream is not supported by the data. ...

Spiegel: We thought that as a rule Americans don't begrudge the rich their wealth, though.

Stiglitz: There is nothing wrong if someone who has invented the transistor or made some other technical breakthrough that is beneficial for all receives a large income. He deserves the money. But many of those in the financial sector got rich by economic manipulation, by deceptive and anti-competitive practices, by predatory lending. They took advantage of the poor and uninformed... They sold them costly mortgages and were hiding details of the fees in fine print.

Spiegel: Why didn't the government stop this behavior?

Stiglitz: The reason is obvious: The financial elite support the political campaigns with huge contributions. They buy the rules that allow them to make the money. Much of the inequality that exists today is a result of government policies.

Spiegel: Can you give us an example?

Stiglitz: In 2008, President George W. Bush claimed that we did not have enough money for health insurance for poor American children, costing a few billion dollars a year. But all of a sudden we had $150 billion to bail out AIG, the insurance company. That shows that something is wrong with our political system. It is more akin to "one dollar, one vote" than to "one person, one vote." ...

Spiegel: So your answer to the inequality problem is to transfer money from the top to the bottom?

Stiglitz: First, transferring money from the top to the bottom is only one suggestion. Even more important is helping the economy grow in ways that benefit those at the bottom and top, and ending the "rent seeking" that moves so much money from ordinary citizens to those at the top. ...

Nothing particularly new here, but I wanted to highlight the point about rent-seeking, anti-competitive practices, etc. once again since I don't think this cause of inequality receives enough attention.

This blog post was republished with permission from The Economist's View.

Globalization Hurting US Jobs Market

The historically dominant belief among economists is the economic globalization and increased trade has not been a detriment to the U.S. job market, pinning the blame squarely on technological shifts that have eroded the need for many jobs – particularly in the manufacturing sector. While many accept that advancement in technology has had some role in jobs decline, according to a recent poll in New York Times more economists are changing their opinions about globalization’s role in U.S. unemployment. Analysts now say cheap labor abroad is having more of an impact than previously realized. For more on this continue reading the following article from Economist’s View. 

Edward Alden of the Council on Foreign Relations:

Changing Views of Globalization’s Impact, by Edward Allen, Commentary, NY Times: ...For decades, economists resisted the conclusion that trade – for all of its many benefits — has also played a significant role in job loss and the stagnation of middle-class incomes in the United States. ...

Rather than focusing on trade, economists argued that other factors – especially “skill-biased technical change,” technological innovation that puts an added premium on skilled workers – played the biggest role in holding down middle-class wages. But now economists are beginning to change their minds. Responding to The Times’s recent survey about the causes of income stagnation, many top economists have cited globalization as a leading cause.

While the evidence is still not conclusive, it is pretty strong. Trade’s effect on jobs and income, which was probably modest through the 1990’s, now seems to be growing much larger. [list and discussion of recent studies]...

The usual rebuttal to these findings is to argue that they stem mostly from manufacturing. And manufacturing, the argument goes, is facing a long-run, secular decline in employment that is largely technology-driven, not unlike the story of agriculture in the 20th century. The job losses in manufacturing may seem as if they have been caused by trade,... but they have actually been caused by technological change.

Through the 1990s, that story was largely plausible. But over the last decade it is not. ... There is no question that over the last decade United States manufacturing has declined, taking away jobs and driving down wages for those who are still employed. Robert Atkinson and colleagues have a useful paper on this topic, showing that the loss of more than five million jobs in manufacturing in a decade was not primarily a technology and productivity story.

The real-world evidence makes it surprising that it has taken economists so long to catch on...

I've expressed pro-trade views in the past, and I still have them. But it's not enough to say, as we do, that the gains from trade are such that (under fairly general conditions) we can make everyone better off and no one worse off. If the actual result is that all the gains go to the top of the income distribution, and all the costs go to the working class -- if the distribution of the gains results in a large class of losers -- then it is much harder to defend. We must find a way to ensure that trade realizes the promise of "lifting all boats" instead of just the yachts.

This blog post was republished with permission from Economist's View.

Americans View Taxes as Immoral, Experts Say

Although Americans are not taxed nearly as much as people in other Western countries, particularly Canadians and the British, there is nothing that vexes U.S. citizens more than more taxes. Experts say this is because middle-class Americans view taxes as more of a moral issue than other cultures, and one that is always tinged with a hint of exploitation. A recent survey showed that the middle class feels it is stuck paying for handouts to a lazy welfare class while the class above them manipulates tax laws in their favor. In the end, Americans view taxes as a matter of right and wrong, and the current tax structure appears immoral. For more on this continue reading the following article from Economist’s View.

This reinforces points I (and others) have made about why people oppose taxes:

 Why are some people morally against tax?, EurekAlert: ...Americans are famously hostile to taxes even though they are not heavily taxed in comparison to Canadians and the British. ...Dr Jeff Kidder and Dr Isaac Martin, from Northern Illinois University and the University of California-San Diego, explore how middle class feelings of exploitation lie behind this hostility.

"Everyday tax talk among the middle class is not simply part of a wider ideological view about economics or free markets," said Kidder. "Tax talk is morally charged and resonates with how Americans see themselves and their place in society."

The researchers conducted 24 semi-structured, open-ended interviews with taxpayers in the Southern states who owned or managed small businesses to discover how they talk about taxes in everyday life. Entrepreneurs are a demographic group which is typically strongly anti-tax, while the Southern States provide many supporters for the radical Tea Party.

Respondents saw themselves as morally deserving and hard-working people, sandwiched between an economically more powerful group that manipulates the rules for its own benefit and a subordinate group that benefits from government spending but escapes taxation.

"We found that people associate income tax with a violation of the moral principle that hard work should be rewarded," said Kidder. "Our research shows that when Americans lash out at 'takeovers,' 'massive taxes' and 'bailouts,' they are looking at these issues from the perspective of a hard-working middle class besieged on all sides. Tax talk is about dollars, but it is also about a moral sense of what is right."

It is typically believed that those who are anti-tax will also be hostile to government aid for the poor and minorities. However, rich recipients of bailouts were also disparaged as people who did not deserve money because they did not work for it.

"A lot of the tax talk you will hear from politicians this election season makes no sense as arithmetic," Martin said. "But it makes sense as an appeal to the moral sensibilities of small business."

"Our research shows that tax talk is not actually about individual self-interest, but about our respondents' sense of the proper relations among groups," concluded Kidder.

Here's how I put it a bit over a year ago:

...People believe they paid for programs such as Social Security and Medicare. They put in contributions each month, the government saves that money somewhere, somehow, and when they use these programs they aren't consuming from "government," they are consuming their own contributions. ...

So it's true that people want the budget cut, but only the parts where people are forced to pay for "underserving" recipients of these government services. The feeling is that they get up every day and do what's needed to support themselves and their families. They go each day to jobs they hate, hate, hate, hate with a passion because that's how life is, and they don't appreciate seeing their hard-earned money taken away and given to people who don't even try, people who could work if they wanted to, but rely on the system instead.

Now, I happen to think that is a very wrong view of the circumstances of the typical aid recipient, but true or not I do think it is the source of the opposition to many social programs. People don't object to Social Security and Medicare because they believe they paid for these programs in full, or close to it. Same for disability, food stamps, and other programs. They paid into these programs for years, just like medical insurance, and now it's their turn to consume some of the funds they put in... It's the people who consume without contributing that raise their ire and cause objections to these programs. It's the "handouts" that are the problem. ...

And as noted above, the same applies to handouts to the wealthy. (Which reminds me of my mom criticizing my uncle as I was growing up -- a very well off and very Republican farmer -- for complaining about welfare recipients while taking crop subsidy payments himself. She used to tell me he was on welfare too, except he didn't need it. I'll just add that financial executives in too big to fail banks didn't need it either.)

This blog post was republished with permission from Economist's View.

Examining Employment Recovery Cycles

Economist Tim Duy examines compares recent job growth and losses with historical data to explain what is happening in the U.S. economy now and what can be expected in the future. He demonstrates a parallel between post-1990 employment recovery failures and manufacturing job recovery, which prompts him to consider whether job losses are structural or cyclical based on losses in supply jobs vs. demand jobs. Duy then ties capital and currency manipulation to job growth, and wonders how much Chinese financial policy and a global demand shortfall impacted U.S. employment in the ‘90s, and whether a similar explanation could explain the current employment fluctuation. For more on this continue reading the following article from Economist’s View.

Tim Duy:

Behind the "Trend is the Cycle", by Tim Duy: Via Mark Thoma, David Andolfatto finds evidence of a permanent component to recent job losses. Reviewing a recent paper (which I enjoyed) by Nir Jaimovich (Duke University) and Henry Siu (University of British Columbia), Andolfatto notes:

The conclusion is that jobless recoveries are due entirely to jobless recoveries in routine occupations. In this group, employment never recovers beyond its trough level, nor does it come anywhere near its pre-recession peak. This is in stark contrast to earlier recessions.

He further sees a smoking gun in this chart:

And again notes:

This last figure is quite dramatic. It shows how, prior to 1990, routine employment rebounded strongly following a recession. But since 1990, it appears not to rebound at all. Indeed, the pattern appears to be one of a precipitous decline in recession, followed by a period of relative stability in the subsequent expansion.

I have to admit that I was perplexed by Andolfatto's surprise with this result - the basic patterns of this chart should be easily recognizable as simply the path of manufacturing employment in the US:

That employment in this sector has not rebounded after the past two recessions is not exactly a secret (there is likely some construction element in the first chart as well, but I am putting that aside for the moment). That said, I think there is an interesting question here - should we define these job losses as primarily structural (supply) or cyclical (demand)? To be honest, I admit that I have gone back and forth on this topic.

If I am in a mercantilist frame of mind (see here), I would say this becomes an issue in the mid-1990's when China devalues and fixes the renminbi. This act of currency manipulation to gain a competitive advantage is ignored by the Clinton Administration, and the offshoring craze goes into hyperdrive. Non-durable goods manufacturing begins to slide immediately, and durable goods employment contracts during the 2001 recession and never rebounds as firms choose to restart production in China rather than the US. I anticipated the same after the 2007-2009 recession, a prediction that has not been entirely true.

Somewhere in here is also a construction story, in which the flow of capital into the US finds its way into the housing market, which in turn boosts construction jobs which are subsequently lost. The construction jobs would fall into the routine manual worker category that appears to have suffered from permanent dislocation.

Is this a structural story, or rather just an outcome of a global savings glut/demand shortfall? If domestic demand in China had been higher, wouldn't the Chinese current account surplus have been smaller? And shouldn't the same be true of Japan and Germany? And if this was the case, would the US current account deficit also been smaller, suggesting external factors were less of a drag on demand? And if that were the case, would job losses in manufacturing have been so severe? Would the housing bubble have erupted as it did? And would other sectors have grown more quickly to compensate for job losses in manufacturing?

What I am thinking is that in a world with a global demand shortfall combined with currency manipulation, international trade can become a zero-sum game that leads to dislocations that appear to be structural but are in fact largely cyclical or more broadly demand related.

Alternatively, rather than rely on the global imbalances story, you can argue that the drop in manufacturing is entirely the result of productivity increases. I really don't think this helps, as it doesn't explain why the displaced workers have not been entirely reabsorbed elsewhere in the economy. Remember, we used to argue that all those displaced workers would simply find jobs in the rapidly growing sectors of the economy. Apparently, this has yet to happen. It is kind of hard to argue that the problem is retraining or skills. Perhaps this is true in the short-run, but we are talking about trends that are nearly two-decades or more old. Surely a greater degree of adjustment should have happened by now. It is just as easy to believe that the demand is lacking to absorb the released resources (a euphemism, by the way, for fired workers), which fits with a global savings glut/demand shortfall story as well.

Moreover, a structural story doesn't answer the problem of sticky wages. If in fact the jobless recovery was simply an artifact of job losses for employees with routine skills, why is wage growth for remaining workers so muted? Why such a high proportion of zero wage gains?

Finally, I would add that if you believed that fundamentally a global demand shortfall and related imbalance story was at play, some rebalancing, due, for example, to a mixture of higher foreign wages and a weaker dollar, would have predictable impacts in stimulating export and import competing industries. Some evidence for this can be found in the upswing in durable goods manufacturing:

This is where I was wrong; it is more of increase than I would have expected given my mood in 2010. See also recent stories about the re-shoring phenomenon. For example, from the FT:

Jeff Immelt, General Electric’s chief executive, says the decision to put $1bn into the group’s domestic appliances business is “as risky an investment as we have ever made”.

He may well be right. The decision to bring back to Louisville, Kentucky, hundreds of jobs that had been outsourced to Mexico and China is emblematic of his strategy for GE. If it fails, it will be hung around his neck forever.

“Reshoring” production is a strategy being tried by many American manufacturers, as rapid wage growth in emerging economies and sluggish pay in the US erodes the labour cost advantage of offshore plants.

The US has added 429,000 factory jobs in the past two years, replacing almost a fifth of the losses during the recession.

Trend or fad? Too early to tell.

Bottom Line: I don't think the results Andolfatto cites should come as much of a surprise. If you were looking for a jobless recovery two years ago, the "routine" task sectors of construction and manufacturing were cause for concern. But I think the dynamics in those sectors can be explained in the context of a global demand shortfall rather than entirely structural phenomena.

This blog post was republished with permission from Economist's View.

So What Will Be The Next Financial Bubble To Pop?

Now that it appears the real estate bubble has just about run its course, it is time to look for that next big bubble. Some financial analysts are pointing to Europe, and even the Euro currency, as the source of pending financial doom, but one analyst from Money Morning has another idea. He is pointing at student loan debt. With the costs of education rising, and wages not even remotely keeping pace, it seems to me that he has some valid points. For more on this, continue reading the following article from Money Morning.

Don't look now but there's another giant bubble out there. It's so big it rivals subprime.

I'm talking about the student loan bubble.

Recently, the outstanding volume of student loans passed $1 trillion. What's more bothersome is that the average individual amount owed by new college graduates has passed $25,000.

With college costs zooming upwards faster than inflation, this is rapidly becoming another subprime mortgage-like sinkhole.

Just like subprime, the problem is that people of modest means are being suckered by high-pressure salesmen into taking on too much debt.

The difference is that since student loans are government guaranteed and can't be released in bankruptcy, the burdens will be paid by the unfortunate ex-students and the U.S. taxpayer.

The standard justification for soaring higher education costs is a simple one.

The United States needs to maintain an educational lead in order for its wage levels to remain above those of its competitors.

I'm talking largely about emerging markets, which have been helped enormously by modern communications, making global sourcing much easier than it was.

There are two problems with this view.

First, the more esteemed colleges take great pride in not providing vocational training, and graduate large numbers of students with degrees that don't obviously qualify them for anything.

In what way is the U.S. being made more competitive by graduating students in (insert your favorite useless college major here)?

Second, even as the demand for a college education is increasing, the efficiency of providing it is declining. Both the Ivy League and state university systems increase tuition rates far more rapidly than overall inflation.

The Student Loan Bubble Drives Up Costs

In fact, there is considerable evidence that finance availability is itself pushing up college costs.

As college funding has become more readily available to the general population, it has reduced the financial pressure on colleges, since few of their students are today paying their way from part-time jobs and parent cash flow.

Huge endowments in the Ivy League, which allow those elite colleges to provide full scholarships for students, focus the competition between colleges ever more closely on league table "prestige" rather than costs.

The ranks of college administrators have also exploded since they are effectively insulated from market forces - not unlike those in medical professions.

So have their earnings - according to The New York Times, in the decade between the 1999-2000 and 2009-10 college years, the average college president's pay at the 50 wealthiest universities increased by 75%, to $876,792, while their average professorial pay increased by only 14%, to $179,970.

Meanwhile, the cost of tuition has increased by 65% while prices generally rose by 31% during the same decade.

That's precisely the opposite of what you'd want to happen, if you were concerned about college productivity and cost.

Buried in Debt by Student Loans

There are two factors pushing the escalation in student loan volume.

One is the nationalization of most student loan programs in 2009, providing government guarantees on most student loans.

That has altogether removed the risks of student loan provision from banks, as well as encouraging low-quality degree scams by for-profit colleges. For-profit colleges are a good idea, but not when combined with government-guaranteed student loans.

The other factor pushing up student loans is the Bankruptcy Act of 2005, which allowed consumers to relieve themselves of all debts in bankruptcy except student loans.

This special privilege for the student loan market has caused great hardship.

The Washington Post reported this week that Americans 60 and older still owe $36 billion on student loans, and gave one sad example of a 58-year old woman who had borrowed $21,000 to fund a graduate degree in clinical psychology in the late 1980s (which one would think was at least moderately useful), had never been able to earn more than $25,000 per annum and was now left with student loan debt of $54,000.

If government guarantees and bankruptcy exemption remain in place, the volume of student loans will continue soaring, as unscrupulous lenders provide them to naive students.

That will cause the cost of college to continue rising in real terms as college administrators pad their sinecures.

As with the subprime mortgage industry, an eventual crash is inevitable. But unlike subprime mortgage borrowers, student loan borrowers will be unable to start afresh after bankruptcy.

The solution is to eliminate the two unwarranted subsidies to the student loan industry. Student loans must no longer be guaranteed by the government.

And in bankruptcy, they must be treated like any other debt. The banks will scream, and student loans will be much more difficult to get.

For most students, that will return them to choosing a cheaper institution and working their way through college, in the traditional way - some of them might choose more marketable degree courses, too.

For the poor but brilliant, the Ivy League can continue providing full scholarships and the government can continue providing Pell grants - with their cost fully accounted for on-budget.

College costs will drop back to 1970s levels in real terms, as overstuffed bureaucracies are eliminated.

And for college administrators and student lending banks, life will get considerably harder - which is no bad thing.

All bubbles eventually burst. This one will be no different.

This article was republished with permission from Money Morning.

Defining ‘Fiscal Stimulus’

Many people wonder why the much-touted fiscal stimulus did not do more to boost the economy, and some experts answer this question with another: what stimulus? Menzie Chinn, professor of Public Affairs and Economics at the University of Wisconsin, explains in a recent article how the stimulus package was not overly large when examined as a ratio of the GDP. Chinn breaks down the stimulus as it relates to Bush-era tax cuts, spending for the Iraq war and Obama’s health care legislation, demonstrating that in the face of such costs there was really no hope such a fractionally small stimulus package could have stimulated the economy. For more on this continue reading the following article from Economist’s View.

Menzie Chinn makes a point I've been trying to emphasize (with less than full success). When people ask why the fiscal stimulus didn't do more to elevate the economy, the right question to ask is what fiscal stimulus? When the federal efforts are combined with the contractions at the state and local level, there was very little net stimulus. That doesn't mean the federal efforts didn't do something positive and important -- if the federal government hadn't offset the state and local contractions things would have been even worse -- but it does mean that people looking for more than simply treading water as evidence that the fiscal stimulus had an impact are asking the wrong question:

Re-Examining that "Massive Stimulus", by Menzie Chinn: I keep on seeing references to "massive stimulus", so much I have this feeling of innumeracy everywhere. ...

Total nondefense spending at all levels rose from 27.2% of potential GDP in the last quarter of the Bush Administration (2008Q4) to a shocking 29.9% by 2010Q4, before declining to 28.4% in the last quarter for which data are available for.

That's not to say that the Federal government did not increase spending; merely that to a large extent it was offsetting the contraction at the state and local levels of government, as I pointed out in this March 2010 post. ...

Even if the state and local governments had not contracted expenditures, the fiscal stimulus arising from the ARRA (spending and tax provisions) would not have been particularly large, when expressed as a ratio of GDP. As I noted on February 6, 2009, as the bill was close to being signed:

I want to stress the adjectives "massive stimulus" conjoined to the noun "bill" is a matter of context. Dividing by baseline GDP shows that in a proportional (rather than dollar) sense the bill is rather modest. The fiscal impulse to GDP ratio never exceeds 2.5 ppts in any given fiscal year.

But then, it was clear that many of the critics never wanted to do the hard work of long division. (Oh, and I still want to talk to all the critics of the bill who said the spending would kick in long after the economy had recovered...).

A parting observation. The impact on the budget (tax reductions and outlays) can be placed in context by comparing to other major undertakings.

Figure 3: Impact on budget balance, in billions of FY2010$, for EGTRRA; for JGTRRA; cumulative budget authorization for operations in Iraq (Operation Iraqi Freedom, not including incremental debt servicing costs) through FY2012; for Patient Protection and Affordable Care Act; for American Recovery and Reinvestment Act, all in billions of FY2010$, deflated using CPI. Source: CBO, Budget and Economic Outlook: An Update (August. 2001), Table 1-4; CBO, Budget and Economic Outlook: An Update (August 2003), Table 1-8 (revenue implications only); and CBO, "H.R. 4872, Reconciliation Act of 2010: Estimate of direct spending and revenue effects for the amendment in the nature of a substitute released on March 18, 2010," (March 18, 2010), Nominal figures from Amy Belasco, "The Cost of Iraq, Afghanistan, and Other Global War on Terror Operations Since 9/11," RL33110, Congressional Research Service, March 29, 2011, Table 3. Data for FY2011 Iraq operations is for continuing resolution, for 2012 is Administration FY2012 request (see notes to Figure 2 of this post for calculations); for ARRA, CBO Budget and Economic Outlook (January 2012), Box 1-1, page 9; for CPI, historical from FREDII, and forecasts/projections from CBO (January 2012), Table 2-1 (using calendar year forecasted inflation for FY inflation). ...

Just to decode: The EGTRRA = The Economic Growth and Tax Relief Reconciliation Act of 2001, JGTRRA = The Jobs and Growth Tax Relief Reconciliation Act of 2003, PPACA = The Patient Protection and Affordable Care Act.

That is, the first two entries are the Bush Tax cuts, the third the Iraq war, the fourth is Obama's health care legislation (which actually improved the budget outlook according to the CBO), and the last is the federal stimulus package.

The sum of the first three entries -- the Bush tax cuts and the Iraq war -- are approximately four times as "massive" as the stimulus package.

This blog post was republished with permission from Economist's View.

Ron Paul ‘Faces Nation’

Ron Paul recently fielded questions from Bob Schieffer on Face the Nation, and critics of the interview point out mainstream media’s tendency to put words in Paul’s mouth and otherwise find ways to undermine the GOP candidate’s message. Schieffer questioned Paul on his stance on U.S. foreign policy and military presence, Iranian nuclear proliferation, and the closing of several government agencies. Paul explained and defended his position despite Schieffer’s clearly argumentative approach, demonstrating why Iowa numbers have placed him in the running with contenders Mitt Romney and Herman Cain. For more on this continue reading the following article from Tim Iacono.

GOP hopeful Rep. Ron Paul (R-TX) appeared on Face the Nation yesterday and host Bob Schieffer provided a very compelling display of how, for the most part, the mainstream media works against any fundamental reform for the U.S. government as Schieffer seems to only be interested in putting words in Paul’s mouth that, fortunately, are rejected.

Some media-watchers have called this a hit-job after Paul had risen to a statistical tie for the lead in some Iowa polls and it’s hard not to come away with that impression when you examine Shieffer’s words closely, as was done by Paul Mulshine of the New Jersey Star Ledger in the article No wonder these talking heads don’t like talking to Ron Paul.

This blog post was republished with permission from Tim Iacono.

Fed Fends Off Negative Interest

Some economists wonder why the Federal Reserve does not lower its current interest rate on reserve holdings from 0.25% to zero, thereby possibly encouraging banks to ease lending restrictions rather than hold on to currency. One answer is that the Fed fears interest slipping into negative territory, which could eliminate banks’ incentive to borrow funds from various markets and keep interest positive. Negative interest, which incentivizes dumping cash now that won’t be worth as much in the future, could cause disruptions in treasury auctions, money market mutual funds and federal funds that are not designed to weather negative interest. For more on this continue reading the following article from Economist’s View.

I've been wondering why the Fed hasn't lowered the interest it pays on bank reserves from its current value of .25 percent to zero. It probably wouldn't do much, but it would slightly lower the incentive for banks to hold cash rather than loaning it out, and more loans would help to spur the economy, so why not give it a try? In addition, unlike some other policies the Fed might pursue, this would be easily reversible, and it would help to convince critics that the Fed is trying everything it can think of.

Though it's buried deep within the post, the NY Fed explains the FOMC's reluctance to pursue this option. The argument is that it's possible for some interest rates to go slightly negative, and if they do it will cause various problems the Fed would rather avoid (see below). Since banks can borrow from anyone charging less than the rate they earn on reserves and arbitrage the difference away, paying interest on reserves puts a floor on interest rates. Here's the full argument:

Why Is There a “Zero Lower Bound” on Interest Rates?, by Todd Keister, Liberty Street: Economists often talk about nominal interest rates having a “zero lower bound,” meaning they should not be expected to fall below zero. While there have been episodes—both historical and recent—in which some market interest rates became negative, these episodes have been fairly isolated. In this post, I explain why negative interest rates are possible in principle, but rare in practice. Financial markets are generally designed to operate under positive interest rates, and might experience significant disruptions if rates became negative. To avoid such disruptions, policymakers tend to keep short-term interest rates above zero even when trying to loosen monetary policy in other dimensions. These policy choices are the source of the zero lower bound.

The standard description of the zero lower bound begins with the observation that the nominal interest rate offered by currency is always zero: If I hold on to a dollar bill, I’ll still have one dollar tomorrow, next week, or next year. If I invest money at an interest rate of -2 percent, in contrast, one dollar of saving today would become only ninety-eight cents a year from now. Because everyone has the option to hold currency, the argument goes, no one would be willing to hold some other asset or investment that offers a negative interest rate.

This argument is only part of the story, however. Safeguarding and transacting with large quantities of currency is costly. One only needs to imagine the risk and hassle of making all transactions in cash—paying the rent or mortgage, utility bills, etc.—to appreciate the safety and convenience of a checking account. Many individuals would likely be willing to keep funds in deposit accounts even if these accounts pay a negative interest rate or charge maintenance fees that make their effective interest rate negative.

Large institutional investors are in a similar situation. They use a variety of short-term investments, such as lending funds in the “repo” (repurchase agreement) market and holding short-term Treasury bills, in much the same way individuals use checking accounts. These investments will remain attractive to large investors even at negative interest rates because of the security and convenience they offer relative to dealing in currency. Some repo rates did in fact become negative in 2003 (see this New York Fed study) and again more recently (see Bloomberg). Interest rates in the secondary market for Treasury bills have also been slightly negative recently (see Businessweek).

In other words, market interest rates can move somewhat below zero without triggering a massive switch into currency. Nevertheless, central banks typically maintain positive short-term interest rates even while using less conventional tools (such as large-scale asset purchases) to provide additional monetary stimulus.

The Federal Reserve, for example, currently pays an interest rate of 0.25 percent on the reserve balances that banks hold on deposit at the Fed. The ability to earn this interest gives banks an incentive to borrow funds in a range of markets (including the interbank market and the repo market) and thus has the effect of keeping market interest rates positive most of the time. The Federal Open Market Committee (FOMC) discussed the idea of reducing the interest on reserves (IOR) rate at its September meeting, but no action was taken. Reducing this rate would tend to lower short-term market interest rates and might push some rates below zero. The minutes from the meeting report that “many participants voiced concerns that reducing the IOR rate risked costly disruptions to money markets and to the intermediation of credit, and that the magnitude of such effects would be difficult to predict.”

Similarly, the Monetary Policy Committee (MPC) of the Bank of England discussed the possibility of lowering the official Bank Rate below 0.5 percent at its September meeting, but decided against doing so. The MPC had previously expressed concern that “a sustained period of very low interest rates would impair the functioning of money markets.”

Some examples of areas where disruptions could potentially arise in U.S. financial markets are:

• Money market mutual funds: Money market funds operate under rules that make it difficult for them to pay negative interest rates to their investors, either directly or by assessing fees. Many of these funds would likely close down if the interest rates they earn on their assets were to fall to zero or below, possibly disrupting the flow of credit to some borrowers.
• Treasury auctions: The auction process for new U.S. Treasury securities does not currently permit participants to submit bids associated with negative interest rates. If market interest rates become negative, new Treasury securities would be issued with a zero interest rate—effectively a below-market price—and bids would be rationed if demand exceeds supply. Such rationing, which has occurred in recent auctions, would generate an incentive for auction participants to bid for more than their true demand, leading to even more rationing. This situation could generate market volatility, as unexpected changes in the amount of rationing in each auction could leave some investors holding either many more or many fewer securities than they desire.
• Federal funds: A decrease in the IOR rate would also likely affect the federal funds market, where banks and certain other institutions lend funds to each other overnight. A lower IOR rate would give banks less incentive to borrow in this market, which would likely decrease the amount of activity. When less activity takes place, the market interest rate will be influenced more by idiosyncratic factors, making it a less reliable indicator of current conditions. This decoupling of the federal funds rate from financial conditions could complicate communications for the FOMC, which operates monetary policy in part by setting a target for this rate.

These examples demonstrate that many current institutional arrangements were not designed with near-zero or negative interest rates in mind. In principle, these arrangements—such as the rules governing mutual funds and Treasury auctions—could be changed. The implementation of a “fails charge” in 2009 for the settlement of Treasury securities (see this New York Fed study) is one example of an institutional adaptation that allows markets to function better at very low interest rates. (A similar charge is scheduled to take effect in some mortgage-related markets in February 2012.) In practice, however, such changes may take significant time to implement and could simply move disruptions to other markets.

Given the markets’ limited experience with very low interest rates, it is difficult to predict with any degree of certainty how they will react to them. If the types of disruptions described above turn out to be significant, taking steps to lower short-term interest rates could actually make financial conditions tighter rather than looser and thus hinder the economic recovery. To avoid this outcome, policymakers tend to choose policies that keep market interest rates positive. In other words, the potential for negative interest rates to disrupt financial markets limits the extent to which policymakers can stimulate economic activity by lowering interest rates. This limit is known as the zero lower bound.

This article was republished with permission from Economist's View.

October Jobs Report Shows Slight Improvement

Unemployment and underemployment are down and payrolls are up, according to the latest report from the U.S. Department of Labor. Unemployment dropped .1% to 9.0% for the month; however, the number of unemployed hasn’t strayed more than two percentage points from this level in seven months. Despite improvement, the numbers are not as high as predicted and are still far too low considering population growth. While private-sector payrolls are up construction and government payrolls saw an overall decline, which does not bolster predictions of economic recovery. For more on this continue reading the following article from Tim Iacono.

The Labor Department reported that nonfarm payrolls increased by 80,000 in October after an upwardly revised gain of 104,000 in August and 158,000 in September as the jobless rate fell from 9.1 percent to 9.0 percent.

While the October payrolls gain came in slightly below consensus estimates, total upward revisions of 102,000 for the prior two months helped to offset this disappointment, however, the U.S. labor market continues to add jobs at a pace that is failing to keep up with the growth in the population, payroll gains averaging just 90,000 over the last six months and 123,000 so far this year.

The unemployment rate was little changed last month and has now stayed within a narrow range of between 9.0 percent and 9.2 percent for the last seven months. The number of unemployed persons fell from 14.0 million in September to 13.9 million in October while the number of long-term unemployed fell by 366,000 to 5.9 million, or 42.4 percent of total unemployment.

The broader U6 measure of underemployment (including discouraged workers and those settling for part-time work instead of full-time work) fell from 16.5 percent to 16.2 percent and the civilian labor force participation rate was steady at 64.2 percent.

Private sector payrolls increased by 104,000 in October paced by gains of 35,000 in trade, transportation, & utilities and 32,000 for professional & business services, almost half of which were new temporary positions. Education & health care services added 28,000 jobs and there were 22,000 new positions in leisure & hospitality.

Some 20,000 fewer jobs at the state level paced an overall decline of 24,000 in government payrolls and a net reduction of 22,500 in nonresidential construction jobs drove the construction category sharply lower.

Overall, this report is consistent with the recent “slow growth” performance of the U.S. economy where economic activity is, basically, just keeping pace with population growth but nothing more.

This blog post was republished with permission from Tim Iacono.

US Inflation Up, Prices Increasing

The U.S. Department of Labor reports a 3.9% annual increase in inflation when including food and energy, with gasoline up 33.2% on the year and food 4.5% more expensive. Clothing costs are also on the rise, despite remaining lower than prices reported two decades ago thanks to inexpensive imports, leaving consumers to deal with price increases in three key purchase areas. Observers note inflation is now at its highest since September 2008, although the central bank reports inflation controls are in place and working. For more on this continue reading the following article from Tim Iacono.

The Labor Department reported that the rising cost of energy products and food drove consumer prices 0.3 percent higher in September and that the annual inflation rate now stands at 3.9 percent, the highest level since September 2008.

Paced by a 2.9 percent rise for gasoline, up 33.2 percent on a year-over-year basis, overall energy prices jumped 2.0 percent last month and are now up 19.3 percent from a year ago.

Food & beverage prices rose 0.4 percent in September and are now 4.5 percent higher than last year at this time while the “food at home” subcategory rose 0.6 percent for the third month in a row, now up a stunning 6.3 percent on a year-over-year basis.

Elsewhere, price increases were more moderate and clothing prices reversed their recent trend by dipping 1.1 percent last month, however, apparel prices are still 3.5 percent higher than a year ago, down from the August year-over-year rate of 4.2 percent that marked a 20-year high.

Amazingly, up until this summer, apparel prices had been 10 percent or more below the highs seen in the mid-1990s, this 15-year trend due largely to the rise in inexpensive imports. However, from April to August of this year, apparel prices have surged more than five percent, cutting this gap almost in half.

Here’s a long-term chart showing this recent dramatic increase:

Americans can now add clothing to two other categories where prices have been rising sharply lately – food and energy – as these indispensable items put more pressure on consumers despite assurances from the central bank that inflation is under control.

This blog post was republished with permission from Tim Iacono.

Bernanke Taking Backseat, Economist Says

Economist Tim Duy believes that Federal Reserve Chairman Ben Bernanke’s latest address to Congress sounded a lot like he was trying to shift the responsibility for economic recovery to fiscal policymakers. Duy argues, however, that it is the Fed that must work to normalize monetary conditions by allowing inflation to rise so as to escape the current liquidity trap and achieve a nominal GDP or price level. Otherwise, fiscal policy reinforces deficit spending that will lead to successive recessions or worse. Duy says the Fed’s insistence that inflation stay below 2% is not going to help secure economic recovery in the long term and that fiscal policy will not change that. For more on this continue reading the following article from Economist’s View.

Tim Duy:

Don't Let Monetary Policy Off The Hook, by Tim Duy: Re-reading Federal Reserve Chairman Ben Bernanke’s latest testimony to Congress left me increasingly puzzled by his conclusion:

Monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the U.S. economy. Fostering healthy growth and job creation is a shared responsibility of all economic policymakers, in close cooperation with the private sector. Fiscal policy is of critical importance, as I have noted today, but a wide range of other policies--pertaining to labor markets, housing, trade, taxation, and regulation, for example--also have important roles to play. For our part, we at the Federal Reserve will continue to work to help create an environment that provides the greatest possible economic opportunity for all Americans.

This is a clear effort to shift the focus away from monetary policy onto the fiscal side of the equation. But I think there is a significant flaw in that position. Fiscal policymakers will be completely unable to address medium- or long-term budget issues as long as there exists a sizable output gap and high levels of unemployment. Persistently low levels of output will necessitate deficit spending, and low interest rates will justify that spending. That is the lesson of Japan. Nor will the economy naturally gravitate toward such any other outcome – we are stuck in a liquidity trap. That is also the lesson of Japan.

Assuming the proximate cause of the current US economic environment is indeed a liquidity trap, then a solution to that problem lays solely in the hands of monetary policymakers. In short, the primary economic challenge is to lift the US from the zero bound floor; until that happens fiscal policy will limp along like that of Japan, with ever-growing debt that does little than serve as a partial stopgap. The deficit spending becomes a long-run outcome rather than a short-run solution.

Simply put, the Federal Reserve needs to take responsibility for ending the liquidity trap. Instead, as Scott Sumner summarizes:

The Fed has plenty of credibility, that’s not the problem. The problem is that they are using the credibility to assure investors that low inflation is here to stay. With the right target, there would probably be no need for massive quantitative easing, or other extraordinary policies.

First and foremost, low inflation is the primary objective of Fed policy. They have repeatedly set expectations that the increase in the balance sheet is only temporary, and will be reversed as soon as possible. On not one but two occasions this cycle they prematurely shifted gears to setting expectations for tighter policy, which is effectively the same thing as engaging in tighter policy. They have offered a half-hearted attempt to remedy this situation by announcing a commitment to low rates, but have made it remarkably clear it is not a real commitment. From the Fed minutes:

Most members, however, agreed that stating a conditional expectation for the level of the federal funds rate through mid-2013 provided useful guidance to the public, with some noting that such an indication did not remove the Committee's flexibility to adjust the policy rate earlier or later if economic conditions do not evolve as the Committee currently expects.

Fear of inflation prevents the Federal Reserve from making an unconditional commitment. And therein lies the stumbling block to real policy change. It is virtually impossible to imagine reestablishing the pre-recession nominal GDP trend, and entirely impossible to regain the pre-recession price trend, without accepting a temporary acceleration of inflation along the way.

More succinctly, we will not lift the economy off the zero-bound without accepting higher than 2% inflation. Since the Federal Reserve has made it clear they will not accept inflation greater than 2%, the economy will not clear the zero-bound. And if the economy does not clear the zero-bound, we will be faced with perpetual and unavoidable deficit spending.

Deficit spending is not accommodated by the Federal Reserve via low interest rates; it is made necessary because the Federal Reserve sees no urgency ending the lower bound challenge. Which means it is ridiculous to believe that the Fed can dump off this problem on fiscal policymakers. How can the state of monetary policy have deteriorated so much that now even Bernanke claims “regulation” is holding back the economy? Yet here we are.

Where should the Fed go from here? First and foremost, they need to make a commitment to pull away from the zero-bound. As Sumner suggests, they need this commitment clearly defined by a target such as reestablishing nominal GDP or price level. The need to implement open-ended action to achieve this target. My suggestion is to announce they will make permanent additions to their balance sheet by purchasing on the secondary market $5 billion of US Treasury securities every week until the target is reached. I think they need to make permanent additions to be credible – they have clearly expressed that previous balance sheet expansions should be viewed only as temporary.

Won’t this amount to monetization of deficit spending? Yes, but if Sumner is correct, less than might be feared, as the commitment is more important than the size of the purchases. And I already arrived at the conclusion, aided by Bernanke’s 2003 speech, that the situation requires a greater coordination of monetary and fiscal policy. Moreover, even if sizable purchases are required, there is no reason this needs to be a problem. As Bernanke has already explained, the Fed simply needs to make clear its target and once that target has been reached, they will adjust policy appropriately to maintain the nominal GDP or price level trend. In other words, purchases will be suspended and policy will by that point revert to traditional interest rate management, with the possible reduction of the portion of the balance-sheet expansion that to-date has been viewed as temporary.

Once the Fed achieves normal monetary conditions, the ball will be back in the hands of fiscal policymakers, who may then soon understand that policy is a lot different when interest rates create real constraints on spending and taxes. But that is a battle for another day.

Bottom Line: It is ludicrous for the Fed to declare the primary economic responsibility is now on fiscal policy. As long as we are in a liquidity trap, fiscal policy is stuck in a never-ending cycle of deficit spending. Absent that spending, the economy will simply slip backwards into recession again and again. The exit from the liquidity trap can only come from the monetary side of the equation. Try as he might Federal Reserve Chairman Ben Bernanke cannot escape his policy responsibilities. And we shouldn’t let him.

This blog post was republished with permission from The Economists View

Americans Losing Hope Economic Recovery

It is no secret that the U.S. public’s outlook on the economy has been suffering, but new Gallup polls indicate confidence is sinking even lower. One poll measuring sentiment from 2009 to 2011 shows that those who once believed the economy was getting better has fallen nearly 30%, while those who feel the economy is the same or worse has risen nearly 30% over two years. Another poll covering the same period indicates that fewer Republicans, Democrats and Independents feel the economy will get better “one year from now.” Moreover, the number of people who blame President Obama for the economic mess has risen 32% in the last two years. For more on this continue reading the following article from Tim Iacono.

It shouldn’t be too surprising to see the kind of polling data that Gallup has been reporting this week, given that, to many Americans, there never really was an economic recovery from the 2008 recession. From this survey published yesterday, it seems there is little optimism left out there as the hope that many had two years ago has faded.

Even more bad news for President Obama comes via this separate Gallup poll in which, for the first time ever, more than half the respondents blame him for the nation’s economic woes, up from 32 percent two years ago. Of course, 69 percent still blame former President George W. Bush, down from 80 percent in 2009, however, those trends are certainly not the friends of anyone in or near the White House.

This blog post was republished with permission from Tim Iacono.

Cultural Infrastructure Key to Economic Growth

Most people think of roads and bridges when they hear the word “infrastructure” in reference to federal funding, but one economist quotes social activist Arlene Goldbard to draw attention to the equal importance of investments in cultural and social infrastructure. President Franklin Delano Roosevelt saw the importance of supporting the arts, public spaces and cultural institutions in leading the country out of the Great Depression, Goldbard once said, and that lesson should not be forgotten as the current administration decides how to stimulate growth through infrastructure spending. For more on this continue reading the following article from Economist’s View.

Via Ecological Headstand:

"Infrastructure has another meaning, too," Sandwichman: Arlene Goldbard points out the not-so-obvious to those who misplaced concreteness makes them see only roads and bridges where public support of culture -- books, plays, paintings, sculpture, dance performance, concerts and cultural workshops -- would employ far more people, more creatively with less capital intensity.

Cultural infrastructure, social infrastructure: these describe the institutions, customs, ways of communicating, expressions of caring, celebrations, ceremonies, and public spaces that enable people to feel seen and to know they are welcome in their own communities. Cultural infrastructure is the aggregate of innumerable public and private actions, of many threads weaving the social fabric we share. When it becomes badly frayed—when foreclosures, homelessness, long-term joblessness are epidemic, when countless families are forced to relocate to find work, when bleeding-edge gentrification become commonplace, when scapegoating rises and ordinary Americans are unable or unwilling to cross lines of color or class—when the social fabric is as shredded as it has become after decades of me-first corporate-driven politics, mending it is clearly a public sector responsibility. Who else’s should it be?

Three-quarters of a century ago, President Franklin Delano Roosevelt’s New Deal drove public-sector interventions that helped to pull us out of the Great Depression. Roads and bridges, parks and ampitheatres were built, to be sure. But the largest single New Deal intervention was Federal One, comprising five massive cultural programs that put jobless Americans to work. They made plays that helped us face the issues we had to resolve and images that reminded people of a history of struggle and cooperation that built their communities. They created enterprises that brought exciting innovative design into the public sphere; taught children to make music so that access to beauty and meaning did not become an attribute of privilege, but was recognized as a human right; and preserved living history as a reservoir of resilience we could draw on to face the future.

FDR understood that shoring up physical infrastructure wouldn’t save us without comparable investment in cultural infrastructure. People wouldn’t have faith in the future, they wouldn’t be willing to spend their hard-earned dollars, they wouldn’t be aligned with national goals for recovery, unless they had meaningful, personal connections to our collective story. Unless they felt connected and saw their own actions as helping. Demonstrably, he was right.

This article was republished with permission from Economist's View.

Rick Perry’s Absent Economic Staff

More details emerge about GOP candidates as the field of contenders gets tighter, with focus finally beginning to shift from the individuals’ sound bites to their planned policies and the staff they are assembling to carry them out. Economist Tim Iacono notes that GOP frontrunner Rick Perry does not have one economist on his staff and relies on the economic successes of Texas to support his proposed performance in the White House, meaning to suggest he does not have anyone to help him craft the economic policy he will use to replace the one currently being used by the Obama Administration – a plan for which Perry and Republicans have no shortage of criticism. For more on this continue reading the following article from Tim Iacono.

There’s a lot not to like about Texas Governor and GOP candidate Rick Perry, but, clearly, two of his redeeming qualities are his disdain for the Bernanke Fed and, based on the fact that his campaign team is, so far, devoid of economists, a seeming dislike for the entire dismal set. Prior to last night’s GOP debate, this story in Fortune discussed the latter.

The governor relies on the Lone Star State’s economic performance under his leadership over the last decade to make his case. But where is his economic plan for the nation? Or, at least, where is the economic team that will help him craft it?

So far, apparently, neither exists.
…
As he stands up his campaign, there is evidence Perry is reaching out to private-sector leaders for economic advice. He brought a handful of Washington hands who lead small business trade associations down to Austin last month for a lunch meeting that one participant described as a “pure policy session” on job growth.

And it may be that Perry would like to hold off on hiring economic eggheads for as long as he can. The governor has cultivated an anti-elitist image, distancing himself from his predecessor in the Texas governor’s mansion, George W. Bush, by noting the 43rd president went to Yale, while Perry was a Texas A&M man. On Fox News, he recently blasted Obama for surrounding himself with academics who claim prestigious degrees and no real-world experience. “They are intellectually very, very smart but he does not have wise men and women around him,” Perry said.

As for Tuesday night’s debate, according to this Housing Wire story, the nation’s chief economist – Fed Chairman Ben Bernanke – isn’t too popular with this crowd, both Newt Gingrich and Mitt Romney saying they would not reappoint Bernanke to another term as the Fed chief if they were elected president, Gingrich saying he’d “fire him tomorrow”.

Based on Newt’s position in polls, Bernanke can rest easy until the end of his term.

This post was republished with permission from Tim Iacono.

Advice for Obama

Economist Brad DeLong has some suggestions for President Obama regarding how he should handle the country’s current economic crisis without expecting any help from Congress, because they can’t agree on anything. This means that regulatory reform is a non-starter and the president will have to result in putting pressure on the Federal Reserve to increase quantitative easing, close the spending gap and be willing to invest government dollars in infrastructure projects. It would also help, he argues, if the Treasury Secretary spoke on the benefits of a weak U.S. dollar to help exports and give a boost to the struggling European economy. For more on this continue reading the following article from Economist’s View.

Brad DeLong:

...What in most important is not just what Obama proposes on Thursday (because nothing will get done by congress), but rather what he does in the weeks and months afterwards to actually tune the economy so that it creates more jobs. I think Obama should:

1. Apply a full-court press to the Federal Reserve to get it to target nominal GDP to close the spending gap, for it is fear of risk that nobody will spend to buy what you make and confidence that your purchasing power is safe in cash that is holding back businesses from spending money to hire people.

2. Apply a full-court press to the Federal Reserve to get it to engage in more quantitative easing--into taking more risk onto its own balance sheet, for it is an unwillingness on the part of Wall Street to hold the risk currently out there that is making it very difficult for a wide range of risky spending projects to get financing.

3. Quantitative easing does not have to be done by the Fed: the Treasury can use residual TARP authority to take tail risk onto its own books as well, and should be doing so as much as possible.

4. Expansion does not require that the federal government spend: using Treasury (and Fed!) money to grease the financing of infrastructure and other investments by states would pay enormous dividends.

5. For the Treasury Secretary to announce that a weak dollar is in America's interest right now would not only boost exports, but it would immediately lead to a shift in monetary policy in Europe toward a much more expansionary profile--which would be good for the world.

None of these is first-best. All of these are likely to do some good. All should be tried.

What's discouraging is that there doesn't seem to be any sense of urgency about the employment crisis itself. It's more of a reluctant and begrudging response driven by a shift in the political winds. If the polls weren't falling, I doubt we'd even be hearing a speech on job creation. So I hope there's follow-through as well -- these things should be happening already -- but we'll see.

This article was republished with permission from Economist's View.

Choices Few in US Economic Fix

Economist Tim Duy provides a broad overview of the current state of U.S. economic affairs by examining the Federal Reserve’s role and options in supporting a turnaround. Duy’s guess is that monetary policy is the only card left to play as the administration’s plans for an economic boost will likely fall short and new legislation seems out of the question given policymakers’ inability to find consensus. This makes the Fed and its choices on quantitative easing, mortgage-backed securities and long-term policy positions as the deciding factors in whether the country will experience another recession. For more on this continue reading the following article from Economist’s View.

Tim Duy:

Questions and Answers, by Tim Duy: I thought this might be an easier way to get back into the game after an extended hiatus.

Does the economy need more stimulus?

Always good to start with a softball question - YES! The US economy is two years into an economic expansion, and yet the unemployment rate remains above 9 percent. National output growth averaged just 0.7 percent in the first two quarters of the year. Job growth was zero in August, albeit with some downward pressure from the Verizon strike. Output is $1 trillion below CBO potential – and the gap is expanding. The 30-year inflation indexed Treasury bond just traded at 90 basis points. None of which should be happening two years into an expansion. Yet here we are.

Will the private sector provide the needed stimulus?

Federal Reserve President Dennis Lockhart summarizes the situation:

It is necessary that the process of deleveraging plays itself out, which may take several more years. When economies are deleveraging they cannot grow as rapidly as they might otherwise. It is obvious that as consumers reduce spending they divert more of their incomes to paying off debt. This shift in consumer behavior increases the amount of capital available for financing investment. But higher rates of business investment are not likely to fully offset weakness in consumer spending for some time, as businesses continue to grapple with uncertainties about the future.

Lacking the equity wealth provided by the housing bubble, households are simply unable to sustain the debt loads of years past. Hence, deleveraging continues. Without anyone else to pick up the slack, it is tough to see how we eek out anything other than subpar growth, trend growth (2.5 - 3.0%) at best. Not enough to quickly lift the economy back to trend output.

Will the government provide the needed stimulus?

On the fiscal side, the answer is no, or at least not yet. As Paul Krugman points out, fiscal policy is already contractionary, while the recently passed budget deal promises only more austerity. And, via Brad DeLong, Macroadvisors predicts that President Barack Obama’s impending jobs plan is not likely to provide much if any of an economic boost. That leaves monetary policy as the only game in town. And here we can anticipate that more easing is coming. But will it be enough to pull the economy from its slump? At this point, almost certainly not.

Why will monetary policy fall short?

Here again it is useful to refer back to Lockhart’s recent speech:

Given the weak data we've seen recently and considering the rising concern about chronic slow growth or worse, I don't think any policy option can be ruled out at the moment. However, it is important that monetary policy not be seen as a panacea. The kinds of structural adjustments I've been discussing today take time, and I am acutely aware that pushing beyond what monetary policy can plausibly deliver runs the risk of creating new distortions and imbalances.

Lockhart is not ruling out additional policy responses, but makes obvious his view the Fed is nearly, if not already, out of bullets to deal with a balance-sheet recession. Moreover, he shows his sympathy with the camp, I think best identified with the views of Kansas City Federal Reserve President Thomas Hoenig, that the Fed at this point risks doing more harm than good. This, I believe, represents the center of FOMC thought at the moment. This group is simply not inclined to initiate a new large scale easing in the absence of clear deflationary pressures. The five and ten-year TIPS breakevens are 1.81 and 2.05 percent, respectively. Combined, I believe they argue, at least from the Federal Reserve point of view, for more easing, but nothing dramatic.

But didn’t the most recent FOMC minutes reveal a more dovish constituency?

Yes. From the minutes:

A few members felt that recent economic developments justified a more substantial move at this meeting, but they were willing to accept the stronger forward guidance as a step in the direction of additional accommodation

Chicago Federal Reserve Bank President Charles Evans is a good example of this group. Via a recent CNBC interview:

In his view, QE needs to stay in place until unemployment plunges to 7 percent or if inflation gets past 3 percent. Core inflation, which strips out food and transportation, is about 1.8 percent, though the number is 3.6 percent including the more volatile measures.

Evans is a voting member on the fed Open Market Committee and traditionally has been among its more dovish members when it comes to interest rates and inflation.

"Strong accommodation needs to be in place for a substantial period of time," he said. "If we could sort of make everybody understand that this is going to be in place for a longer period of time, we could knock out some of that restraint that comes about when people talk about premature tightening."

As far as I am concerned, he is preaching to the choir. There has been a remarkably irresponsible tendency of Fed policymakers to turn hawkish at the slightest hint of economic improvement. I think this belies their discomfort with the expansion of the balance sheet, and renders the rest of us unsure of their commitment to the dual mandate. And I believe the Fed needs to accept the possibility of higher inflation.

What can the Fed do at this point?

The usual suspects: Reduce the interest paid on reserves, extend the maturity of the Fed’s portfolio, expand the balance sheet further, shift the portfolio in favor of mortgage-backed securities to support the housing market, make a firm commitment to zero interest rates regardless of the inflation outcome, or raise the inflation target from 2 percent to 3 or 4 percent. I suspect the first three are most likely in play, although the magnitude of an additional balance sheet expansion will likely fall short of what is needed.

Wait a second. Didn’t the Fed already commit to zero interest rates until 2013?

No – they just said that given current forecasts, they anticipated an extended period on low interest rates. This does have some value in marginalizing the hawks. That said, the minutes make clear this is only a soft commitment:

Most members, however, agreed that stating a conditional expectation for the level of the federal funds rate through mid-2013 provided useful guidance to the public, with some noting that such an indication did not remove the Committee's flexibility to adjust the policy rate earlier or later if economic conditions do not evolve as the Committee currently expects.

What we really need is a hard commitment that can weather a period of higher inflation.

Where is Federal Reserve Chairman Ben Bernanke is this mix?

It appears that Bernanke is right of the dovish contingent revealed in the most recent FOMC minutes. I think this first became evident in his June press conference, when he made clear the bar to QE3 was high. The bar was high because inflation expectations had rebounded, and inflation was the only clear target the Fed had control over. This basic idea was evident in Bernanke’s Jackson Hole speech:

The Federal Reserve has a role in promoting the longer-term performance of the economy. Most importantly, monetary policy that ensures that inflation remains low and stable over time contributes to long-run macroeconomic and financial stability. Low and stable inflation improves the functioning of markets, making them more effective at allocating resources; and it allows households and businesses to plan for the future without having to be unduly concerned with unpredictable movements in the general level of prices.

Once inflation is close to the Federal Reserve’s target, Bernanke apparently sees little else monetary policy can do to relieve the cyclical pressures on the economy:

Notwithstanding this observation, which adds urgency to the need to achieve a cyclical recovery in employment, most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.

I think the Bernanke’s focus on the 2 percent inflation target will severely limit the magnitude of additional easing to support job growth. It is increasingly my opinion that to lift the economy beyond the zero bound, we need a commitment by the Fed to lift inflation above 2 percent to allow nominal spending to return to the pre-recession trend. This is policy the Fed Chair appears dead set against, leaving only half-measures.

Note, however, the above only applies when inflation and inflation expectations are near the Fed’s target. I do believe Bernanke will press for more dramatic action should deflationary pressures become evident. I just don’t think we are there yet.

Would a shift to additional mortgage-backed assets help?

It wouldn’t hurt, and could push mortgage rates down further and thus encourage additional refinancing. Back in the day I would have been worried that the Fed risked looking like it was trying to sustain bubble-level prices, but I think we are beyond that. Still, note the problem in mortgage markets is deeper than interest rates – the problem is the inability to finance due to tougher underwriting standards and underwater mortgages. I am not confident that lower rates would alleviate these challenges. This seems more like the purview of the US Treasury, which could push for all federally guaranteed mortgages to be refinanced at a lower interest rate, regardless of the loan to value ratio.

Are we headed for recession?

I would not discount the possibility of recession given the US economy was clearly operating near stall-speed in the first half of the year. That said, it would be easier to embrace the recession story had the US economy ever returned to trend output during the recovery. As noted earlier, the economy is operating well below trend, and typical sources of strong downdrafts in demand – housing and autos – remain below pre-recession levels. Indeed, the absence of any rebound in housing is striking. Under these circumstances, I find it easier to embrace the “Japan” scenario, a sustained period of choppy and low growth. Recession or not, a tragedy by any measure.

What’s going on in Europe?

The Europeans are vexed with a political establishment that is not conducive to maintaining a single currency (of course, we too in the US are vexed with a dysfunctional political establishment, just a different one). In particular, they lack a mechanism to make sizable fiscal transfers within the Euro area. This is simply an important element of running a “one size fits all” monetary policy. As it stands, Euro-policymakers are attempting to enforce IMF-style austerity packages on troubled economies without the usual currency depreciation that helps offset the resulting fiscal contraction. It is obvious this approach is not working – Greek two-year debt is trading at 50 percent and the spread on Italian and Spanish debt widens. Paul Krugman asks where is the ECB? Where indeed? Perhaps they see their earlier debt-buying efforts as a failure, thus concluding the problem is a solvency problem, not a liquidity problem. And there is no European solution for a solvency problem, other than more austerity for troubled economies. Where does this end? Either the Euro-area comes together as a strong fiscal union or the periphery is jettisoned from the Euro. It really looks like the smart money is on the latter outcome. Drachmas anyone?

Update: 10:09PM PST

I see the ECB was not completely asleep at the wheel and was buying bonds. From the Wall Street Journal:

The ECB purchased Italian and Spanish government bonds Monday in a bid to keep 10-year borrowing costs from rising further above 5%—a threshold analysts say is key to their ability to finance their high debt loads. The ECB has purchased over €50 billion in bonds since reactivating the program four weeks ago.

This post was republished with permission from Economist's View.