Yves here. Late in the afternoon, after three days running of Mr. Market being in a bad mood, the Wall Street Journal sent a news alert titled “Fed Sees Action if Growth Doesn’t Pick Up Soon.” The message:
Federal Reserve officials, impatient with the economy’s sluggish growth and high unemployment, are moving closer to taking new steps to spur activity and hiring.
Since their June policy meeting, officials have made clear—in interviews, speeches and testimony to Congress—that they find the current state of the economy unacceptable. Many officials appear increasingly inclined to move unless they see evidence soon that activity is picking up on its own.
As I sputtered by e-mail:
This would be funny if it weren’t pathetic and real people weren’t being hurt.
The state of the economy is “unacceptable”? Really? Where were you when bank reforms were needed and the Obama administration was too chickenshit to go for bigger stimulus?
And the Fed has already tried every confidence fairy and central bank trick on offer. But Bernanke refuses to believe that loanable funds is a fallacy. Putting borrowing on sale is attractive to speculators, but not to real economy types who don’t see opportunity and/or have legitimate worries re repayment.
The post below is a longer-form treatment of what passes for policy thinking at the Fed. Oh, and it roughs up on Matt Yglesias too.
By Dan Kervick, who does research in decision theory and analytic metaphysics. Cross posted from New Economic Perspectives
Matt Yglesias beats a dead monetarist horse – the same defunct nag whose flogged and forlorn carcass should have been cremated years ago – by again seeming to pin the chief responsibility for attacking unemployment on the Fed, and on its supposed control over inflation and inflation expectations. And yet as is often the case with Yglesias, the elected political leaders of the most economically powerful nation in the world rate no mention in his post, despite their scandalous and incompetent failure to address a national employment debacle.
One of Yglesias’s readers asks a straightforward question in the comments section: “Is it strictly necessary to have inflation to have growth?” Now, while I expect correction from a few academic economists on this score, it seems to me that the correct answer to this question is “Absolutely not!”
First, if an economy is experiencing severe unemployment of human and material resources – e.g. if it is an economy such as the economy we are in now – then it is entirely possible for that economy to grow fairly quickly in response to a surge in demand, without a rise in the price level. The economy can match that demand with new output almost right away, without a significant rise in unit production costs. Unit costs might in fact decline due to increased productivity from more efficient use of existing equipment and workers.
And even in an economy running at full capacity, output can continue to grow without rising prices so long as the increased supply of output is not outpaced by increases in demand. The outpacing of supply by demand can and does occur in a humming economy, no doubt. But there is no strictly necessary reason it has to occur.
But setting aside these hypotheticals about the full capacity economy of our dreams, let’s stay focused on our own present-day society with its weird combination of hyper-unemployment on Main Street and hyper-unconcerned politicians and opinion leaders in Washington. Why are Yglesias and other pundits of the neo-monetarist tendency so insistent on pursuing a policy of growth and employment through central bank-engineered inflation? They have in fact experimented with a few different rationales in defending their approach.
Sometimes they forthrightly advocate achieving full employment by reducing labor costs and the real wages of the employed through inflation. But this is not such an attractive route to prosperity given that we live in an economy already characterized by a skyrocketing income gap and surging corporate profits gained on the backs of abandoned and punished poor and middle class workers. So this rationale is heard less frequently these days – at least in public.
Then there is the theory that higher inflation expectations should lead to a “use it or lose it” attitude among savers toward their money. Savers concerned about the declining real value of their money will presumably spend more of it, and spend it more quickly. That is a plausible, if empirically iffy, hypothesis – so long as the inflation expectations rise sufficiently dramatically. The problem is that Yglesias and the other neo-monetarists have never proposed a plausible mechanism whereby the Fed can raise inflation expectations in any significant way. Even two rounds of QE accompanied by large outpourings of Austrian-libertarian caterwauling and garment-rending about hyperinflation doom scenarios didn’t do the trick.
But the monetarist faithful continue to believe and affirm the creed. The source of the Fed’s power over inflation is supposed, they say, to lie in one of two places: The first is the discredited old model of bank reserves providing a finite stock of loanable funds, with the Fed controlling lending levels in accordance with the “money multiplier” by adjusting reserve quantities. This model has been refuted so many times on this blog that another demolition is hardly necessary.
The other alleged source of Fed power consists in verbal magic. The devotees of the monetarist church believe that the money-using multitudes hang on every word of the Fed Chairman, and adjust their behavior in response to words alone, abiding in firm conviction in the economy-wide potency of the Fed’s mighty syllables. Here’s Yglesias’s latest version of the expectations magic approach:
We should probably just retire the term “QE” at this point. What he’s [SF Fed President John Williams] talking about is going back to doing asset purchases, but doing them in potentially unlimited quantities in order to meet a goal. You say, for example, “we’re going to spend BLAH BLAH a week to try to get inflation expectations up to YADDA YADDA and if after five weeks we’re not there yet we’re going to start spending DOUBLE BLAH BLAH.” This is not my idea of what an absolutely optimal policy agenda looks like, but it would work much better than trying to decide how much to buy in advance. What you want to do, after all, is move markets and coordinate expectations. If everyone who pays attention to these things knows where the captain is trying to steer the ship, then they’ll all adjust their behavior in the direction of the new point that the Fed is trying to coordinate towards. If it’s all done through rumors, signaling, and off-the-record chats with key reporters then it’s much harder.
I have never been able to read this kind of thing without being dumbfounded. Outside of the abstract models found in academic papers in philosophy and economics about otherworldly communities of idealized economic agents, where are all of these people who regard Ben Bernanke as the captain steering the macroeconomic ship, and who coordinate their business decisions to fall in with the course plotted by our great capitalist helmsman? I don’t believe I have ever met one personally. Maybe I spend too much time below deck.
Sometimes the Seekers of the Credible Fed Statement argue that the point is not to produce growth via inflation. They reason instead that the Fed needs to signal it will at least tolerate higher inflation so that potential producers and employers aren’t frightened off of their business investment plans by the concern that the Fed will succumb to inflation fears and put the kibosh on growth, nipping the shoots of economic expansion in the bud before they have fully sprouted.
I find this last approach extremely implausible. I just can’t believe that there is any significant number of real-world business people who currently espy a landscape of promising economic opportunity, but who are being scared off of investment by some vague fears that the Fed might do some vague something-or-other in the future to tamp down demand and price pressure, employing some vague and mysterious Fed mechanisms. I can’t say nobody thinks this way, but my guess is that it is mainly some economists – not the bustling hordes of everyday business folk who pay barely any attention to the yada-yadas and blah-blahs emitted by the Fed.
A business will invest in production whenever they are convinced they are going to have customers willing to buy what the business produces, at a price profitable to the business. The biggest and most awesome customer in existence is the US Government. Those given to focus on authoritative verbal statements and expectations management might do well to realize that the most powerful kind of expectations-management we could get right now would come if prominent neoliberals and conservatives like Barack Obama, Simon Johnson, Ken Rogoff, Tim Geithner, Scott Sumner, Bill Clinton, Erskine Bowles, Alan Simpson and others – who are all apparently fighting a desperate war against everyone to their left, an effort aimed at preserving the neoliberal order and fending off any return to activist government and energetic fiscalism – would stop fibbing about the existence of a long-term public debt problem, and advocate dramatic fiscal expansion instead. The most ill-advised and economy-crippling thing Barack Obama ever did was tell the world the US government is “out of money”. He followed up this false and apocalyptic statement with his decision to fight a protracted war with the Republicans over how best to contract government spending over the long haul. He might as well have told us all that the most important customer in the whole world had just died.
If anyone deserves to be looked upon as the nation’s “captain” it is the President of the United States, and Cap’n Obama needs to reverse course. His faux-responsible budgetary fear-mongering and demoralizing visions of long-term penny-pinching underline and accentuate the even more radical fear-mongering and austerity-hawking of the Republicans. The bipartisan gloom and doom has lowered a cloud over the whole economy. It is slamming business and consumer confidence, and blighting expectations for the future.
There is no long term public debt problem for a country like the US, since the US is – unlike some of its unfortunate European friends – the sovereign issuer of the nominal medium of its own debt. Solvency is no challenge for the US, and borrowing is not required. President Obama should tell the world that if elected along with a Democratic Congress, he and his Democratic colleagues are planning to spend a great heap of public money on everything from eradicating global warming to building bridges to nowhere and escalators on Mars. And he might remind them at the same time that Mitt Romney will likely do the same thing, since the Republicans have a clear track record of believing that deficits matter only when Democrats are in power, and switching to the view that deficits don’t matter once Republicans are in charge.
It’s time for government to go big in its fiscal campaign. Damn the debt and full speed ahead. At the very least, the mere announcement of this born-again fiscal enthusiasm should wake up the hyperinflation hyperventilators – and maybe before a single additional dollar is spent we will get some of those elevated inflation expectations Matt Yglesias says he wants.
By Dan Kervick