The Fed -- Too Little Too Late

What happens when you bring too little too late?  For example, you arrive at the party with only a thimble full of JD. Everyone else has peaked and there you are sober as a judge and all the really cool girls are taken. You might as well retire to the library. You could try to “catch-up” quickly but you know how that will end up. That is the way it is with too little too late. All the good options are gone.

So why do people do this kind of behavior? For one thing, maybe we are clueless. Some of us don’t see a problem or opportunity coming until it runs right into us. Garsh honey, after being married for 28 years I didn’t know you had blue eyes. Anyway, a second reason for coming with too little too late is that you are just basically conservative. You NEVER strike first or fast. You prefer to see how things play out. 

Finally there are those people who assess each problem independently. Sometimes you address the issue quickly – like when your daughter brought home that guy with the really loud motorcycle. Other times you believe a more patient approach is best.

So too little too late can occur for many different reasons. I am thinking about this after Ben Bernanke was quoted last week as saying that while he noticed that his low interest rate policy is creating financial bubbles, he doesn’t see any reason to change his policy. 

His speeches make one pretty sure that important people like Federal Reserve Chairmen are studying problems judiciously and coming to very good decisions. But it is worth wondering out loud whether he is either clueless or inflicted by a habit that ALWAYS waits too long to make the right decision.

A recent report quoted in the press was very critical about Fed Policy in 2007 – faced with a slowdown in the economy, the Fed seemed to be the last one to know that a recession was taking place and needed a boost. Of course just before that the Fed was faced with about-to-explode bubbles in real estate and financial markets and closed it eyes to anything they might do about all this. Inasmuch the Fed went from a policy to stimulate the economy quickly to one that slowed it and then back to a policy to stimulate the economy. Wow – now that is frying pan to the fire kind of stuff. The Fed seemed to be the last one to know that a change in policy was needed.

Of course none of this is new. As inflation built during the 1960s and then early 1970s it seemed to take forever for the Fed to react. By the early 1970s the Fed had to jerk the economy around – so much that they finally had to give up for fear of creating an economic crisis. They admitted failure to control inflation when after being the backbone of the Gold Exchange Standard for almost 30 years, the USA unilaterally backed out of that system. Then Nixon, realizing the Fed could not solve the economic problem talked privately to his own portrait several times and decided to implement Wage and Price Controls. Of course that didn’t work. The main effect of W&P Controls was that a 50 cent candy bar was soon a lot smaller and still cost 50 cents. Apparently the W&P Controls didn’t differentiate between price and price per ounce. Lovers of Baby Ruth bars went into the streets and rioted.

We weren’t finished with inflation – it kept escalating throughout the 1970s – until the Fed finally got serious – after doing too little too late they followed that with too much too late in 1980. Remember the stories of 20% interest rates? Those are not fun stories. It pretty much wrecked us for a while.

This history shows why the Fed ought to be on top of their policies. If Bernanke is seeing bubbles forming then he would do us all a huge favor by taking out a really big and sharp needle and popping those suckers. Do it right now. Why doesn’t he do that? I don’t think he is clueless. I don’t think he needs to study this problem. I think he has a wait and see syndrome. But how much more evidence does he need? Hey mom – I see bear droppings on the front porch. I am scared. Don’t worry honey – there are no bears around here. The Ranger told me so.

Bernanke does not want to upset the applecart. The right policy now is to admit that it is time to end the low interest rate policy. But Bernanke isn't when the bubbles will burst. He doesn't want to do anything to anger investors or bankers right now. We can deal with the aftermath of the bubbles if they ever pop on their own. The Democratic Party is saying the same thing about debt relief. Paul Krugman said we can take care of exploding debt in 2030. The government can be counted on to do too little about bubbles because of politics. 

That is understandable. But the Fed is legally independent of the President and Congress. The Fed does NOT have to support expansionary policy. The Fed is supposedly run by apolitical technocrats. Or did the last financial crisis change that? Has the Fed become a lackey to politicians bent on endless stimulus? I hope not. Too little too late will bring another round of too much too late. And of course another recession. 

Timeout For Lucy

The Debt Ceiling is Scarier Than the Fiscal Cliff was Alan Blinder’s latest contribution to macro policy (WSJ page A17, January 15, 2013). I guess he never read Snoopy and witnessed how Lucy routinely pulled the ball away as Charlie Brown tried to kick it. Now he wants to scare Charlie enough so that he takes one more kick at a vanishing ball. The Republicans have apparently agreed to pass a debt ceiling increase but Lucy is still at work and needs to go to time-out for a while.

Blinder spends the whole article explaining all the horrible things that might happen if the debt limit is not lifted. I admit it is pretty scary stuff although I think he doth exaggerate. We all know the debt limit will be lifted – it is just a question of how long it takes to reach a compromise. Our government is clever enough to juggle the spending for a month or two without really throwing old folks over the cliff. I love the way Blinder and other Democrats keep bringing up how Social Security and Military pay checks might be delayed because recalcitrant, hard-hearted, mean, selfish Republicans won’t lift the ceiling. The President could arrange that kind of evil spending priority but it would be only for political purposes – he and Congress have many other options for spending changes that would be less onerous on a temporary basis.

Blinder mentions how world investors and ratings agencies will downgrade and flee US assets because of a failure to reset the debt ceiling another trillion dollars or more to cover the planned deficit this year. He worries the US would be technically bankrupt. Of course, nothing could be more false. The US has plenty of money and an unshakeable obligation to pay interest to its creditors…more spooky scare tactics by Blinder and his friends. He knows but won’t admit that those creditors could care less about the debt ceiling – what they care about is getting paid back. What matters for creditors is the size of future deficits and growth of the debt. The extra trillion we need now is just a down payment on future increases in the debt that arise because government will not agree on a program to manage the debt. A credible medium- or long-term fiscal program is all that matters. That is what the ratings agencies want to see. That is what the creditors want. Raising the debt ceiling is like me promising to fit into my wedding suit by asking for one more slice of pie.

What is silly is that these scare tactics are so obviously political and so wrong that most people completely write them off as puffery. We all know that the Democrats want one more chance to pull the ball away from Charlie. The Democrats wanted a tax increase on the rich and they got one – as well as a sizeable increase on everyone on a payroll. Now they want more tax increases on the rich. What happened to all that talk in the last year about a comprehensive tax reform and spending restraint? What happened to entitlement reform? “No Charlie – I promise not to pull the football away this time. Take a big whack at the ball.”

The unfortunate message from the Democrats is that they are proving they cannot be trusted to enact anything that comes close to deficit/debt moderation. Higher taxes on the rich won’t do anything beyond nibbling around the edges of the budget pie. Ignoring a broad tax reform and arguing loudly against entitlement reform sends an even stronger signal to ratings agencies and creditors that we are not serious about controlling our debt.

I was once critical of both parties but when I read Blinder’s scare tactics it made me want to point the finger of blame in one direction. Democrats and their mouth pieces must stop holding our country hostage to their unflinching goals of income redistribution and unfettered spending growth. They have to stop these stupid scare tactics and sit down with Charlie Brown and do the hard business of putting our country on a stable financial path. 

Age of Aquarius is over – Put some clothes on

Comments I received after my last blog confirm what I have been sensing since the last US presidential election – people are losing interest in analysis. It is not possible to summarize all the facets of this loss but a common thread is that we are in an age or a cycle that appears to be strengthening – and that stage or cycle is one that seems to be on auto-pilot. 

Thus attempts to argue or reason against it are virtually useless. That some Democrats stress that winning the election gives them the right to move on with their agenda of change just reinforces these feelings of inevitability. 

This posting is meant to address this seeming loss of hope amongst those who do not agree with the policies of the Democrats. I am a little more optimistic than some of these worried folks and I believe my optimism is supported by history. But I have to admit, it is not easy as a macroeconomist to watch the current experiment. It reminds me of looking back at the early 1970s and the Nixon Wage and Price Controls. 

Everyone knew they would fail – the only question was when they would end and how much damage they would cause. Instituted in August 1971 they were finally abandoned in 1974 as prices continued their escalation through 1980. Nixon, a conservative economist was mystified by the newly coined macroeconomic disease – Stagflation – and he lost faith in traditional macro and opted to try something new and different. (By the way I coined the term Infession at the time but apparently my status as a graduate student did not allow my terminology to rival the more popular term stagflation.)

Today our government is tormented again by a new disease – this time it is a housing and financial crisis that led to a deep recession of six quarters followed by a very slow and weak recovery period. Our policy makers responded with a strong dose of traditional Keynesian stimulus – a coordinated fiscal and monetary expansion that injected trillions of dollars into the economy. At the onset of the recession in 2008 it seemed reasonable to support a housing/financial intermediation with a strong Keynesian spending impulse.  But we are now many years beyond the beginning and the end of the last recession and the Keynesians are not ready to throw in the towel. The reluctance to ditch continued stimulus seems shared in many important places including Japan, Switzerland, Great Britain and others.  The European Central Bank joins our Federal Reserve in a pledge to do what is necessary to keep spending growing.  Both have acknowledged risking higher debt and inflation for the sake of short-term economic stimulus.

It may be surprising to many of you that some monetarists support the use of a Keynesian stimulus in the short-run.  Some monetarists accept much of the Keynesian model as it relates to the short-run. But monetarists and other non-Keynesians distinguish themselves when they disagree with Keynes’ statement that we are all “dead in the long-run.” This was Keynes’ way of saying that all that matters is the here and now. Non-Keynesians, however, think we need to worry more about the future. Many non-Keynesians might agree to the stimulus in 2008 and 2009 yet object strongly to continuing such a policy beyond the worst of the recession.

And that is where we find ourselves in 2013. Keynesians believe that austerity or a policy to even gradually remove stimulus today would be tantamount to pulling the proverbial rug out from under the economy.  They don’t even want to talk about it. It is like global warming. If a person challenges conclusions from weather data they are branded immediately as either ignorant or falsely motivated. And those are the nice names. Someone who worries today about future debt or inflation is not considered to be serious. In this environment it is no wonder that people don’t want to analyze or argue.

So let me turn away from the specifics of the debate and explain why history makes me somewhat optimistic. I think we are rapidly nearing the end of an age of government growth. You will scoff at this prediction because you see no end to government growth but it is often just when things look like they will never change that they do. I am not predicting that the government will vanish but I do see signs that the share of government in the economy will stabilize and decrease.

Who could imagine the Soviet Union falling when it did? At one time it seemed impossible that the German advances before World War II could be stopped. Before coal was discovered European wood was rapidly being depleted with the usual consequences on energy and transportation costs. At one time all the South American countries were run by dictators who promised a future with a closed, self-reliant economy. Much of Africa was once run by European colonials and much of the population was in slavery. The Age of Aquarius as depicted in the musical Hair promised a change in values that had its day but petered out...or else we'd all be wearing tie-died clothing.  History suggests that times do change. Sometimes when they seem the blackest is when they are closest to change.

And that makes sense. Because when times seem the worst is when it becomes more and more difficult to tell the same old untruths. The story of the emperor who wore no clothes was written for an important reason. People will go along with things so as to not disturb the leaders. In that story it was child who said the obvious – noting that the emperor was as naked as a blue jay. And then EVERYONE agreed to that reality. Clearly the emperor needed some new duds.

In the case of government growth and current macro policy it won’t take that much longer to see the failures. We have had about 75 years of this age and while I have no desire to go back to the 1930s it is clear that the government process needs a lot of oversight and improvement. The gem of the government process – Social Security – is nothing like what was promised.  Young adults worry that this protection will not exist for them when they retire. The cost of Medicare and Medicaid grew by multiples of original cost estimates. The War on Poverty has done almost nothing to eliminate poverty and some might say that it has institutionalized it. Obamacare is just getting started and one can predict that it will not fulfill some of its most important promises as the economy tries to digest its thousands of pages of new regulations. An article I read this week projects private healthcare policies doubling in price as early as 2014. They will likely be called traitors by our current government. 

Already there is visible proof that neither the government nor the central bank knows how to reverse what were supposed to be temporary stimulus programs. The end of the temporary decrease in payroll taxes in 2013 is causing the US economy to slow even further this year. The politicians promise to reverse engines at just the right moment but we all know that the date is coming closer and closer when we will have violent reactions to rising inflation, interest rates, and national debt.

I probably left out a lot of the writing on the wall – but the more important part of this story is that the average voter is going to soon feel the negative impacts of the end of the Age of Government Growth. We know the rich cannot and will not support the present and future growth. No amount of make-up applied to smiling political faces will be able to mask the impacts on the middle class. Their incomes will be taxed away and inflation will eat at their earnings. The next government financial crisis will make it impossible for young people to save anything for the future as their 401Ks shrink in value. Young workers will feel hemmed in without future prospects. Government programs will be less affordable and the world will no longer lend money to the US government. Government programs will have to be seriously scrutinized. People will be heard saying – why didn’t we see this coming? Why did we let this go so far? We have had major government deficits ever since the 1960s! 

The average person will come to understand through personal experience that while it sounds good for government to help them – it often is not their best alternative. Somehow the government kept this deception going for nearly a century.

So let’s keep arguing. Let’s keep making the case for unintended consequences. Let’s be specific about why stimulus is not always the answer. Let’s keep reminding people why piling up national debt is self-defeating.  Let's keep explaining how and why more conservative policies, though not perfect, are often better than knee-jerk government solutions. The Age of Aquarius is over. So is the age of rapid government growth! Somebody please put some clothes on Nancy Pelosi!

Macro Confusion

I doubt I have ever seen a time when there was so much confusion about macro and policy. I recall being a teaching assistant for Professor Benavie at UNC in 1973 when a student streaked naked through his macro class of 300 freshmen. That was pretty confusing. Benavie was quite a pro. As I recall he made an offhand gesture about the color of the guy’s ski mask and went on talking about GDP.

I wish things were that easy right now. I hardly know where to begin so perhaps a tiny sip of JD will get me headed in the right direction. Okay. The main confusion comes, I think, because macroeconomic policy has several goals. One goal is long-run oriented – to keep the capacity of production and employment growing. A second goal is short-run oriented – to keep current output very close to or at capacity. A third goal is to use policy in such a way that you are able to pay for whatever macro policies you employ.

As you know, the federal government’s macroeconomic policy following the recession in 2008 was to stimulate demand and production. Recessionary conditions meant people were not spending enough. The government created massive fiscal deficits as a means to replace or offset the missing private spending.  Tax cuts and government spending increases were used towards that end. A very expansionary monetary policy was used by the Fed to supplement the government’s attempt to bring weak demand and output back to capacity.

By 2012 the economy was beyond the end of the recession but recovering very slowly. In such times we would normally begin to reduce the amount of short-run policy stimulation. Furthermore after several years of very large government deficits, most politicians agreed that our financial stability and our economic recovery were threatened by rapidly growing federal government debt.  As such politicians set out to find a policy that would address this debt problem. One only has to look at recent history in Europe to know how damaging a debt problem can be to a country. Of course, one can look at Europe and also see how politics can come into play when one has to be specific about the tax increases and spending reductions that would compose such a policy.

Despite wide agreement about the urgency of a deficit reduction plan, no progress was made. So US politicians made a contract with the devil. They agreed on a very extreme austerity program that would automatically raise taxes and reduce spending harshly. It was one way to solve the looming debt problem, albeit an extreme one.

But such austerity clashed with the short-run goal of strengthening the economy. Why? Because such an extreme and fast solution for the debt would knock the wind out of the economy. The plan, of course, gave politicians most of 2012 to come up with a more reasonable way to solve the debt crisis. Please underline something there – the idea was to give them more time to come up with a way to resolve the debt problem.

And here is where the confusion comes in. The government did do something toward the end of 2012 and the first few days of 2013. It was heralded as an historic compromise. It did manage to avert at least partially the phony fiscal cliff they had created. But please note – the purpose of the fiscal cliff and the policies debated all year were aimed at reducing national debt. So what was this great historic agreement? It was an agreement to increase the US national debt by another $1.5 trillion between now and 2017. The debt was already going to increase by $1.7 trillion in those five years – so with the new legislation passed it will instead increase by $3.2 trillion. Already financial experts are predicting a downgrade of US debt. We had more than a year to deal with an explosive debt issue and our government dealt with it by making it larger.

So why would our government behave in this way? I have some possible answers but maybe you do too. So don’t be bashful.

First, these policies to balance the budget appear to be at odds with an economy that has never truly burst out of the last recession. Some people fear that external factors might impact us later this year and push us back into a recession.  I share that concern. But making the debt problem worse right now is no way to strengthen our economy. 

We did not have to accept the drastic tax and spending changes of the fiscal cliff to improve tax revenues and expenditures over the coming five years. We could have gradually implemented a government spending slowdown and an increase in taxes.

Second, they promised to work on the fiscal deficit between January and March of this year. Really! They couldn’t do anything in years about the deficit and we are to believe they are going to do it in two months?  

Third, since the agreed solution was almost totally focused on increasing taxes there was a belief that the coming solution – and one that might address the national debt – would be focused on slowing government spending. But already some politicians say they want more balance with respect to taxes and spending.  The fear is that this is simply code for raising taxes on the wealthy. There are still many politicians who say we cannot remove a penny from Social Security, Medicare or Medicaid. In all, it is hard to see how we will reduce the nation’s debt. 

The most probable path is one where we continue to have macro confusion. It is a path that talks about debt but ignores it in favor of short-term stimulation. It is a path where income redistribution is paramount as we focus on policies to raise taxes on the rich while leaving sacrosanct spending for everyone else.  The sad thing is that this path will do little to prevent a second recession; will do very little to help the middle class; and will do a lot to keep debt high and economic growth low. This is no way to run a country. 

Dumb, Dumber and Space Aliens

Unbeknownst to us, a space ship parked in the outer atmosphere one year ago and promised to destroy Earth on January 1, 2013. It was widely agreed that we could protect ourselves from this menace by launching a two-stage rocket with a nuclear weapon with a large cherry on its nose. Dr. Dumb suggested that the first stage rocket be red. Dr. Dumber wanted the first stage rocket to be blue. In no way would Dumb agree to have the first stage be blue. Dumber explained a red first stage would be unacceptable as well.

Knowing they had the luxury of a year to come up with a solution they did write on a stone tablet that if they were unable to come to an agreement by Dec 31, 2012 then an automatic solution would be implemented in which the red leadership would have to spend a whole evening fox trotting with Nancy Pelosi. The blue leadership would spend the night playing chess with Rush Limbaugh. Enough said. A solution would be coming. No one would want to expose the nation to these possibilities.

Dr Seuss, a well -known compromiser, explained that a purple rocket  might work but that was unacceptable to both sides. So during 2012 the Dumbs and the Dumbers argued. The Dumbs passed a bill in the Dumb House that would shoot a red rocket half way. They reasoned that while it would not kill the aliens, the beauty of the red rocket going halfway would make people more cheerful, especially people in Indiana, Georgia, China, and Nebraska and other places that love red. The Dumber House was not going to fall for that stupidity and spent the year legislating a new requirement that all overweight people would have to spend 90 minutes a day with a hula hoop.

On New Year’s Eve 2012 the Dumbers finally did pass legislation. It advanced a proposal to have the first stage of the rocket be blue but allowed for the possibility that the tip of the propeller could have a small red dot. That was fair and the Dumbs should have no trouble with that. They promised by swearing an oath on Ho Chi Minh’s grave that the next time we have a space invasion they will advocate a first stage rocket totally painted red. And they gave the Dumbs three minutes before the stroke of midnight to decide. The Dumbs were dumbstruck and called in Oprah for help. They decided to call the Dumbers a lot of really bad names. The Dumbers responding by saying nah nah nah nah  and your mother wears combat boots. Both sides did agree at the last minute to send Jello shots into space in such a way that it spelled out a message to the aliens -- “please give us two more months to work on this.”

When the clock was about to strike 12 Cinderella arrived on the scene and kissed the frog and everything was made better. No that’s not right. At midnight the aliens came to earth and announced that they had changed their plans. Planet Earth was obviously too stupid to destroy – and they planned to televise our daily activities on an intergalactic cable network reality TV show called Democracy at Work.

So have a Happy New Year.