Ben Bernanke: More Important Than The G20 Summit

It may strike you as extraordinary that the G20 summit barely touched on what is, arguably, the key policy issue going forward – what will central banks do, including the detailed when and how of avoiding falling wages and prices (deflation).  Fiscal stimulus is already almost fully in play around the world, regulatory reform will at best be slow and not relevant to the recovery, and “we promise to avoid an irresponsible protectionist trade war” is nice but more about not making things worse rather than getting our economies going again.  Funding and leadership model change for the IMF can help prevent emerging markets from cratering, but in terms of impact on global growth or unemployment, it’s second order relative to the macro policies of the world’s largest countries.

The real issue is monetary policy, including interest rate cuts where there is still room for these – to me the biggest news of the week was actually that the European Central Bank cut rates by less than expected (its main interest rate stands at 1.25 percent).  This confirms the ECB still does not see deflation as a clear and present danger.  Look at all the downward pressures in the European economy, from East European collapses (and associated West European banking problems) to property market declines in the UK, Ireland and Spain (and what that means for banking) and export industry stress (and they have bankers too).  The ECB is taking an extraordinary and – to my mind – incorrect position.  If they truly wait until deflation is “fully in the data” (central bank jargon), it will be too late.

The dramatic trans-Atlantic, or at least eurozone-dollar, contrast is in terms of monetary policy, not fiscal stimulus or attitudes towards future regulation.  In our piece in the Washinton Post Outlook section on Sunday (already online), we provide an updated back story on how exactly the Fed and its chair got to the point of taking bold and unprecedented moves towards expansionary monetary and credit policy. 

In our view, the Fed’s current “print the money” strategy (and, yes, I know the Fed doesn’t like this term or even “quantitative easing”) is make-or-break for turning the economic corner any time soon.  It’s incredibly risky in terms of potential inflation – more than the Fed would ever concede – but preferable to all the available alternatives.

The power of our big banks presents a profound economic and political problem.  Whatever happens – miraculous recovery or prolonged depression – this needs to be fixed.  But we also can’t wait around for attempts to break up the banks; the prospects for unemployment and poverty are too dire to tolerate delay.  First and foremost, we need to prevent global deflation and begin the difficult process of sustaining a recovery. 

Remember this.  If you run an expansionary fiscal policy (building bridges), I have an incentive to free ride (selling you BMWs) and not engage in a similar fiscal stimulus.  But if you run an expansionary monetary policy, your exchange rate will tend to depreciate, putting pressure on my exporters and I’ll be pushed – by BMW-type producers – towards providing a parallel monetary stimulus.

There is only one person who can talk the ECB out of its current, ruinous policy: Ben Bernanke.

By Simon Johnson

Update (by James): This article has gotten a fair amount of commentary already.

  • Mark Thoma says it depends on whether inflation expectations remain anchored (at 2%, where the Fed wants to peg them).
  • Tim Duy says that we are making the mistake of confusing “credit easing” with “quantitative easing.” Duy points out (correctly) that Bernanke has repeatedly insisted that the Fed will mop up the excess money when necessary in order to dampen inflation; this means that the Fed is trying to keep inflation expectations where they are, despite the influx of money now. This could be Bernanke’s intention, but I think there’s still a question of whether the Fed will be able to follow through when necessary, and the resulting uncertainty could itself feed inflation expectations.

One thing I want to clarify, which Simon says above but is perhaps not clear in the article, is that we do not think that Bernanke is making a mistake. We think that despite the inflation risk, this is still the right strategy, because of the risk that the other tools used to restart the economy may not have sufficient oomph.

52 thoughts on “Ben Bernanke: More Important Than The G20 Summit

  1. With the IMF conjuring up SDR’s to the tune of $250 billion the G20 deliberations could turn out, in the longer run, to be a major step towards a “solution” to the deflation problem that you referred to. Presumably $250 billion is part of a new planetary QE policy where the longer term risks of commodity based inflation are ratcheting up.

    For more on this (and please forgive the plug) see:

  2. This may sound crass, but… who cares about central banking policies when financial markets and institutions are fundamentally disfunctional? Do you really think a few basis points may make a difference?

    The first problem is with the bank, and we’re *way* behind the curve (on both shores of the Atlantic).

  3. So-

    What is it going to be? Inflation from the printing press or deflation in the scenario above. That is whay nobody takes you seriously. You flip like a pancake.

  4. Perhaps the issues is whether one thinks the lack of credit (and the conflicting results (very short term lower but longer short term higher) interest rates from the Fed’s policy, budget deficit, and bank crisis .. .etc.) could be a supply shock significant enough to cause stagflation regardless of the gaping output gap.

    Thanks for all your work and thought about these issues.

  5. The Europeans are right. Inflation is the key concern. There is no sign of deflation in the general price level of goods and services. The exceptions would be certain commodity prices that have soared in the last two years and are now coming down to reasonable levels, the prices on distressed merchandise to adjust inventories of things consumers are not buying (e.g., pontoon boats and cruises) and the price of houses. Everything else is going up or staying flat.

    The one thing Bernanke knows is how to prevent deflation and he is doing this with a vengeance.

    Monetary policy turned inflationary in September and we will see the results on schedule beginning in the second quarter.

  6. I’ve just finished your piece in Atlantic’s May issue. A question has been concerning me regarding the prescriptions, such as yours, about nationalization, write-downs of bank assets, and re-sale when healthy. In these types of scenario, “wipe out the shareholders” is always a consequence. My question and concern is: who are these shareholders and what would be the effect of wiping them out?

    As a Canadian, I’m happy to say that none of my RRSP money is placed in shares of American financial institutions. But it doesn’t take a lot of imagination to envisage what would happen to U.S. citizen neighbours who have squirreled away their retirement nest egg in supposedly stable or safe funds.

    Are you advocating that they be wiped out? I’d be interested in reading something that goes a little further into the, to me, rather simplistic scenario of ‘controlled bankruptcy by nationalization.’

  7. Just a reminder that the United States “Federal” Reserve Bank is not really an organ of the Federal government but a private banking institution not subject to the framework of checks and balances in the Constitution.

    Before we hail Mr. Bernanke (that “soft-spoken but authoritative academic”) as the last great hope for saving the world economy, let’s reflect on the transparency of the Fed’s actions, especially over the last 6-12 months, and examine carefully for whose benefit those actions appear to have been taken. Bernanke may have “redefined the Federal Reserve on the fly and exercised powers that Greenspan never dared touch” but he has done so outside the framework of democratic, constitutional government.

    Of course, one could argue that the official branches of the American government have been complicit in this exercise of extra-constitutional power. And one might be right.

  8. Thanks for directing our attention to this development. I hadn’t seen any mention of it elsewhere.

  9. “This confirms the ECB still does not see deflation as a clear and present danger.”

    People tend to interpret the actions of others with bias. Thus, since the EU hasn’t acted aggressively to ward off inflation, they must not understand the danger. Of course, there are other interpretations.

    1)They see the risk of deflation, but believe it is manageable with actions taken to date.

    2)They see the risk of deflation, but are more averse to the risk of subsequent inflation which will be more difficult to control.

    3)They understand the substantial moral hazard of bailing out irresponsible debtors at the expense of creditors and savers. They understand that rising future inflation expectations, coupled with punishment of those who misplaced their trust in fiat currencies and rewarding those who spent recklessly, could (will) eventually lead to an inflationary climate that is almost possible to contain. Throw in some global commodity shortages and you have a recipe for disaster.

    But, maybe I’m just giving them too much benefit of the doubt.

  10. I agree with LP. With already low interest rates, I think a focus on monetary policy is a mistake.

    Confidence has to be restored. That means the failing banks have to be taken over and broken up. Derivatives have to be completely transparent and regulated, to the extent they are to exist. In addition, people need to be prosecuted and punished for fraud.

    There is no reason the government can’t be, temporarily, in the business of lending – if banks and other institutions aren’t comfortable yet. Corrupt and fraud riddled institutions should not be viewed as viable conduits.

    A true safety net has to be created: people need, and many more will need, shelter and food. The time to address this is NOW.

    Instead of filling the coffers of the uber-rich, refund all individual Federal income tax paid over the last 3 years.

    Debt has to be paid or wiped off the books before we can create a new, stable, floor off which to build again. Asset prices have to come back to the norm (residential housing = 2.7 median income). Then, and only then, do we have an economic future we can be optimisitic about.

  11. Many of you strike me as people lost examining the trees, without any concept of the forest.

    It’s funny how birds, fish, mammals, etc. manage to live simply and comfortably without banks, governments, etc. And people think humans are the advanced species. What a joke.

  12. So, in other words, after all of the hoopla, the ball is in the hands of a Bush appointee? Are you sure that the Obama plan – whatever it actually is – relies that much on monetary measures?

    Measures affecting taxes, the ownership of capital, public works and social programs are likely to have a far greater impact on the economy in general than a marginal change in the federal funds rate, though obviously if you’re in hedge funds, they’re not at all as attractive.
    Being sanguine about the ECB keeping interest rates slightly above zero also seems to me a bit of a waste of energy. At least the rates in Europe can still be lowered. Japan’s experience with zero rates is not very conclusive – in an environment that was far more controlled than that of Europe, not to speak of the US free-for-all.
    The problem, as I see it, is not just the power of the banks but the power of the entire financial system. Lawrence Summers’ sellout to a hedge fund and acting as a bankers’ bimbo reflects his and many of his colleagues’ mindset, which places a higher value on financial wealth than on economic well-being.
    I used to naively think that economists were not very good at making money for themselves, and that, like other scientists, they were searching for the “truth”. Obviously not all of us are sellouts, but before I hazard a guess as to what Mr. Bernanke is going to do, I’d like to know what his priorities are. The Rubins and Summers have done very well for themselves, but in government you’re supposed to do good.

    And I wonder how Summers’ economic expertise may have contributed to the Shaw fund. After all, don’t those funds just give their money to a Madoff of some kind? Do they need the help of a former chief economic adviser for that?

  13. Ties neatly with this:

    Personal profit trumps public interest every time, but I am bothered a lot less by the Eliot Spitzers of this world than by megalomaniac clowns like Lawrence Summers and Robert Rubin.

  14. I agree with the basic point of this post. The key thing, more important than a bank recap, is to change inflationary expectations – i.e. to change expectations from deflationary to inflationary. Only in the context of that change is a bank recap even doable. Otherwise the bank assets just keep decaying – and the recap becomes impossible. Congress would never put up the money, and a bank debt-equity cramdown would be profoundly deflationary and insanely dangerous.

    But Bernanke actually does not agree. He is not trying to change expectations, as Tim Duy unfortunately makes clear:

    If Bernanke wanted to change expectations he would say so – directly – by promising a permanent increase in the money supply – which he is exactly not doing.

    I go back to this blog:

    If the Fed actually wants to change expectations, which I certainly think they should, they are not doing much pf a job.

  15. I recognize that there are complications to nationalization, but I don’t think wiping out the shareholders is one of them. The shareholders have already been wiped out – bank stocks are down about 90% from their peak. The damage has already been done. For certain large banks, the only buying in thelast few months has been betting on a generous bailout from the government.

  16. My personal observation is that the last few basis points of an official interest rate make little or no difference towards any positive solution. The principal problems are transparency and illiquidity, leading to a simple inability or lack of trust to lend in any meaningful quantity. Until banks are regulated effectively, audited appropriately and managed for the long term benefit of shareholders nothing will change.

    In the past, many institutions, both public and private have sought tacit approval from “analysts” and from the press, resulting in a short term boost** to its share price and collective bonuses, often at the expense of jobs, retained experience and sadly long term damage to shareholder value. Until the majority of financial institutions publish accounts/data that we can trust and rely upon, liquidity in the form of reciprocal interbank lending or to the wider wholesale markets cannot improve.

    A logical price we must eventually embrace is to let bad institutions go bust –Until depositors actually lose money or accept that their funds are at risk when chasing the extra % in the form of BCCI, Icelandic banks etc. Currently bad institutions are subsided by blanket support rather than allowing the fresh air of natural selection to take place. As an experienced trader I strongly support the dictum that there is nothing wrong with risk providing it is correctly proceed and well managed. Clearly pricing mortgages at or near cost of funds does not meet this criteria as credit risk is not adequately recognised. Risk is not a four letter word! The sooner we are able to move to a competitive regulated environment where all banks are transparently not equal, the safer and more productive our economies will become. As Margaret Thatcher might perhaps have said, “we accept failure at the expense of not risking success”. This will mean that homeowners and businesses alike must take responsibility for their own credit worthiness and also accept that they must pay a premium over the cost of funds to offset the credit default risk to their lenders.

    Allowing banks to pay tax free interest in the form of shares is a possible consideration together with a two tier deposit guarantee system with a choice between 90% and 75% protection. Banks would pay more premiums for the larger benefit. Alternatively shifting some the regulatory focus from liability/depositor protection, who logically should accept more risk responsibility. Hopefully this will deny liability funding for bad banks on the basis they cannot lose deposits they do not have, moving to a risk based levy upon assets.

    Consideration of intelligent and targeted VAT adjustments along French lines for example; artisan costs for labour and materials based at 5% would potentially provide a quality and quantative stimulus to consumer/non manufacturing based economies such as the UK. The ineffective blanket drop in UK VAT is an inept government equivalent of cutting jobs** to boost a share price, which will ultimately cause more pain when eventually reversed, and once again boosting inflation.

    Perhaps the one solid lesson to be learned based upon experience in the UK from these developments is that a falling property market/lower property prices does not benefit our economy and perhaps it should become policy for all future manifestos that a sustainable increase in property prices protects more interests than it harms.

    The global market economy is very much like a marriage – without trust we have nothing.

  17. Paris,
    The americans MUST face the reality of their situation…as bad as it may be, just face it. They have a huge current account deficit, which is ridiculous for an economy with the potential of theirs to even have. They continue to import massive amounts of junk to consume. No good. Their collective governments (Fed, state, county, local, etc) spend entirely to much money, as a % of GDP. They have deeply corrupt elected officials and high ranking government employees. Their government has been taken over, or at least certainly deeply influenced by the special interest groups and lobbyists. That last one being a HUGE problem. They have worn out infrastructure. They have a good work ethic, but they have very little to do that makes any kind of sense, regarding production, and you cannot base your economy on fiat currency and finance. Nope. Additionally, they have made financial commitments and promises that they will NEVER be able to keep. Social Security, Pensions, Medicare’caid, etc., not to mention the actual public debt, now in the tens of trillions. There’s just no way on earth they can EARN their way out of this mess. This current shit-storm is only the beginning of their problems over there in America. What are they planning on telling all the now-in-fact retiring Baby Boomers when they start to show up for there benefits, en masse? And remember, the rest of the world, who hold US treasuries, have a baby boom generation on their hands to deal with as well. As they have told the US, the plan was, all along, to use those treasuries as investments to cover their obligations/promises to THEIR baby boomers. The US must change – dramatically. Putting a band-aid on something that needs surgery doesn’t ever have a happy ending for the patient. But, it’s not going to happen until they have a complete, and total implosion over there. Continue to kick the can down the road….but they are running out of cans, and the road is a dead end.

  18. I wholeheartedly disagree with Jim P.

    Inflationary expectations may be viewed as a positive event for those in ivory towers. For the average joe on the street – it will bring greater despair.

    Perhaps civil war is what you would consider a success?

    I expect that unless there is a significant turn-around in the attitudes of most US Congressional reps (demonstrating they “get” the rage building on main street), it will take a Red Brigade to bring a solution palatable to the general public. Truthfully, at this point I am looking forward to that day. I, unlike President Obama and his groupies, have no hope left.

  19. But….he said he would give us “change we could believe in”. He’s right, we’re getting “change”, while Wall Street is getting all the dollars.

  20. The other day, I saw a bird that own a house in the suburb. I saw a fish drove around town in a station wagon. I saw many silly things like that! It is amazing how these mammals and etc. can make all these major purchases all in cash! Maybe these mammals stole the money from our mattress when we sleep!

    Perhaps humans should devolve to the good old days! btraven, try lobotomy, it is very quick!

  21. It is nice to have some coherent discussion on nationalization. Some people seem to think it implies making Obama the head of Citigroup and Bank of America.

    The current goal seems to be to keep bondholders from losing any money, shareholders get an option.

  22. Simon Johnson was on NPR’s On Point on March 31 and it surprised me he was so positive on the actions of the Fed. It seems the Fed is crowding it all other investors in the credit market, and I think eventually people will question the solvencey of the Fed or the Treasury when it bails out the Fed. Inflation seems the obvious end result.

  23. You’ve lost sight of the big picture. Many business are still viable. Most people still have jobs. Many banks are health.

    Lower the interest rate will help a lot to all of the above. It is also not a few basis points. Just compare the interest rate on 9/1/08 and what it is now.

  24. The economic/financial crisis, aided and abetted by the oligarchs, has many origins embedded in the economy that really should be treated more like a crime scene characterized by corruption and fraud and embezzlement and political-corporate influence peddling. World Com,Enron, etc lead to jail terms for some of those implicated and this latest round of crime should be of a size to fill the largest jail imaginable.

  25. Describing the Feds moves as “bold” is somewhat misleading. I think desperate is more appropriate. They are doing what they must to keep the present day financial system from collapsing and it will work for awhile, but all they are doing is buying time. The ECB WILL follow; they do not need to be convinced by Bernanke. Eventually, the current monetary system will be replaced by something new and hopefully improved. I believe preparations for this are already in progress.
    The Chinese economy appears to be rebounding. If so, we should soon see the prices of commodities and oil rise causing inflationary pressures to build.
    The Fed manages inflation by talking. I have little faith that they have or will have any options to actually do anything about it if they want to keep the game going. The government cooperates by massaging data to show the lowest inflation numbers but this will become increasingly difficult. Inflation is coming. Protect yourself.

  26. I know I’m repeating myself, but… the risk of inflation is only present because of the failure to control velocity.

    Inflation is not merely the presence of too much money. Inflation is too much money chasing too few goods. In the current economy, money is inseparable from credit, and velocity is inseparable from credit growth. The Fed is kicking up base money, which is exactly the right move since it does not appear to have (or be willing to implement) policies to increase monetary velocity.

    I am all for the creation of new money – a lot of it, particularly when the world is deleveraging. However, doing this creates the _potential_ for inflation when velocity kicks back up. The Fed has stated many times they intend to soak up the extra money when the economy turns (whether they will know when it turns, or have the will and/or instruments to do so without triggering a relapse, is uncertain).

    The long term solution is extremely simple and impossible to execute. In addition to printing money, _permanently_ increase bank capital requirements. This will make the entire system much more stable, and will restore to the federal government a key source of revenue (seignorage) which the Feds appear to have delegated to banks.

    Make no mistakes about the impact of printing money while increasing capital requirements:

    Such a policy would involve a _massive_ transfer of capital from banks and other financial institutions to the federal government.

    Government has essentially given to banks the power to create money (by issuing debt on a sadly small capital base). This is immensely powerful, particularly when you don’t bear the downside risk. It also tremendously enriched the financial sector, and particularly the financial elite.

    Govt. needs to take this power back. The banks will fight this tooth and nail, and they will enlist their agents to help them. The Friedmanomicons will argue that banks will use the power to create money more responsibly than the govt. due to the “discipline of the market”.

    Allowing banks to retain the power to print so much money is vastly more toxic than the current CDOs and CDS. And, unless govt. reclaims this power and chooses to exercise its constitutional authority, we will almost certainly see an inflationary rebound.

    On a separate note:

    SJ and JK are absolutely right that monetary policy is more important than fiscal policy. However, even with an expansionary monetary policy it can be very hard to force-feed money into the economy and kick-start velocity. When the economy is this burdened by debt, simply making credit nearly free will not work because investors are fearful of making investments due to diminished consumer spending power. The government thus needs to get the new money into private hands.

    This can happen through a number of means – tax refunds, grants to states, or spending programs. This has real distributional consequences, as well as real consequences in determining how society will allocate its resources (e.g. buying cheap imported electronics, or building a new energy grid).

    So in that sense, fiscal policy is a critical companion policy to monetary policy in the current near-deflationary environment.

  27. “bad institutions are subsided by blanket support rather than allowing the fresh air of natural selection to take place.”

    The price paid by society to enforce “market discipline” is so immense as to be impractical, even if we could make banks believe that we were committed to letting them fail.

    Howwever, this argument begins with the false premist that “market discipline” is the only to fix the system. This false premise ignores that fact that banks were well regulated for 50 years after the great depression.

    So our choices seem to be:

    A) A somewhat inefficient banking sector (like we had in the 50’s and 60’s) that is fairly robust and limited in its ability to “innovate”

    B) A de-regulated banking sector that is more efficient over the short term but periodically requires that the world suffer a catastrophic depression in order to enforce “market-discipline”.

    Which do you suspect most people would prefer?

  28. You are ignoring option 4:

    Option 4) The ECB sees a risk of deflation, but they are really ticked off at the US and think the US should bear the burden of subsidizing the global economy. Moreover, if they can consistently inflate at a slower rate than the US, they hope that other economies will shift to the Euro as the preferred default currency.

    In other words, they are playing a game of chicken.

  29. So many things:

    “pricing mortgages at or near cost of funds does not meet this criteria as credit risk is not adequately recognised”

    This is simply not true when housing markets are stable. These are collateralized loans, and large losses are rare when houses can be sold near or above the loan value.

    When a 20% down payment is included, mortgage loans are extremely low risk (particularly if everyone in society is required to have 20% down, which puts a hard liquidity limit on housing bubbles). The borrower would almost always have equity above loan amount, and the loan is as close to risk free as one can hope to get (especially if the bank requires hazard insurance, which it does).

    Next point:

    “a two tier deposit guarantee system with a choice between 90% and 75% protection”

    The reason for the deposit protection system is two-fold: 1) psychological and 2) coordination.

    Banking is a confidence game. Even a _hint_ of bank default can create a run, which can trigger bank default, and can spready _rapidly_. That is the reason for _100%_ protection… _precisely_ so that most consumers don’t take on the burden of worrying about a bank defaulting. If a consumer thinks they are at risk of only recovering 75% of their money, a run on the bank will still occur.

    The presumption is that government, since _it_ now bears the risk of loss due to default, would do the worrying (and regulate to prevent excessive risk and low capital reserves). And for 50 years after the great depression, government did its job.

    In the last 20 years, however, government was essentially captured by financial interests, and this capture occurred under the mantra of “de-regulation” that hit the mainstream in the 80s.

    This crisis did not result from government stupidity or incompetence. It resulted from deliberate dismantling and disabling of regulatory authorities, justified under the intellectual aegis of Friedmanomics, and executed by a corrupt political party machine (and though both parties were at fault, one was more at fault than the other).

  30. “Government has essentially given to banks the power to create money (by issuing debt on a sadly small capital base). Govt. needs to take this power back. ”

    Your confidence in government is sadly misplaced. Government’s easy money policy for the last 25 years (the Greenspan/Bernanke put) is the primary causative factor for the current credit bubble. Private bankers operated with a false sense of security that central bankers would never allow housing prices (or general prices) to fall. Therefore, excessive lending was perceived to be safe and over time a massive debt crisis was born. Look at the total debt/GDP chart for the last 25 years of “moderation”, born of the calming influence of Greenspan’s interest rate manipulations.

    The true solution is to take power to set prices, including the price of money, away from government, let the imprudent banking institutions fail, and then start from scratch with a renewed understanding of the individual right to failure. Only then can a complex self-regulating society function efficiently. Any pain that is suffered now from deleveraging will be much less than what we face after the next bubble implodes. Do not prop up this global economy with false money and false wealth.

    Government is not smart enough to regulate society, and contrary to popular opinion, government is no more moral or ethical than private business. Both are run by people with ambition for power. The secret for ending cronyism and corruption of the government is to give the government less power, not more.

  31. In spite of some differences among member countries,the G20 summit displayed a desire to cooperate and may mark the beginning of an era of change.
    It would be silly to take the cynic’s view that summits like this one are useless.
    The summit may succeed in rejuvenating the global economy and thus instil a modicum of faith among investors and bankers.

  32. Apparently you’re happy with the doc who performed yours. Maybe you can provide a referral, in case I want to live in the suburbs someday.

  33. The case for a central bank independent of the government and political posturing was made two weeks ago when the Congress was caught in a populist fit, passing ridiculous and unconstitutional laws and spooking everyone in the banking and business community.

    In the midst of that Bernanke took bold action which you may or may not agree was the right medicine, but the markets received very well and helped change the narrative.

  34. thank you for this interesting post. have you been rading the monetarist thinking/theories/arguments at “the money illusion”. worthwhile read going back at least 3 months. one of the main points there is that the fed is being too timid. so while you make the point that the fed must choose its current policy as the least worst, some others are making compelling arguments that in fact the fed is not doing enough.

  35. Thank you for articulating the Friedmanomic position so clearly. In solving this crisis, the two warring intellectual positions are:

    1) A return to more/better govt. regulation (e.g. 50s and 60s)

    2) Even greater dismantling of existing government influence over the economy (e.g. return to a gold standard, as existing in the Great Depression and earlier)


    As to the Debt/GDP ratio, I have linked it multiple times.

    I do factually question whether Greenspan (previously lauded as a hero by the free market) is the primary culprit. Many things happened at the same time. In modeling, we call this “collinearity” – meaning it’s impossible to empirically identify which was the primary causal factor (or if multiple factors were required). Was it repeal of Glass-Steagal? Was it the govt-debt fueled booms of the 80s (under reagan) and early 2000’s (under Bush II)? Was it the strong dollar which killed out trade balance? Or the decline in real median incomes, which forced an increase in debt to preserve consumption levels? Or something else?

    As to whether a restoration of govt. control over the money supply is better than a dismantling of govt. control over the money supply, I submit to you this question:

    Was the world economy more stable and peaceful between 1800 and 1944 (the age of gold and mercantilism), or 1945-2008?

    And as to the link between the Gold Standard and the Great Depression, note:

    Click to access great_depression.pdf

    There is a nice, short discussion.

    And finally, to your assertion that the secret to better government is less government (or in the words of Reagan, government is not the solution but the problem)…

    “The question we ask today is not whether our government is too big or too small, but whether it works — whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified. Where the answer is yes, we intend to move forward. Where the answer is no, programs will end. And those of us who manage the public’s dollars will be held to account — to spend wisely, reform bad habits, and do our business in the light of day — because only then can we restore the vital trust between a people and their government.”

  36. Is your argument that if the American congress is passing unconstituional laws and derogating its democratic responsibilities, that decisions affecting the future of the country should be turned over to an un-elected non-governmental official? Just because you think his “bold action” is justified?

    I think the implications of your view, if I understand it correctly, reflect a much more serious problem than whether Bernanke is correct or mistaken. There are historical parallels which are extremely chilling.

  37. StatsGuy – your points are all well put, but I don’t quite see your view about fiscal stimulus. It seems to me that there are time-series auto-correlative effects with regard to consumer spending: People (and consumption) simply don’t ‘snap back’. They learn, sometimes painfully, and the resultant effects are with us, often for generations (not that this is all bad, by any means). Therefore, the marginal propensity to save may be permanently increased, as a sea-change in consumer behavior that throttles consumer spending even in the face of massive liquidity. In view of long-term effects, notwithstanding the pain and suffering of unemployment/underemployment, are we really wise to eschew fiscal stimulus? Might it not be better to advance a reasonably-efficient and broad-based jobs program to put some term into the consumer’s thinking and break the cycle of fear?

  38. Yes, I agree, and I understand your point about the auto-correlative effects. And about the behavioral aspects (which many sane people will agree have a good side to them).

    In arguing that monetary stimulus is more critical than fiscal stimulus, neither I nor others (including, I think, the authors of this blog) mean to imply that fiscal stimulus is unnecessary in the current situation (particularly as rates have hit the zero bound).

    The issue is this:

    This crisis is _no longer just a credit crisis_. It is a balance sheet crisis. The economy has been running on debt-financed consumer spending. That well has gone dry – consumers are tapped out, already suffering under massive debt, and the last refuge of debt-financing (home equity) is now not only gone, but actually negative. Those consumers who could get credit and go on a buying binge don’t want to do so (even though they secretly hope that everyone else goes on a buying binge so they can keep their jobs and build up their own savings).

    Economists tell us that it will take 3+ years for consumers to dig out from this debt, but in the process what will keep the economy going (and keep those consumers employed)?

    That is why I’ve been arguing that recapitalizing banks and “unfreezing credit” has been a red herring from the beginning. Perhaps necessary (that is debatable, since individuals with good credit have not had problems getting loans), but entirely insufficient.

    The key is to restore spending power by lowering the debt burden, and for the US, this really means the debt burden on the middle class.

    The only entity that has the power to do this is the government, and the government can do it in two ways:

    Print money or Borrow money

    Borrowing money will merely shift debt from private balance sheets to the public balance sheet.

    Printing money is a tax on dollar-denominated wealth.

    Borrowing money sucks capital out of the private sector into safe T-bills (bad). Borrowing money creates huge obligations for future generation (bad). Borrowing money from abroad keeps the dollar overvalued.

    Printing money causes inflation (usually bad, but good when there is a risk of deflation and/or the goal is to devalue debt obligations). Printing money also devalues the currency (usually bad, unless your international debt obligations are denominated in your own currency and your trade balance is negative).

    The thing about printing money is that you still need to get it into the hands of people willing to spend it – one very easy way to do this would be to cut taxes by 50% for a couple years and pay for it by printing money (easy, but not necessarily good). In effect, when the Treasury buys T-bills (QE) it is printing money to offset a tax increase.

    Just because you can give money to someone who will spend it does not mean that you _should_. Contrary to simplistic economic models, it _really matters how the money gets spent_!!

    Will it get spent on imported cars, or building an effective IT infrastructure for the medical industry?

    An alternative is to print money and spend it on specific social objectives that have been long neglected.

    The great challenge to this is political – it is coming from people who are more concerned about preserving their accumulated individual wealth than getting the world economy moving. These individuals will raise the following arguments:

    1) They earned their fortunes by contributing great value to society . Thus, they desserve their money and it’s just fundamentally unfair to impose an inflation tax.

    2) The inflation tax causes economic inefficiency…

    News flash: So does the property tax, and the wage tax, and the sales tax?

    Why is a big work-tax better than a small wealth tax?

    I would like to see data showing that a 3% inflation tax causes more inefficiency than a 35% wage tax.

    3) If you tax wealth through inflation, then this will decrease the incentive to save.

    In the short term, this argument is hokey because right now we need more spending and less saving. In the long term it is a strong point – we can all hope the psychological lessons learned today will stick for a few decades.

    4) Hyperinflation! Scary. Boooo! Hyperinflation!

    Uh, no. Remember that point about our international debt being denominated in dollars? We aren’t living in Argentina.

    5) Other countries won’t loan us money!

    Good – our currency will devalue until US companies stop outsourcing US jobs.

    6) Printing money is evil and Un-American. It will destroy the social fabric of the country and doom us all forever.

    I would laugh, if it weren’t for the fact that so many people believe these arguments and they are so obnoxiously loud (particularly on talk radio) that they tend to intimidate others into silence.

  39. I am surprised by those who state deflation is not in the numbers. Over the last 18 months, the U.S. has spent, loaned, guaranteed or committed an estimated $11.6 trillion (all borrowed of course) in an attempt to bail out failing companies, save Wall Street, and prevent an economic disaster. Yet, despite all this, per the latest Feds Flow of Funds report American households have lost $12.9 trillion in (paper) wealth. Nearly dollar for dollar and more, whatever the Fed pumps in pours out the back end. Millions have lost their jobs, or have seen their wages reduced. According to Case Shiller’s latest report the 10 and 20 city composite price indices indicate annual declines of 19.4% and 19% respectively. My home has fallen 50% in value. Recently the John Hancock Tower in New York, which sold in 2006 for $1.3 billion, sold on 3/31/2009 in a foreclosure auction for $660 million, nearly a 50% reduction. Oil prices have fallen from over $140 per barrel just a few months ago in July 2008 as well as other commodity prices have fallen. What am I missing here? In addition, recently while introducing his plan to deal with banks toxic assets Mr. Geithner stated “as a nation we borrowed too much and let our financial system take on irresponsible levels of risk.” This is of course a true assessment of our crisis. But how in all logic after making this assessment can the administration and Congress continue to follow in the footsteps of the Bush Administration and extend more credit and more leverage as a viable solution? How is it possible for the cause to also be the solution?

    Dangerous Unintended Consequences: Banking White Paper

    Click to access banking-white-paper.pdf

    Case-Shiller March Report
    Feds – Flow of Funds Report:

    Click to access z1.pdf

    See page 112, Table; R.100 “Change in Net Worth of Households and Nonprofit Organizations”
    See Lines 10, 11, 12, 13, & 14 – Total, Change in Net worth for Nation, see line 1

  40. Hear-hear ER! And don’t forget, the Fed is a private entity with the blessing of our annointed non-representing representatives!

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