Lesson 8 Macroeonomic Policy: Out Of Bullets?

Yesterday: General Sir – the enemy keeps coming should we keep firing at them? Yes, Private keep firing. But Sir, I am running low on ammo and most of the enemy intruders are the weak ones carrying no weapons. Private – I said keep firing. You never know when one those weaklings might hit you on the head with a broom stick.

Today: General Sir, I am now out of ammo and a whole new army is coming at me. What should I do? General? Are you there General? What should I do General? Click. Buzz.

When the market fell last week, it became more and more obvious that our policy makers are out of bullets. Which brings up the topic of what we mean by Macroeconomic Policy. So this is another lesson on macro for all you folks who tell me that you only understand one out of seven words in my posts. It is also an opportunity to crow about what  I have been calling jeopardy for years.

My parents never tired of warning me about jeopardy – meaning that today’s decisions can put you in a vulnerable place. My mother would shout, Larry quit playing Party Doll on your Victrola over and over and over. Do your math homework. If you don’t do your math homework you will someday be a horrible guitar player with no source of financial stability.

So I learned the concept of jeopardy at a young age. And that explains why I have been writing for at least five years about how the US Government and the Fed have put the nation at jeopardy. And this also explains why we are now in a very risky economic state because we may be facing tough times ahead and our policy makers are out of policy bullets.

Liberal or conservative, there is room to believe in the efficacy of national macroeconomic policy. But let’s start at the beginning using some questions.

What is macro policy? Macro policy is aimed at making national policy variables approach desired ends. It is not about specific industries or specific companies or specific regions. National policy ends are economic growth, low inflation and unemployment, and so on.

What are the options for macro policy? In most macro courses we teach that there are these four policy areas: Monetary Policy, Demand-side Fiscal Policy, Supply-side Fiscal Policy, and International Trade Policy.

Monetary Policy consists of the Fed managing interest rates and money. Demand-side Fiscal Policy involves the government (Congress and President) implementing policies designed to impact spending in the economy. Supply-side Fiscal Policy is about the government legislating policies that improve incentives to produce goods and services – more efficiently and in greater volumes. International trade policies are not popular in the US but generally involve countries trying to improve their competitiveness so they can sell more goods abroad. These policies include exchange rate manipulation as well as policies like Free Trade Agreements that would make US goods more desired by the rest of the world.

So are we out of policy bullets? If not out of bullets we are getting close to zero balance.

Fed policy is easy to start with. As you know the Fed has spewed a lot of money into the system and lowered interest rates to zero. None of that inspired a strong recovery. The Fed admits to economic weakness every time they explain the economy is too anemic to return to normal policies. So if a future shock weakens the US economy the Fed has little left that it can do. Any new monetary policy that would lead to negative interest rates or new rounds of quantitative easing would signal weakness and would worry world investors. You saw a little bit of that in the stock market last week.

How about Demand-side Fiscal Policy? The story is similar. The US government reacted to the past world economic crisis with huge increases in spending accompanied by policies to reduce tax rates. This was meant to prevent the economy from tanking. 

This activity took us into new territory when it comes to national debt. Without throwing around big numbers let’s just say that the relative size of our nation’s debt more than doubled and so far the debt burden is planned to get even higher in the future. When times improve we are supposed to reduce debt. But that never happened. Now as we approach a possible new economic contraction the government has no room to increase spending and/or reduce taxes. Do we want the national debt to double again? If we do try to use Demand-side Fiscal policy, then this will be taken as a sign of extreme alarm by world investors. We do not want that. I won’t even bring up Greece here. But I think you get my drift. Greece is clearly out of bullets. They don’t even have a slingshot.

How about International Trade Policy? I think we are out of bullets there since problems abroad mean that other countries are not buying much from the rest of the world and definitely are not buying from us. The value of the dollar is rising – not falling. Free trade agreements won’t do much to solve a crisis since the fundamentals mean that foreigners will not be buying more goods from us. They can barely buy goods from themselves.

What a pessimistic picture. Or is it? I left out one type of macro policy – Supply-side Fiscal Policy. Talk about tainted meat! Supply-side policy is an interesting alternative but it is saddled with cuss words like Reaganomics, Trojan Horse, Trickle-Down, and more. Liberals light up and glow when they use these terms. Sort of like when you got mad at your friend in third grade and called him a poopy-head. 

But SSFP -- let's call it that since it is less provocative -- is simple and straight-forward economics. Like bitters -- SSFP is not perfect for every situation but bitters is a necessary ingredient to make an awesome JD Old Fashioned. SSFP does wonders when suppliers of goods and services are reluctant to produce. SSFP attacks disincentives to produce. SSFP looks at things that unnecessarily add to business costs. SSFP is NOT about getting consumers to buy more. But it ends up increasing demand if it promotes firms to compete better and harder. 

SSFP tools are many. The best tool for today comes from examining what is constraining businesses right now. Why aren't firms hiring more workers? Why are firms reluctant to purchase new capital equipment and software? Why are some firms moving their assets abroad? Answer those questions and then use SSFP to remove the impediments. I won't prioritize the answers but clearly there are many areas of policy we can examine including minimum wage increases, environmental regulation, Dodd-Frank banking regulation, Obama-Care impacts on employment, and corporate taxation. 

My liberal friends will scream that we need all those taxes and regulations. Don't interpret me as saying we need to get rid of them. But just acknowledge that if we are truly out of policy bullets, then some small backtracking on these priorities could be very useful in getting this train wreck of any economy back on its rails. As J. Cash would sing -- Look Yonder Coming -- Coming down that railroad track.  It's the SSFP Special bringing my baby back! Humming is permitted.