Howling Wolf

On October 13 Martin Wolf wrote a column in the Financial Times called Time has Come for Intelligent Policy Making (http://www.ft.com/intl/cms/s/0/f4d3fdce-f42f-11e0-bdea-00144feab49a.html#axzz1auKt9tCY ). He ends the article with the following quote:

There are two big points here. First, fiscal and monetary policy converge when interest rates are close to zero. The authorities have to co-operate closely, to prevent an unnecessary disaster. As Deng Xiaoping said: “It does not matter if a cat is black or white, so long as it catches mice.” Who cares if a policy is called fiscal or monetary, so long as it works? Second, without economic growth, it is almost impossible to deleverage an economy. The prime minister revels in his pre-Keynesian views. When weak demand is the immediate constraint on output that is simply terrifying.

What is terrifying is that Wolf, a very influential writer, fails to recognize facts and continues to render advice that will truly harm the world for many years to come. He makes two important errors. First he believes that the present macroeconomic problem is deficient demand. Second he thinks that if past stimulus policies have failed then it behooves government to try them again – now with bigger doses of policy and with more coordination between the government and the central bank.

His belief that the main macro problem is a deficiency of demand or spending is like believing that driving accidents involving drunk drivers result from speeding. It is true that these accidents are correlated to driving speeds just as economic malaise is heightened by under-spending. But correlation is not causation. The accidents were caused by people drinking too much. Our lack of spending derives from very specific causes like years of unsustainable debt, a housing and financial crisis, a European sovereign debt crisis, and the attendant effects these trends have had on both Wall Street and Main Street. Calling for policy to induce people to spend more is like putting up new speed limit signs for drunks. Neither of these solutions addresses the root problem and the result is that neither will work. To the extent that Wolf continues to advise governments to focus on deficient demand means policymakers who follow his advice continue to avoid progress on true causes and thus threaten to make things worse.  

It is interesting that Wolf does not appear to read Wolf. In other columns he is quite lucid about the financial roots of our problems and is instructive on the need for private investors and tax payers to share in the solution burdens. Why he avoids his own advice and keeps coming back to strongly advise stimulus policies aimed at deficient demand is an interesting question. Maybe he doesn’t understand cause and effect? Maybe he believes the situation is so dire that cause and effect seem to be less important than trying ANYTHING to solve the problems. This is not 2008. I just don’t understand why he is so willing to throw caution to the wind and grab at straws.

This brings me to my second point. Wolf wants to see more stimulus and he wants a coordinated monetary and fiscal policy. Apparently the past programs were not enough. But Wolf doesn’t really say how much would be enough. By most measures the past fiscal and monetary injections were huge. And while there may not have been explicit coordination, the Fed and the US government were doing plenty without sending texts or tweets to each other. In theory a solo fiscal policy might lead to higher interest rates as government borrowing crowds out private borrowing. But that didn’t happen this time. I have read nowhere that rising interest rates have prevented recovery. Wolf seems to believe that if the Fed buys the government bonds that will somehow provide even more spending oomph. But does he really believe interest rates are not low enough now for people to want to buy a home or for firms to buy another machine? Does he really believe that the simple announcement of a new, large, and coordinated stimulus will cause people to run in droves to Amazon.com and Walmart with confidence and zest?

Much of Wolf’s conclusions derive from his belief that deflation is a bigger problem than inflation. I will give him that. I do not see imminent inflation for the world economy. But I see that fact different from him. This higher probability of deflation today stems from a belief that monetary and fiscal policy are spent and are NOT the right way to solve our macro problems. The more people listen to Wolf the more worried they become. This worry shows up in uncertainty and a desire to retrench. They don’t spend more when stimulated. The more the government tries to help, the more it nibbles off its own foot. I suggest we keep this Howling Wolf out of the hen house. More stimulus and more coordinated stimulus are going to scare the Hell out of people. What we need is for government to address the causes of housing and financial distress. Only then will we see a resumption of growth in output and employment. A wolf howls at the moon to no avail. I hope the same is true for the Wolf named Martin.