Sunday, November 7, 2010

Beyond aliens and the trilateral commission

This past week markets again were dazzled by myriad events. The elections produced the expected results. QE was put in motion and defended by the Fed president himself in an unusual Op-Ed piece written after the Fed meeting. October jobs were stronger than expected and past job gains were revised to be stronger so that the trend is now firmer looking and backsliding should see a much more remote possibility.

There’s something about QE… The Fed chairman has defended QE as being not that far from the doings of normal monetary policy. He says that there is little deviation by the Fed from its normal policy. H also says that the Fed takes both sides of its mandate equally seriously. This alone is huge break from the past.

The economics profession has gone a long way in agreeing to what the Phillips curve really is. In the long run there is no unemployment –inflation tradeoff. So what is the Fed chairman doing apparently seeking more growth and more inflation? Well, the economy has lots of slack so there is plenty of room for stimulus to work some magic without creating inflation of the bottleneck sort. But what of inflation due to expectations and stronger money growth? Can’t we get that even with an output gap? There is a debate about that.

Benjamin’s choice: What the Fed has done this time that is different, is to take on the burden for growth in the short term, a burden that had been lifted from its shoulders. Under Paul Volcker the Fed had ‘resolved’ the apparent dichotomy between looking for maximum sustainable growth (MSG) and price stability by arguing that MSG is a long run property, not a short run property. It argued that by pursuing price stability it was freeing the economy to be all that it could be in the long run which is all that the Fed and monetary policy could be expected to do. It is not clear why Bernanke has ‘bought into’ the notion of the Fed having responsibility for short run growth especially with interest rates at zero. Isn’t that about all that the Fed can do? Why put yourself on the hook for more?

The trilateral commission, aliens, and smoke filled rooms - Some think it is because the Fed was under duress and pressure from its role in the financial crisis. While the Fed acted when no other agency did it also did some things that are controversial. On top of that, it made mistakes that helped to foster the crisis. The Fed eventually lobbied to get more power instead of to lose power in the re-regulation of the economic system, and it won its case but to do so did it have to strike a bargain ‘with the devil’ and is this it? Is taking responsibility for short run growth the Fed’s pay-back for retaining and acquiring more power? We may never know if this is some conspiracy theory allegation or if there is truth here. Whatever the reason, Bernanke’s choice puts the Fed in an odd spot.

So is this QE a Bad idea or not? The economics are complicated. But basically the idea is that banks have excess reserves, the raw material to make loans. They choose not to do that,however. They are also under pressure to raise capital and have been prohibited from dividend pay outs. They are being hounded by bank examiners. But they are being encouraged to lend! In any event, they are not lending so money supply is not expanding (or it has not been until recently). As long as we have excess reserves without loan growth the reserve growth is ineffective so why do more?

What it is - The answer here is complicated but it’s a lot of like this… Suppose you have a car and it is sound, except the starter is broken. As long as the starter won’t start it the car can’t run and it sits idle. But if you and some friends can push it down the street, and pop the clutch with the car in motion, the car just might start and be able to run and get to the garage where it could be fixed- problem solved. So there is a way, a bit of an unusual way, to get the car going with a broken starter. In some ways this is the Fed’s plan. The problem is that while it’s a work around it’s a work-around with risk. It’s like getting all the big guys to push that car and putting the lightest teenage pre-driver at the wheel. Once the car gets going can he control it? Can Bernanke? For all his protestation he is in uncharted waters and he is running the Fed on a completely different model since the Fed became successful in controlling inflation. In many ways we are back to the Arthur F Burns trust-me (I’m a central banker and expert) days of five monetary-aggregate monetary-monte. Only Bernanke’s shtick is the depression he means is bank reserves.

Is that a good thing? Aren’t we already depressed?

The really good news and new news last week was the jobs report. For chapter and verse on that see our weekly PowerPoint on the subject.

Let’s Boogie with the Boogieman- For our purposes here, let’s just hit some of the highlights: 159K jobs reported in Oct. combined with upward revisions to past months means that the level of jobs rose by 240K in Oct. We now have more momentum. The work week expanded so its jobs and hours-worked in demand. The NFIB (small business) survey showed less resistance to hiring among small firms. The productivity report showed productivity gains waning from having workers whipped and cajoled and threatened and coerced. The thrill of overtime and fear of unpaid hours worked are gone. There is no more gas in that tank. Firms will now have to HIRE to get more output and spending is picking up. All that is good for job growth prospects. Best of all, however, spending on services is picking up, since that is both the low productivity sector and the sector where jobs are created - that is good news indeed. It’s about time. So those are the main reasons to be really optimistic and to spank any pessimist you see. Double dip is a risk that is gone. It never was that big; those rumor mongers will continue to talk about it until they can put it to rest without harming their own credibility. These are the same people that keep their children from sleeping by telling them the boogieman is under their bed. He isn’t but they don’t know that, so they worry all night about something that isn’t there. It’s a case of how something you ‘know’ that’s really wrong that can hurt you. So forget those fears don’t waste time worrying about what ain’t there. Time to boogie with that boogie man.


qawsedr5567 said...

IS VERY GOOD..............................

The Arthurian said...

Hello, sir. The "next blog" button brought me here.

But what of inflation due to expectations and stronger money growth? Can’t we get that even with an output gap?

A most excellent question. Expectations, and money growth, and cost-push forces that have been squeezing profits for decades. The "inflation-is-caused-by-excess-demand" notion died in the early '70s or before.

Is taking responsibility for short run growth the Fed’s pay-back for retaining and acquiring more power? We may never know if this is some conspiracy theory...

ehh... Too much philosophy here. Not enough focus on the problem.

As long as we have excess reserves without loan growth the reserve growth is ineffective so why do more?

Agreed... Your car-that-won't-start analogy suggests to me that the Fed has inadequately analyzed the problem.

All in all, I like the post. It has a good "feel" to it, though I cannot say what I mean by that, nor shall I take the time to ponder it. Your well-written ending is optimistic but I offer a caveat... As a best case, we may be able to resume the sort of unsatisfactory growth we had in the 2000s, or perhaps more of the debt-intensive growth we had in the 1990s. Neither is acceptable.

We need the sort of growth that Reagan was looking for, growth sufficient to bring the federal budget into balance. But there is nothing new in the policies of Bernanke or Obama or the recently elected, or the angry voters, nothing to bring about the sort of change we need.

Good luck with that.



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