DeLong and the Republicans are both wrong

Tyler Cowen and Greg Mankiw linked to a Keith Hennessey graph that has been getting a lot of attention.  It shows the ratio of spending to GDP over the next 10 years as estimated in Obama’s proposed 2010 budget (last year), as well as the spending/GDP ratios expected in his current budget. 

It’s easy to look at the graph and assume spending is out of control, and that Obama hasn’t kept his promise to reduce spending in the out years.  But that is slightly misleading, as DeLong argues here:

Left out of Hennessey’s “analysis” is the reason that an 8.3% of GDP deficit is warranted: that the economy is very weak.

Left out of Hennessey’s “analysis” is the reason that President Obama projects bigger deficits this year than he did last year–that the economy is extremely weak, and is much weaker than we expected it to be, and when the economy is weak the deficit goes up as revenues fall and social-insurance spending rises: a year ago the administration expected the unemployment rate now to be 7.7%, but it’s 10.0%; a year ago the administration expected the unemployment rate at the start of fiscal 2011 to be 7.0%, but now it expects it to be 9.8%; a year ago the administration expected the unemployment rate at the start of fiscal 2012 to be 6.4%, but now it expects it to be 8.9%.

All very good points, but in the end they lead to a dead end.  If Hennessey is wrong, then DeLong is just as wrong, albeit for two different reasons. 

DeLong says we need more fiscal stimulus because the recession is far worse than predicted.  Let’s stop right there.  Last January Obama knew exactly the sort of financial crisis we faced.  He proposed a major stimulus, which he claimed would spur the economy.  New Keynesian models say that the expansionary effect of stimulus begins occurring when it is announced.  New Keynesian theory suggests that current AD is strongly influenced by changes in future expected AD.  So here is my question; what was the impact of the first stimulus package?  Yes, we know it wasn’t as big as DeLong would like, but what was its impact? 

To answer that question, it would seem logical to look at how NGDP grew, and compare that growth to the trajectory expected in the absence of the stimulus.  Trust me, if you are a Keynesian you don’t want to do that.  Instead, a Keynesian would argue that things quickly deteriorated after the first projections were made, but the stimulus somehow prevented the deterioration from being even worse.  Possibly, but there are two problems with that explanation.  It still leaves us without a shred of evidence that the stimulus worked, it merely indicates there might be an excuse for it seeming not to work.  Even worse, that near-term deterioration is not supposed to happen in forward-looking New Keynesian models where the stimulus is expected to boost output later.  So the Keynesians don’t have any good explanation for the horrible performance of NGDP in 2009 relative to the expectations back in January.  Banking problems?  We already knew about that, they occurred in 2008.  Mysterious drop in consumer confidence?  Animal spirits?  Those are terms people throw around when they haven’t a clue as to what’s going on. 

To summarize, the Keynesian complaint is “the economy deteriorated far more severely than we expected when we proposed our massive $800 billion dollar stimulus, consumer confidence has been shattered by all those scary stories on FoxNews about a government near bankruptcy, so we need to run even bigger deficits.” 

I admit all this is highly debatable, but here is my real complaint with DeLong’s post, (or the Republican view for that matter.)  Everyone wants to set the debate up as follows:

1.  Do you favor massive deficits or are you content to have the economy self-correct, risking high unemployment for several years?

I want to scream when I see the debate structured that way.  That is not the issue.  Rather there are two distinct issues:

1.  Is more AD desirable, or should we let the recovery take its natural course?

2.  If we need more AD, is monetary expansion preferable to massive budget deficits?

Let’s review a few simple ideas.  Fiscal stimulus does not boost AS, it boosts AD.  (OK, MTR cuts can boost AS, but Obama’s opposed to those.  And some public investment like education might have a long-term payoff.  But let’s get serious.  We are talking about high unemployment over the next 5 years.  A more educated workforce won’t have much short term impact.)  So if fiscal stimulus is to help the recovery, it does so by exactly the same method as monetary stimulus—boosting AD. 

I happen to favor more stimulus, although I understand that some thoughtful economists disagree with me.  I happen to think monetary stimulus is preferable to fiscal stimulus, and in this case there aren’t any thoughtful economists who disagree with me.  Not one.  If there was going to be one, it would be Paul Krugman.  But even he admitted late last year that monetary stimulus is the first choice, and you only move on to fiscal stimulus is the Fed won’t play ball. 

So here is the debate:  Do we need more monetary stimulus, or should we let the economy recover naturally.  But DeLong wants to say the debate is between fiscal stimulus and stagnation.  How can he do that?  Buy simply assuming away monetary stimulus.  Presumably he would say that Obama doesn’t control monetary policy, so he can hardly be blamed for relying on fiscal stimulus.  Has Obama made a single public statement calling on the Fed to promote higher NGDP growth, or higher inflation, or higher whatever?  And then there is the little problem that Obama just re-appointed Ben Bernanke last month.  Bernanke’s now his guy at the Fed.

I am actually not trying to blame Obama personally.  As with all other politicians I assume he does not understand that low interest rates don’t mean easy money.  Most economists don’t even seem to understand that.  Rather as with any President, the term ‘Obama’ is really shorthand for the entire policy-making apparatus.

Don’t get me wrong, I’m not that naive.  I understand it would be very hard getting the Fed to change its ways at this point.  But can we at least have a debate?  I was about to ask if we’ve reached the level of passivity of the Japanese, but then I recalled that they are engaged in a fierce debate right now, and Finance Minister Kan is putting strong pressure on the BOJ for more stimulus.  So compared to us, the new Japanese administration is almost Rooseveltian.

If Obama doesn’t want to have that debate, that’s fine.  But then don’t tell us fiscal stimulus is the only answer to high unemployment.  And don’t tell us that Obama doesn’t understand monetary policy.  I thought the whole point of replacing Bush with Obama was to get an intellectual in the White House.  Someone who understood the issues.  If we have “grown-up” intellectuals in the White House, then let’s have that debate.  Let’s see some discussion of unconventional monetary stimulus.  Can’t Congress at least pass a law repealing the interest on reserves program?

BTW, I’m just as frustrated at the right-wingers at the Fed.  We are running up trillions of dollars in debt precisely because the elected leaders of our country think we need more AD, and the Fed doesn’t.  I understand the need for the Fed to be independent, but how about some honesty at least.  If these inflation hawks really believe what they are saying, show some guts and come out and say “We are not doing more monetary stimulus because we feel a need to offset what we regard as excessive fiscal stimulus, and prevent it from raising the expected inflation rate.”  If they really have the courage of their convictions, then why not admit what they are doing?

In February I said fiscal stimulus wouldn’t work, as the Fed had some sort of nominal aggregate target in mind, and was going to simply offset the fiscal stimulus.  And that is what happened.  In March when things looked scary, like a Depression was possible, the Fed announced its big program of buying Treasuries and MBSs.  Later in the year when things picked up a bit, and we were clearly going to avoid a depression, the Fed started furiously back-peddling.  They started talking about ending the bond buying program and “exit strategies.”  Ask yourself this; what does that back and forth behavior tell you?  It tells me the Fed has some sort of implicit nominal target, and if the economy seems to fall short they’ll pull out all the stops and flood the economy with liquidity.  That’s why the $800 billion dollar fiscal stimulus was a complete waste of money; the Fed wasn’t going to allow NGDP to fall much further than the actual 2.5% it fell.  Shame on us for not figuring that out, and shame on the Fed for not explaining that to us. 

Oh, and shame on the Fed for not having a more aggressive policy even with the stimulus.

And shame on me for writing this post just one day after I resolved to be less opinionated.


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29 Responses to “DeLong and the Republicans are both wrong”

  1. Gravatar of Mark A. Sadowski Mark A. Sadowski
    2. February 2010 at 18:58

    Dag nab it, I’m first. I hate when that happens.

    Scott wrote:
    “as the Fed had some sort of nominal aggregate target in mind, and was going to simply offset the fiscal stimulus”

    Do they really? I’ve read that the Fed might have some aggregate target in mind, but I never thought it was to offset the fiscal stimulus.

    Mostly I thought they were going to set the non real QE stimulus at the ZIRP (if that makes sense).

  2. Gravatar of Mike Sandifer Mike Sandifer
    2. February 2010 at 19:08

    I don’t know much about economics, but this post seems to broadly explain well the data that everyone should be familiar with. For whatever reason, the obvious wasn’t obvious.

    I am a liberal who believes in big spending during recessions, at least to alleviate suffering. I was taught that fiscal policy is required to boost AD in intro to macro, but, I really had my doubts about whether the fiscal stimulus worked much. I didn’t think it would fail in the beginning. I didn’t have nearly that much sophistication. But, it didn’t make sense to me that things would get that much worse, even with a stimulus only half the size of that desired by many. And anyway, even if fiscal stimulus could be more effective right now, could we trust people to use it who do such a poor job at economic forecasting? It may have helped slow down the nGDP decline, but was the price worth paying?

    I am no fan of Obama and don’t vote for Democrats in general, but there were some changes I was broadly wanting to see and was starting to get excited about. This failure on the stimulus is disasterous for progressive causes.

    Scott, your perspective seems to sum everything up and even wraps it in a nice little bow. I wish I was smart enough to think in these terms before the fact. I only can after the fact if someone lays it out for me. Maybe I should get a degree in economics or something.

    I wonder to myself just what sorts of things Obama could do to spur the Fed to offer more monetary stimulus. I wonder to myself, because there’s no reason to believe Obama will do anything, but actually undermine AD now.

  3. Gravatar of Jon Jon
    2. February 2010 at 20:07

    DeLong is in politician mode.

    Left out of Hennessey’s “analysis” is the reason that President Obama projects bigger deficits this year than he did last year–that the economy is extremely weak, and is much weaker than we expected it to be, and when the economy is weak the deficit goes up as revenues fall and social-insurance spending rises:

    Hennessey’s analysis is about the relative differences in 2011 versus the 2010. Indeed, the crux is not deficits are bigger this year than last, the crux is about 2011 versus 2010. DeLong screws this up pretty badly. Accordingly to DeLong’s argument, Obama’s deficit is justified by short-revenues and long-expense in 2011.

    How’s that for forward expectations of AD?

  4. Gravatar of thruth thruth
    2. February 2010 at 21:15

    Scott: Nice post.

    On this bit: “We are running up trillions of dollars in debt precisely because the elected leaders of our country think we need more AD, and the Fed doesn’t. I understand the need for the Fed to be independent, but how about some honesty at least. If these inflation hawks really believe what they are saying, show some guts and come out and say “We are not doing more monetary stimulus because we feel a need to offset what we regard as excessive fiscal stimulus, and prevent it from raising the expected inflation rate.””

    Perhaps some of the hawks regard some of the Fed’s actions as fiscal? (especially the QE)

    Also would be curious to hear your thoughts on this analysis of the macro situation from the CBO in their most recent economic outlook: http://www.cbo.gov/ftpdocs/108xx/doc10871/Chapter2.shtml#1045445

  5. Gravatar of Kosta Kosta
    2. February 2010 at 22:20

    Great post, thank you!

  6. Gravatar of Tony McGovern Tony McGovern
    2. February 2010 at 23:07

    This is your best post yet. Keep it up.

  7. Gravatar of Bill J Bill J
    2. February 2010 at 23:19

    Haven’t these bums done enough damage.

    Real unemployment is almost 20%. We’ve been following their policies for years, stumbling into one crisis after another, one lost decade after another. Before Keynes and quack monetary science there was never more than a year of contraction before growth and employment stabilized.

    They’ve taken over our money, co-opted and subsidized the entire financial system, systematically dismantled the real industrial economy, so that 45% of corporate profits are now from debt-merchants shuffling paper, insulated from loss and entitled to everyone else’s money. Even when their entire business model fails and brings the economy down around it.

    How do they have any credibility left?

  8. Gravatar of anon/portly anon/portly
    3. February 2010 at 00:40

    “I happen to think monetary stimulus is preferable to fiscal stimulus, and in this case there aren’t any thoughtful economists who disagree with me. Not one.”

    I think Mark Thoma has been expressing a preference for fiscal stimulus, and he is nothing if not thoughtful. This isn’t a full expression of his views, perhaps, but I think it gives the flavor:

    http://economistsview.typepad.com/economistsview/2010/01/should-the-fed-do-more-to-reduce-unemplpoyment.html

  9. Gravatar of scott sumner scott sumner
    3. February 2010 at 05:52

    Mark, I think the point people keep missing is that if they have a numerical target in mind (and they certainly act like they do) then, ipso facto, they are offsetting fiscal stimulus. I’m sure they don’t consciously think “let’s offset everything Obama is doing”—but effectively it comes to the same thing.

    Mike, Thanks, but after the previous post I think you guys are being too nice to me.

    Jon, If I read you correctly, you are saying they didn’t do a very good forecasting job, and I agree.

    Thruth, Perhaps, but if they regard some actions as fiscal, they should favor more non-fiscal types of monetary stimulus so that they don’t have to rely so much on fiscal policy. They could still stop paying interest on reserves, set level targets, and buy trillions more in Treasuries. Believe me, that would wake up the stock market.

    In the table from the CBO, the number that jumps out is 2011, 2.8% nominal and 1.8% real growth. That is a horrible number, worse than 2010. I actual don’t think it will be that bad, as I don’t agree with their Keynesian model of fiscal stimulus. (Which I gather they assume will expire in 2011.

    Thanks Kosta and Tony, but I thought people said my last post was my best. :)

    Bill J. Yes, Things are pretty bad.

    anon/portly, I was being deliberately provocative. Krugman has the reputation of being the biggest fan of fiscal stimulus, and the biggest skeptic of monetary. But even he agrees with me.

    Of course I respect Thoma, but those are both horrible reasons for opposing monetary stimulus.

    1. The vague danger of a much bigger Fed balance sheet is not specified. But much more important, a much more aggressive Fed policy would not necessarily require a bigger Fed balance sheet. It could be achieved by level targeting, and the removal of the IOR program. If that wasn’t enough, they could put an interest penalty on ERs. But the key is level targeting, and that doesn’t require any additional balance sheet expansion.

    2. Regarding Thoma’s point, the whole point of monetary stimulus is to raise long term interest rates, not lower them. Long term interest rates are at their lowest level when money is tightest (US 1930s, Japan 1990s-2000s, US early 2009.)

    Here is the basic problem with Thoma’s post; whether he realizes it or not it is ideologically driven. Against those vague and amorphous arguments I could construct 100 times more convincing and specific arguments against the fiscal stimulus route. It will cause the national debt to grow explosively. It will waste resources on pork barrel projects, etc. So even if I agreed with either point, and they are both flat out wrong, I still wouldn’t find the arguments in the slightest way convincing, because if we are looking at side effects, they are far worse for fiscal stimulus.

    If people want to be taken seriously, they have to stop talking like monetary stimulus is nothing more than balance sheet expansion; that is a side issue, and it isn’t even necessary.

  10. Gravatar of OGT OGT
    3. February 2010 at 06:13

    Prof. Sumner- Speaking of Thoma, he’s got an interesting commentary from Christopher Sims on monetary and fiscal stimulus, which I really like because it supports my priors. In short that increasing inflation expectations is particularly hard for a central bank coming out of a standing start with no history of inflation (or NGDP) targeting and fiscal policy may well be inflationary if people are convinced of the fed is willing to be accomodative:

    WHAT WOULD GOOD POLICY BE?

    It would recognize the need to affect expectations of future inflation. In particular, in models with nominal rigidities the objective of policy is to lift expected values of future inflation. It would recognize that monetary and fiscal policies that affect future inflation are intertwined. In an environment where fiscal pressures are perceived to have potential effects on inflation, the implications of a given monetary policy expressed in terms of interest rates depend on assumptions about fiscal policy. In this kind of crisis situation, therefore, inflation reports or other policy announcements should be joint, with mutually consistent statements being made by fiscal and monetary authorities.

    Fiscal policy is important also because it can, if described properly, remedy the problem that announcements of commitments to future monetary policy actions may not be credible if there is no corresponding current policy action. Major fiscal policy interventions, accompanied by a discussion of their implications for inflation and for future monetary policy, might have a better chance at being believed.

    http://economistsview.typepad.com/economistsview/2010/02/chris-sims-on-policy-at-the-zero-lower-bound.html#more

  11. Gravatar of StatsGuy StatsGuy
    3. February 2010 at 06:44

    ssumner:

    “2. If we need more AD, is monetary expansion preferable to massive budget deficits?”

    Let’s go one further – the right question is, what is the appropriate mix of monetary policy, fiscal policy, and what you call “credit policy” (but what many would call financial sector regulation). We always have choices between this OR that, but one of the critical lessons of economics is that the action is at the margins.

    Having said all of that, both DeLong and Hennessey are ignoring a major issue – all of the real “increase” (and, indeed, the real increase over the past 50 years) has been in transfers, not non-military discretionary.
    Looking forward, a considerable portion will be debt service costs as well.

    ssumner:

    “It will waste resources on pork barrel projects, etc.”

    The data on “pork” spending is very inconclusive. Certainly, from 1990 through 2006, # and $ of earmark spending projects increase dramatically.

    http://www.eriposte.com/economy/tax/tax_statistics/earmarks_112403_WP.gif

    But the recent data is not conclusive – levels are lower than in 2007, and that’s counting the huge stimulus bill (which was pretty much all discretionary/special projects). Take out this, and we’re much lower.

    http://www.heritage.org/Research/Features/BudgetChartbook/FY2009-High-Number-of-Earmarks-Despite-Change-in-Congressional-Leadership.aspx

    Note the other Heritage charts (notably, what they call mandatory spending). It’s not the discretionary that’s the problem, it’s the mandatory.

    However, “pork” spending certainly existed before 1990… simply wasn’t captured under “earmarks”. Arguably, more discretionary spending pre-1990 was allocated by the bureaucracy (but MORE of it existed relative to GDP). Is that preferable? (saying “I’d prefer less overall” is cheating) Note that earmarks really started to take off in 96-98 (peaking in 2006), which suggests that they were used as a response by a Republican Congress to seize direct control over the purse strings in order to more rigidly constrain allocations by the opposing Clinton Presidency, but then were kept when Bush II claimed the presidency. One could make an argument that shifting more of the (shrinking) discretionary budget into earmark spending is what the US Constitution intended…

  12. Gravatar of JimP JimP
    3. February 2010 at 07:45

    It just could not be more clear. We are getting what Bernanke wants – another Japan. Some day someone will have to ask him why he wants this. He does give speeches and permits questions. Someone should read his own Japan speech back to him and then ask him why he is not doing that now.

    And Summers should ask him at their weekly meetings. Why exactly are you doing this? And my bet is that both he and Summers have already agreed – to do otherwise would be to collapse the dollar.

  13. Gravatar of DanC DanC
    3. February 2010 at 11:24

    Ok, in my heart I am a supply side person. I think we are moving toward an economy that is too regulated and too taxed. How can an economy really grow in such headwinds.

    I never understood the attacks on supply side economics with the claim that the supply side argument is about cutting taxes to increase tax revenues. I thought the argument was more complex.

    The economy tends toward full employment. High taxes and excessive regulation moves potential AS to the left. Unless you have an oddly shaped AD curve

    Cutting taxes and restraining government allows for the private sector to grow. As the private sector grows the need for public sector declines. You see an increase in government revenues as the economy grows but you also see a decline in the need for expenditures on the government safety net. The two working together help grow the economy.

    Of course if your goal is to grow the role of government because, like Obama, you think that free markets will never give you the equitable outcome you desire (for political or other reasons).

    So is the current administration really interested in growth or the creation of a society, in their eyes, that is more equitable?

    I would like to see fiscal stimulus in the form cuts in the payroll tax and a move away from an increasingly regulated economy.

    Politically that may be dead for now.

    So could Professor Sumner offer an alternative? Is the risk of inflation from flooding the markets with paper a viable alternative?

    If I feed more money into the economy what happens if the markets just view it as an inflationary bump, no real increase in productivity or growth, and just adjust prices upwards.

    Perhaps you might see some adjustments in the economy due to confused signals, the expectations Phillips Curve stuff. But is that enough to get the country to change direction.

    I assume that your argument could have a negative affect on real wages. Enough to return the economy to full employment.

    So why should I prefer your path to a cut in payroll taxes?

    You blog much faster then I can keep up with. Relax three days a week dude.

  14. Gravatar of DaveW DaveW
    3. February 2010 at 11:28

    DeLong has also argued that having the Fed announce an explicit inflation target, and raising it from about 2% to about 3%, would also help to reduce unemployment. The claim that he only supports stimulus is just wrong – I suspect if pressed he’d regard it as a second-best to action by the Fed.

  15. Gravatar of Matthew Yglesias » Is The Fed Stifling Recovery? Matthew Yglesias » Is The Fed Stifling Recovery?
    3. February 2010 at 13:00

    [...] policy, but that’s by way of saying that if you click on this link I’m about to offer to a post about Scott Sumner you’ll see that it initially is on a totally different point. But I wanted to pull this idea [...]

  16. Gravatar of econoblog.info » Secondary Sources: Stimulus Debate, Volcker Rule Loopholes, Bloggers econoblog.info » Secondary Sources: Stimulus Debate, Volcker Rule Loopholes, Bloggers
    3. February 2010 at 13:11

    [...] Stimulus Debate: Scott Sumner says the debate over stimulus is too focused on fiscal, not monetary, stimulus. “I happen to favor more stimulus, although I understand that some thoughtful economists disagree with me. I happen to think monetary stimulus is preferable to fiscal stimulus, and in this case there aren’t any thoughtful economists who disagree with me. Not one. If there was going to be one, it would be Paul Krugman. But even he admitted late last year that monetary stimulus is the first choice, and you only move on to fiscal stimulus is the Fed won’t play ball. So here is the debate: Do we need more monetary stimulus, or should we let the economy recover naturally. But DeLong wants to say the debate is between fiscal stimulus and stagnation. How can he do that? Buy simply assuming away monetary stimulus. Presumably he would say that Obama doesn’t control monetary policy, so he can hardly be blamed for relying on fiscal stimulus. Has Obama made a single public statement calling on the Fed to promote higher NGDP growth, or higher inflation, or higher whatever? And then there is the little problem that Obama just re-appointed Ben Bernanke last month. Bernanke’s now his guy at the Fed.” [...]

  17. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. February 2010 at 15:22

    First, I note that DeLong’s personal nastiness is now so accepted that almost no one bothers to comment on it.

    Second, Hennessey is pointing out something more than just what the short run projections are. Even in the out years when we should be in a full blown economic expansion, spending and deficits are going to be much higher than historical norms. Which he makes clear in this post:

    http://keithhennessey.com/2010/02/02/decade-of-profligacy/

    in which he removes the first three years of the Obama administration for comparison with George W. Bush’s.

    As for the stimulative effects of deficit spending, Thomas Cooley has a nice post:

    http://www.forbes.com/2010/02/02/jobless-recovery-unemployment-economy-opinions-columnists-thomas-f-cooley-peter-rupert.html?boxes=opinionschannellighttop

    ‘Fixed investment, which is about 12% of GDP, shows a very modest sign of recovery and still stands nearly 22% below its peak level nine quarters ago.’

    Which seems to me consistent with the argument that markets see Obama’s stimulus package as more akin to a permanent expansion of the federal govt., hence introducing more uncertainty into investment decisions.

  18. Gravatar of Larry Larry
    3. February 2010 at 19:03

    Scott:

    Interesting point that the Japanese are perhaps rethinking. I’d love to see you participate in that debate. Sometimes you have to do tryouts in Cleveland before you get to Broadway…

  19. Gravatar of ssumner ssumner
    3. February 2010 at 19:42

    OGT, Thanks, I just did a post on it. He also presents evidence for the US that fiscal deficits are not at all correlated with inflation, so I doubt whether big deficits would actually raise inflation expectations.

    Statstguy, You may be right about pork, but the bottom line is that we are only doing this $800 b. stimulus because of the recession. If we had 5% unemployment everyone would regard these deficits as sheer madness. They still are at 10% unemployment.

    DaveW, I Know he has supported monetary stimulus. I was addressing this particular post by DeLong. Here he is saying the more severe recession is a reason to run bigger deficits. I say it isn’t. It’s a reason for monetary stimulus.

    Patrick, That is a very good point about the out years. I was thinking along the same lines, but forgot to mention it.

    Thanks Larry.

    JimP, I’d really like to know what went on at the meetings. But remember that very few economists who are free to speak their minds (say in academia) think Bernanke is being too tight. So the problem goes far beyond him.

    DanC, I am also a supply side economist. I also favor cuts in MTRs. But we can’t afford a payroll tax cut right now. I simply want a stable monetary policy, 5% NGDP growth. That is a very supply-side policy. I oppose attempts to create a boom with expansionary policy, and I oppose attenpts to create a recession with contractionary policies. I want consistent, predictable policies so that people can plan better. Right now they cannot, because the Fed is wildly inconsistent.

  20. Gravatar of clay barham clay barham
    4. February 2010 at 08:17

    Entrepreneurs create new jobs. They think out of the bubble and live out of the box, as cited in Bubbles, Boxes and Individual Freedom on Amazon and claysamerica.com. Ayn Rand’s book Fountainhead centered on Roark’s jury summation, which represents her ideals of an entrepreneur, where individual freedom, elbowroom and individual interests are superior to the interests of community, as sought by the leftists like Rousseau, Marx and Obama. See also Save Pebble Droppers & Prosperity on Amazon and claysamerica.com.

  21. Gravatar of The monetary constraint – Economics - The monetary constraint - Economics -
    4. February 2010 at 09:24

    [...] SUMNER writes:In February I said fiscal stimulus wouldn’t work, as the Fed had some sort of nominal aggregate [...]

  22. Gravatar of Bill J Bill J
    4. February 2010 at 17:55

    Let’s think about what the FED IS and what it can DO.

    The FED is a bank, structurally, and acts as a cartel for the banking system, to manage liquidity, interest rates, and provide a regulatory framework to its members. It doesn’t have the power to either tax or spend money. It has a balance sheet and a P/L statement. It values its independence from Washington, but is far from free from political allegiances. It has a constituency and it represents specific interests, namely the new york banking elite. Even if Washington is beholden to the same interests as the FED, that could change some day and the FED realizes this. It does NOT want to go hat in hand to Washington for a bailout, like the FDIC will, or the GSEs had to; these agencies are far less ‘captured’ or beholden to those they are meant to regulate. The FED is far more insulated than the FDIC or other agencies from a regulatory shake-up or power shift in DC.

    With that said, it is clear the FED can only do a number of things to influence economic outcomes. There is no lever in Ben Bernanke’s office called “NGDP” “GDP” or “CPI” or for that matter anything else. These statistical constructions are not real things, not to mention their flaws in capturing anything relevant to the well-being and interests of America.

    The FED, as a bank, can acquire financial assets, basically debt instruments, to inject money into the banking system or financial markets. This is mainly going to be treasury securities, unless the FED wants to play with fire and risk it’s credibility and solvency. If the FED acquires large volumes of mortgage debt, corporate debt, or other debt subject to possible default, or price swings, it is asking for trouble, losses to its balance sheet, the creation of major price distortions in markets, and the loss of it’s ability to withdraw the dollars it injects.

    It also has no power to force the banking system further into risk and imprudent lending, nor would it want to push the banks deeper into insolvency and embarrasment, the way Washington continues to do with FHA and GSE lending. It cannot create demand for lending, not without doing something to cancel the massive burden of debt already weighing on the private sector, households, etc. This debt can only be eliminated through default, repayment, or fiscal polcy bailouts. The first two damage the economy, the latter is outside of the FED’s powers and counter to the interests it represents.

    Since the FED can’t force the banks to lend, it has no way of causing the base money it creates to circulate. To commit itself to ’5% NGDP growth annually,’ it would have to give up it’s power of discretion in the decisions it makes in order to hit the mandatory or expected target. If such a target requires the tripling or quadrupling of money supply and massive distortion in the prices of assets it acquires, it may hit the target, but it may also find itself unable to avoid huge losses on it’s purchases when attempting to reverse them. As a long term policy, this is not possible. The FED must operate as a sound, solvent bank, and do it’s best to keep the cartel profitable and sound.

    The FED will not likely risk it’s power and independence by getting itself into a jam. The FED has ignored its mandate for decades, allowing tremendous price instability. I don’t think it really cares too much about it’s other mandate, as long as it successfully represents the interests of its banking constituency, which has the power in the long run to determine the fate of the FED. The banks created the FED, the banks can get rid of it if they wanted to. It’s silly to speak about the FED in terms the public interest or it’s stated mandates, when this is clearly window dressing.

    That’s all for now.

    Bill J

  23. Gravatar of JTapp JTapp
    5. February 2010 at 18:35

    Dr. Sumner, I agree with the commenters above that this was a great succinct post summarizing your position clearly.

  24. Gravatar of ssumner ssumner
    6. February 2010 at 06:56

    Clay, Thanks. I haven’t read The Fountainhead, but I did see the movie.

    Billj, I am afraid I disagree. The Fed is nothing like a bank. It is a printing press. A banker that did that woukld be arrested for counterfeiting.

    Asset prices will be much more stable if it targets NGDP, than if it targets asset prices. It targeted asset prices in 1929, that didn’t work out too well.

    Thanks JTapp.

  25. Gravatar of Doc Merlin Doc Merlin
    7. February 2010 at 05:28

    @Sumner, the fed in a lot of ways acts like a hedge fund.

  26. Gravatar of ssumner ssumner
    7. February 2010 at 12:07

    Doc Merlin, That’s not what they should be doing, but they are taking greater risks.

  27. Gravatar of Bill J Bill J
    11. February 2010 at 08:54

    ssumner,

    “the fed is a printing press.”

    total nonsense. the treasury may well be a printing press in the post bretton woods system, relying on the fed — in the long run — to monetize it’s expenditures. but the fed is not in any way a printing press. it cannot print money and do with it what it pleases. the fed exists at the pleasure of the major banks and the congress, and from time to time, the public via the congress. it does not have sovereign rights to issue currency and appropriate it. it is a hybrid institution that has developed out of the confluence of pressures from the banking community and the political establishment over a century, the institutional peculiarities of which are continually being determined anew as political and financial trends unfold over generations.

    like i said in my previous post, the fed acts, operates and identifies as a part of the banking world, doing a balancing act between representing wall street and the major banks on the one hand, and maintaining it’s credibility with and independence from washington and the public on the other hand. it exists and serves at the pleasure of both, and only maintains its halo and teflon status so long as it pleases and keeps its proper distance from both. it cannot and does not act as you theorize. you’re analyzing it from a purely economic perspective rather than the political, social, and historical reality in which it exists and evolves.

  28. Gravatar of Bill J Bill J
    11. February 2010 at 09:06

    how long do you think the fed would continue it’s role in our system if it acted against the interests of wall street or washington? it clearly doesn’t fulfill it’s mandates or show any competence managing the money supply; were it to act against the interests of it’s constituency in banking and washington, it would be toast. they’d turn on it faster than you can say nancy pelosi, and throw it to the wolves. we’d all be welcoming chairman dimon of the fourth national bank of the united states. whether your theories are right or wrong, they must operate within the confines of reality.

  29. Gravatar of ssumner ssumner
    12. February 2010 at 06:48

    bill, You said;

    “how long do you think the fed would continue it’s role in our system if it acted against the interests of wall street or washington?”

    I still don’t think it is a bank, it is aprinting press. It is currently acting against the interests of Obama, and he just reappointed Bernanke. So I’d say it can last a long time going against the interests of the goverment and banks. Were banks helped by the Fed’s tight money policy of late 2008? Obviously not.

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