First, Tim Duy via Calculated Risk:
The point of having an indepndent Fed is so that it is not influenced by day-to-day political pressures. Because politicians are always worried about the next election, they naturally will put a lot more weight on the short-run than the long-run. Think of stimulative fiscal policy like a button. Should the economy turn south, the temptation will be to keep smashing that button, like a sugar-crazed 8-year old playing Nintendo. (One of my mentors, Prof. J.P. Bonardi uses the metaphor of a crank instead of a button. His in-class demonstrations of this concept are complete with sound-effects!) But this short-term gain often has a great deal of long-term pain.
Because the Fed doesn't have to worry about these political pressures, they can afford to play the long-game. I would argue this, in fact, should be their job, since the government is going to naturally be playing the short-game. Sometimes the two will coincide, a bank panic has both short- and long-term consequences. I don't see that being the case here. The best thing the Fed can do for the long-run is to ensure a stable money supply and to keep rates of inflation low and consistent. The wild swings in interest rates we have seen over the last few years are working counter to that.
Why is the Fed having these problems? I believe it is because they lack a clear, single-issue mandate. Are they supposed to be keeping inflation in check? Keeping the economy out of recession? If there is a conflict between the two, how should they resolve it?
A choice has to be made in the short run. Focus on inflation, and hold policy relatively tight? Or focus on growth, hoping that soft economic growth will tame inflationary pressures? The Fed continues to choose the latter path...Second, Allan Meltzer on the Fed:
The die is cast. Look for another 50bp in March and then two more 25bp cuts at subsequent meetings to bring the Fed Funds rate to 2%.
An independent central bank is supposed to maintain the value of the currency and prevent inflation. In the 1970s and again now, Federal Reserve officials repeatedly promised themselves and each other that they would lower inflation. But as soon as the unemployment rate ticked up a bit, the promises were forgotten...Meltzer touches on an issue that has been bothering me for some time.
But the rush to bring real short-term interest rates to negative values is an unseemly and dangerous response to pressures from Wall Street, Congress and the administration. The Federal Reserve became "independent" in 1913 so that it could resist pressures of that kind. And in the postwar years, although it often failed to do so, it was expected to safeguard the purchasing power of our money and maintain economic growth. (h/t: Greg Mankiw).
The point of having an indepndent Fed is so that it is not influenced by day-to-day political pressures. Because politicians are always worried about the next election, they naturally will put a lot more weight on the short-run than the long-run. Think of stimulative fiscal policy like a button. Should the economy turn south, the temptation will be to keep smashing that button, like a sugar-crazed 8-year old playing Nintendo. (One of my mentors, Prof. J.P. Bonardi uses the metaphor of a crank instead of a button. His in-class demonstrations of this concept are complete with sound-effects!) But this short-term gain often has a great deal of long-term pain.
Because the Fed doesn't have to worry about these political pressures, they can afford to play the long-game. I would argue this, in fact, should be their job, since the government is going to naturally be playing the short-game. Sometimes the two will coincide, a bank panic has both short- and long-term consequences. I don't see that being the case here. The best thing the Fed can do for the long-run is to ensure a stable money supply and to keep rates of inflation low and consistent. The wild swings in interest rates we have seen over the last few years are working counter to that.
Why is the Fed having these problems? I believe it is because they lack a clear, single-issue mandate. Are they supposed to be keeping inflation in check? Keeping the economy out of recession? If there is a conflict between the two, how should they resolve it?
Comments
The yield on the 5-year inflation indexed treasury is at 0.13%. It should go negative any day now.
But then this is always the question isn’t it? Maintain Growth vs. Maintain low inflation. What else should an economist expect when they put so much pressure on the Fed. We are constantly taught that fiscal policy is pretty useless compared to monetary policy in terms of needed stimulus. Then when the Fed tries to act, we question whether or not they should have at all. Now I do think the Fed has been very erratic and its message and predictions have been plain wrong to date – so that now they are playing catch-up to reality, but I do think it’s a bit simplistic to say they are playing politics or bending to political pressure.
Bernanke is simply applying the solution that economics teaches us to apply in times of demand-led downturn. Now, the argument Meltzer et al. might make is that this is more of a supply led downturn and that Federal stimulus will just create more “bad” inflation. That’s fair enough, but I would argue that Bernanke is betting the demand-side malaise is the more pressing issue, and that the fundamentals are there in terms of supply such that, maybe a stimulus is what is needed to boost consumer AND producer confidence.
What I fear though is that, from what I’ve seen, entrepreneurs have little faith in the Fed this go around. That is very worrisome to the point that it may make Meltzer’s predictions come true.
Regarding the yield on the TIPS mentioned in the first comment,that is inconsequential. What matters is the brekeven inflation rate and that level has begun to creep wider. The breakeven rate on 10year TIPS has moved from the mid 220s to nearly 250 of late.
JJJ
Short answer: this isn’t just a recession, it’s an economic slowdown exacerbated by heightened risk premiums during a supply crunch, and all issues need to be addressed.
Long answer:
Events over the past year point to a decrease in confidence among decision-makers in the financial sector in their ability to assess risk and therefore to adequately price risk. The signals are quite clear that the default risk premium has increased across the board. Mortgage rates barely budged following the consecutive 125 bp drops by the Fed earlier this year. This tells me that monetary policy alone will be ineffective for the unique reason that financial lenders require something else before responding.
Lest we forget, the Fed has on several occasions publicly tried to work with the financial community to improve their confidence or at least present some additional form of security. There were efforts made to provide a secondary entity to create a more stable market for SIVs. But it seems as though lenders are demanding to hold on to their cash.
This scenario seems to offer more explanation than that the Fed is caving to political pressures in an election year. Indeed, which party’s candidates are hurt by a shaky economy at this point? The president’s approval rating teeters near that of the democratically-controlled Congress, and all three major candidates left come from that Congress.
I wonder how far we will have to drop rates before lenders relax and start lending again. I’d rather the Fed explore other paths because this interest-rate game can have dire consequences.
As far as the Fed’s priorities, they are having difficulty here because this economic malaise is an Anna Karenina Effect: it exists for its own reasons.
Inflation is a concern not because of overheating in the U.S. economy but because of supply crunches for food and oil (drought in Australia, refinery problems in the Gulf, turbulence from Venezuela and OPEC) and increased demand for food, oil and commodities brought on by economic expansion in China and India. The inflation is thus being exported as we continue to compete on the global market for key economic resources, a situation that is exacerbated by the depreciating dollar.
The best solution may require two planks:
1) Market intervention in the form of an institution that guarantees new loans to encourage lenders to continue lending.
2) INCREASING interest rates to stave off the depreciating dollar and help reduce the impact of the rise in prices among imported goods, specifically food, oil, and commodities.
The downsides of such a plan are plain: decreased revenue in the exports sectors, higher servicing costs on variable-rate loans, and the need to find a source of funds for the loan guarantee institution. This last point might be met by requiring a small insurance fee on loans to be paid between lender and borrower, but this isn’t the only funding option.
5-year TIPS yield is at negative 0.03%. I can’t call that inconsequential, though it is most likely an effect rather than a cause.
First the dot com bubble, then the housing bubble, can we call this a treasury bond bubble?
I really believe that we must preserve the economic miracle that has given our citizens one of the highest living standards in the world. This economic miracle has not been due to the efforts of Wall Street MBA’s, Stock Market Gamblers, Real Estate Speculators, Economists, Insurance Salesmen, Junk Bond Salesmen, Lawyers, etc. It has been due to the Industrial Base that produced the items that we consumed, plus produced an excess that we sold to other countries in order to accumulate gold reserves through a positive balance of trade surplus payments. The gold reserves are the basis of the value or buying power of our currency.
Who has decided that we can continue our economic miracle by becoming a service oriented society cooking hamburgers for each other using imported beef, vegetables, etc.; suing each other, and selling insurance & junk bonds to each other, but definitely not manufacturing or creating anything that we can sell as export goods, or that we can consume instead of importing the products that we consume and then paying for them by borrowing more money (issuing and selling bonds). This stupidity will eventually change this country into a third world country when foreign countries discover that we will not repay (redeem the bonds) the money that they are lending us. They will continue buy the real estate, industries, and financial institutions with the low value bonds that we sold to them (to pay for the things that we wanted by way of imports rather than working to manufacture). The US citizens will then be third world employees or slaves to the foreign countries that will own everything in the USA. (Future nationalization of foreign owned assets is another discussion topic.)
There is nothing more saddening or devastating than mass unemployment such as exists in countries such as Mexico or India. Crime, family abandonment, divorce, and other bad things increase during these periods. Our basic industries (Steel, Computer chip Manufacturing, Petrochemical Refining, Appliance Manufacturing, Tire Manufacturing, Textiles, etc.) have been decimated and/or totally eliminated from this country by OSHA and the EPA. The North American Free Trade Agreement has almost eliminated the remainder of the basic industry manufacturing jobs from the USA. The OSHA and the EPA are the major causes of the de-industrialization of the USA. The USA must re-industrialize. Even if OSHA and the EPA were eliminated today, it would take years to re-create the manufacturing and industrial production bases that they destroyed. New jobs created by the EPA are nice, but they are about as economically useful to our balance of payments and our industrial base as raking leaves, since they do not produce anything economically useful that we can consume. Disband OSHA and the EPA in total and fire all of those government employees. Be decisive, not timid or partial.
Our Productive Industrial Base could not exist with foreign invasion, rampant crime, protection rackets, corruption, foreign invasion, sabotage, etc., so a portion of the money earned by this industrial base has usually been taken by taxation to pay the federal government and local governments to prevent these occurrences. Civilizations have always taxed the population base to pay for National Security, Crime Prevention, and other items that assist and protect their industrial production base.
Our U S Government is now spending these taxes and our gold reserves on entitlement schemes in order to buy votes from non-productive citizens that do not contribute to, help, or support our industrial base. There is a limit to how many non-productive people that the productive people within our industrial economic productive base can support by producing enough wealth (gold) to support these non-productive people. When our gold reserves became diminished, we then continued to expand these entitlements by borrowing money from foreign banks and foreign governments by pledging the “Full Faith & Credit of the United States of America” (aka Junk Bonds) in lieu of bond re-payment in gold. We also decided that we could allow OSHA and the EPA to close down the industrial bases that originally created these gold reserves that were the basis of the value of our currency. The federal gold reserve that was created by our positive balance of trade has allowed the USA to expend this gold to provide social experiments, foreign aid, wars, and other functions that would not be possible without the gold reserves created by our industrial bases. The Federal monetary system, the foreign trade deficit (or surplus), and the national debt are interrelated in this way and control our standard of living. You must educate your students and the public to this fact. If we continue to import more and more of the things that we consume, and continue to pay for these items by borrowing money (aka Selling U S Government issued Bonds) since our gold reserves are essentially gone, we could very soon end up being a third world country like Mexico, Somalia or Ethiopia with no jobs for our population. We cannot continue to ignore out balance of trade deficit. We need to be willing to do anything that will replenish our gold reserves. This can be done by exporting more dollar value of goods and services than we import, and then getting the gold from the other countries that buy our goods & services. We must improve our balance of trade situation so that we are importing gold (including cash, bonds & other securities) instead of exporting gold from our gold reserves to redeem our dollars. We must again begin to manufacture and/or create the things that we consume, and/or produce goods that we can export to pay for the things that we import, plus government expenses. We can enjoy free trade if we produce enough value of products that we sell to the foreign nations that will pay us enough for those products that we export to them.
We are borrowing money (aka Selling Junk Bonds) from foreign countries that will soon realize that we have destroyed our industrial base and are borrowing money to purchase the things that we are consuming. The citizens of the exporting countries realize that their U. S. issued bonds are becoming of less and less value every day, but that they can purchase USA real estate, financial organizations, office buildings, apartments, and our remaining industries in the U.S. using their U. S. issued bonds as payment, and this prevents the devaluation of the purchasing power of their U.S. issued bonds that they obtained in exchange for the items that they exported to the U.S. for our consumption and maintaining our quality of life.
If we do not balance the federal budget we will continue to borrow money from foreign banks and nations (aka Selling Junk Bonds) to pay for our social entitlements and social experiments, wars, and our balance of trade, what are we going to do when foreign banks and other nations refuse to lend us more money? (we will offer higher interest payments) Will we just crank up the printing presses like Mexico? It is not fair for us to live high on the hog with borrowed money that our children and grandchildren will have to pay back to foreign banks and foreign governments. The federal debt of 9.25 Trillion dollars divided by 250 million citizens equals about $37,000 per person, or ten times that for each productive (non-taxpayer funded) worker. We must reduce our federal government expenditures.
Our Student loan program gives student loans to students that want to become MBA’s, lawyers, artists, poets, historians, political scientists, plus all sorts of other degrees that generally do not contribute very anything to our Industrial base. Student loans should be available for only those fields such as science, engineering, and medicine that do contribute to our industrial base and our international trade balance. Student loans should not be available for prospective MBAs, historians, English majors, accountants, lawyers, artists, poets, theologians, actors, or any other activities that do not contribute to our industrial base. Let the people that enjoy art, poetry, gambling, playing stocks, and etc. pay for those activities. I believe that there is very little economic future in engineering. I believe that most students want to study business and/or economics to become the Enron type Master Criminals, or like some of the other extremely wealthy master criminals of today. If you review almost any of the SEC filings you will find almost all of the sworn information is extremely false, especially when you get away from the “Blue Chip” stocks. No person in their right mind would major in science or engineering since the pay scale has eroded so much (due to the import of foreign engineers who will work for just slightly above minimum wages and a Green Card). The Foreign Engineers might only be 20% as productive as US educated engineers, but they are willing to work for only 10% or 15% of the pay that US educated engineers are paid, or used to be paid, then it is twice as economically effective to employ foreign educated engineers when compared to U.S. educated engineers, except for the liability of the additional design failures.
a. What are the REQUIRED functions of a U S Federal Government?
Military – To protect us from foreign invasion and allow our industrial activities to provide products to export to create a positive effect on our balance of trade.
Coast Guard – To collect import tariffs, Patrol Coastlines, intercept and deport illegal aliens.
Courts & FBI – To investigate crimes and to enforce domestic laws that keep an organized economy operating with minimal disturbances due to criminal activities.
Treasury – To coin money, regulate Banking, etc.
Postal Service – To process mail – This is a terrible situation – Not as efficient as FEX, UPS, and other non-government mail services. Make it non-union and non-civil service so that postal employees will have to work to keep their jobs.
Immigration & Naturalization Service – Keep illegal immigrants out of this country and deport illegal immigrants. Reduce this agency in size by making it illegal for citizens to hire non-citizens.
DOE – We need nuclear bombs, nuclear energy, and nuclear R&D. The next time we want to make war, use Nuclear Bombs and not troops.
The tidal wave of immigration and high birth-rate propagation of immigrants will eventually allow the immigrants to rule this country. When the Latin Americans (or Africans) take over this country, do you believe that it will be different from any other country run by Latin Americans (or Africans)? Civil and Human Rights go out the window when this happens (Washington DC, Detroit, Atlanta, Chicago, etc.). Stop all immigration into this country, except those with technical educations that will contribute to the re-industrialization of the USA economy.
We need vigorous enforcement and prosecution of the people who benefited from the S&L looting. This includes getting the Keating 5 Representatives into prison. This includes asking how Bill & Hillary paid for their shares of the Whitewater land speculation. Even if you cannot get these people into prison, apply pressure to totally disgrace these people. We need to be more concerned about these white collar crimes.
b. There are some Federal Government functions that benefit the entire nation and can more easily be accomplished on a national level:
Agriculture – But eliminate the capability of this agency to distribute cash tax funds to farmers and agro-businesses. Distribute only advice and opinions to farmers. Conduct scientific agricultural research for the benefit of farmers.
FDA – To certify the quality and safety of food & drugs – This is indeed a national problem.
Health – To advise and protect us from national medical problems and concerns. Expenditures should be limited to R&D only for the benefit of the total population. The medical expenditures in 1950 was less than 1/2 of 1% of the GNP. Today it is 16% and rising rapidly. Maybe we should have National free health, since only the middle class pays for their health care. Medicare, Medicaid, Welfare, recipients plus Illegal Immigrants get their healthcare paid for by the taxpayers anyway.
Interstate Highway – make it self supporting with fuel taxes. Trucks damage the pavement with their heavier axle weights very much more than automobiles, and should pay the most taxes, taxes should be based exponentially upon axle weight limits so that those who damage the paving the most will pay their proportional share. Talk to the Texas Highway Department engineers in addition to the DOT.
Federal Aviation System – This system benefits the air transportation system, including private pilots (like myself). The entire cost of this system should be paid for by the air transportation system, the air passengers, and not the taxpayers. Aviation fuel taxes might be the proper way to finance the total cost of the FAA.
Inter Coastal Canal System – The nation’s waterways benefits the barge transportation system. The entire cost of this system should be paid for by the barge transportation system that benefits from this system, and not the taxpayers. Maritime diesel fuel taxes used by the barge system might be the proper way to finance the Inter Coastal Canal System.
NASA – This is a national ego thing – we could do without this, some R&D benefits are realized. It is not a large expenditure compared to welfare and other entitlements, but this is not a necessary expenditure. This Expenditure does give the USA some prestige & propaganda to the world that is of some benefit.
National Parks Service – Maintain our Parks for the use of all, but increase park use fees in order to make the park users (campers) pay for all of the National Parks Service operation & maintenance cost.
Education – The local education systems have served this country well. Eliminate all of the federal education expenditures. The problems are with the local teachers that do not know the subjects that they teach. Eliminate education courses and education degrees from colleges, make the teachers learn the subjects that they want to teach. The students need to learn science to benefit the nation. Pay science teachers (that have science degrees) more than other teachers. In Texas, the state is trying to make the students study creationism. We need a constitutional amendment to prohibit the teaching or the consideration of any religious, superstition, supernatural or similar based and/or influenced theory as a legitimate science.
Banking Regulation – Have a National record of Loans made by financial institutions so that loan documentation will not be lost or destroyed by unscrupulous parties (like the Whitewater Scandal where the Clinton’s loan documentation could not be found after the S&L loan files were stored at Hillary’s Law firm). The banks need to be aggressively monitored and audited. Banking white collar criminals should be punished severely. These people are modern-day Willie Suttons. You should create a National registry of Loans made by financial institutions to individuals and other institutions so that loan documentation will not be lost or destroyed by unscrupulous parties such as the whitewater loans. Ken Lay was probably the most successful master criminal of all times, even though he was convicted.
Social Security – Why not limit individual benefits to the amount deposited by that individual?
DOT – Why should everyone pay for metropolitan subway systems that benefit only a few people in a particular city or region.
c. There are some Federal Government functions that should be completely eliminated:
EPA – If not disbanded, re-organize with orders not to hamper re-industrialization of the USA – If the EPA had been created in 1865, the USA would be a third world country today, and/or part of Germany or Japan.
WELFARE – Billions of Tax Dollars for multi-generation welfare recipients should be eliminated. Taking funds from workers to pay lazy people not to work should be a crime. Paying People to watch TV and have multiple babies is not right. Referring to these un-married whores and prostitutes as single parents is an insult to the hard working single parents that do support themselves and their offspring. I am also ready to eliminate the AFDC program. What percentage of the AFDC funds are spent on crack cocaine and other drugs rather than children? What percentage of our prison population benefited from AFDC as children? We should build dormitories with large open bay sleeping quarters for the children under 18 that cannot be supported by their parents. Any parent could check their children into these facilities, and only visit their children on weekends. Minimum lengths of stay according to the school semester system could be mandated along with other rules & regulations. We need to take care of our children, but not give AFDC money to the children’s parents to purchase illegal drugs. AFDC money is the only reason that many drug addict parents want custody of their children.
Unemployment Payments – These payments just postpone relocation of people to where jobs still exist. What are we going to do after the EPA and OSHA have destroyed most or all of our industrial and manufacturing jobs entirely? There will not be any jobs anywhere in the U.S. anyway.
SSI – Free money paid to drunks & drug addicts? Why?
World Bank Support – This is another giveaway of U. S. Taxpayer Money to the leaders of third world governments that their leaders siphon off funds to their personal Swiss Bank Accounts. The USA should not continue to loan money to the World Bank. This will not change in the near future, or probably will never change. Generally, they will never pay the U.S. back in total.
FARM MONEY – Billions of Tax Dollars for farm price supports makes some farmers millionaires. This is welfare for farmers. Eliminate the price control part of this department and limit the expenditures to Agricultural R&D. Fire all of the other employees. Disband the Farmers Home Loan Program, and eliminate all cash payments to farmers.
Social Security – Is it fair for people to pay a total of $20,000 into the system, and then draw out $200,000 retirement plus another $100,000 in Medicare benefits during retirement? Change the social Security benefits to be equal to or proportional to the amount paid into the system by each individual. Illegal Immigrants will no longer enter this country, pay $15,000 into the system for 7 quarters, and then withdraw as much retirement as a person who paid into the system for 50 years. I have heard that many of these Illegal Aliens have several Different Social Security Accounts under different names, and draw several retirement checks under these under different names. Maybe we cannot afford Social Security as it is currently structured. Make maximum individual personal benefits equal the total individual contributions. Raise the retirement age, let the benefits float to control costs to match the funds that might be available. Eliminate Medicare. Medicare is Welfare for the Medical Profession. As an alternate, create a socialized medical system, since only the middle class working people pay for their own family medical care.
HOUSING – Stop spending billions of tax dollars for Housing Projects, Mass Transit, Dams, and other projects that only benefit certain people. Stop promising Park Barrel projects to each and every city in order to get votes. The people that benefit should pay for the cost of the things that only benefit those few people. Why is housing a national problem and not a local problem? Why do federally funded housing projects turn into drug and crime areas? Disband the Department of Housing and fire all of the employees. This has been a scandal of taxpayer funding promoters in return for campaign contributions from the beginning.
EPA – The Environmentalists & Sierra Club want to close all industries that emit any pollution. They want polluting industrial plants must close down and relocate the jobs to foreign countries. The Companies will then fire the USA workers and hire foreign workers in the relocated plants. These industrial plants and jobs have been generally lost forever. The Environmentalists have created conditions so that the continental USA is not even considered as a site for any type of new plant or industry that would create any jobs for USA citizens. Jobs that do not produce the food, shelter and clothing that we consume are useless make-work jobs like raking leaves and/or performing environmental clean-up. If the EPA had been created in 1865, the USA would be a third world country today.
TAXES – Why not have a National Retail Sales Tax instead of an income tax. Those purchasing the most probably make the most income. You could fire most of the IRS personnel. You could exempt grocery store food (and maybe residential rents) to help low income people.
NEA – Disband the National Endowment for the Arts and the National Endowment for the Humanities, and fire all of the employees. Taxpayers should not have to pay for these useless activities. The taxpayers should not have to support and pay for monuments to Lawrence Welk, pornographic photographs, bridges to nowhere, etc. Let those that enjoy pornography & any other types of art funded by this agency pay for it. The public does not need to pay for any art. It is a small expenditure, but it represents disrespect for and is an insult to the Hardworking Citizen Taxpayer when public tax funds are expended for pornographic art, like photographs of crucifixes in bottles of the artist’s urine. I wonder how much the government employees paid for that photograph. The average citizen probably does not approve or like anything that the “Art Experts” have done with public funds. How did this ever get started?
The textile and clothing manufacturing jobs were relatively low paying, low skill, labor intensive jobs. This industry could be easily re-created if we wanted it. If un-employment of the un- Labor costs are the prime factor in the loss of these industries. educated and un-skilled persists, trade barriers might be erected to re-create this type industry. We need high technology jobs that require education. This is one of the few industries that the EPA did not destroy. Foreign labor availability and lower labor costs probably destroyed the textile industries in the USA.
The Civil Rights Attorneys Fee Awards Act has made millionaires of many lawyers, released many murderers and other criminals that subsequently committed additional murders and other violent crimes from prison. This has made crime an attractive career for younger people to emulate. This act has removed the deterrence factor from our criminal law system. Repeal this act. This act has transformed our penal system from a place of punishment to a place of Relaxation, Body Building, Weight Lifting, and watching Cable TV for the convicted prisoners.
NEH – Let those who want to study the humanities do it at their own expense. The citizens cannot afford this expense.
Mental Health – Let those who want to have mental health treatment do it at their own expense. Why enrich the psychiatrists and psychologists? Most of the recent mass murderers have been under the care of psychiatrists and psychologists.
HUD – Building of new high rise slums where crime enforcement is not possible (unless the tenants become armed) has been a huge waste of funds.
Foreign Aid – Why should we pay money to governments that pay U.S. government employees to sell them U.S. national asset type secrets? This is a giveaway of U. S. Taxpayer Money to corrupt governments that siphon off funds to the leaders Swiss Bank Accounts.
Government employees previously were lowly paid in return for a secure future. If you count the retirements and security, government employees are now paid about double the salaries paid in the private sector for the same or similar job.