Opinion: New World Economics

Bloomberg flickered on the screen as the Chairman of the Federal Reserve, Ben Bernanke, set out his policy before the world’s press:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.

That’s open-ended Quantitative Easing (QE) to you and me; monetary stimulus a l’outrance designed to expand the money base until unemployment drops below 7% or PCE (personal consumption expenditure) core inflation increases above 3%.

In the words of Professor Scott Sumner, “He kept talking jobs, jobs, jobs.”

And much of it is about getting homes built.

The S&P 500 has risen by 3-4% over recent weeks on rumours of QE3. The old saw, ‘buy on rumour, sell on news’ broke down as the markets continued to power forward, the harbinger of a rise in real GDP. Bingo!

Previously half-hearted QE had failed to counter the decline in confidence that allowed low demand for loans and high demand for cash to persist. This time there’s a belief that the scale and degree of the commitment is a ‘game changer’ heralding a stronger recovery in the incomes of the American people, in the US money GDP.

Under the banner, Federal Reserve Finally Working Expectations Channel With Open-Ended QE,  the economist Matt Yglesias, drew attention to the guidance from the Federal Reserve:

In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

Here’s the message the Fed has sent out to American entrepreneurs: the incomes of your clients will rise more than you had previously thought and whereas normally that would be accompanied by the Fed raising interest rates, this time the Fed won’t raise them until you see unemployment drop below 7% or PCE core inflation rise above 3%. “American, it’s safe to start that investment project now.”

Across the Atlantic, growth with its attendant tax receipts and declining deficit came a giant step closer, and with it the re-election of Obama, who has only 50 days left before America ‘decides’.

For us, there may be as many as two and a half years. Even so, there is no time for delay – the Liberal Democrats should call today for a similar transformation in monetary policy to boost demand.

It isn’t Labour economic policy and it isn’t Conservative. It is, though, the best way to get the deficit down, to get Britain housed, to get Britain working, to get the job that the public want done. Liberal Democrats can make a distinctive difference to the future prosperity of the British people.

* Bill le Breton is a former Chair and President of ALDC and a member of the 1997 and 2001 General Election teams

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  • Ben Bernanke’s actions are similar to Prof Nick Crafts recommendations for the UK in his recent CentreForum paper. http://centreforum.org/index.php/component/content/article/14-news/releases/275-cutting-the-deficit-now-release
    This is what worked in the 1930s, and both Ben and Nick are, of course, economic historians by training.

  • Bill/Tim,

    both Bernake’s QE3 and Proffesor Crafts recommendations are heavily reliant on a belief in the power of the central bank to dramatically alter rational expectations as a means of generating increased economic axctivity.

    The feds interventions are not of themselves substantive in the real economy. The attached essay provides a critique Shaministic economics

    Even if this program proves relatively successful in the US;here in the UK I feel we will need a more direct approach to economic regeneration focused on public investment in housing, infrastructure and industial policy. Such an approach may include quantative/credit easing to support credit markets in housing, infrastructire and commercial bonds. However, merely expanding the existing program of QE in government gilt markets is unlikely in my view to bring about a return to the prior trend rate of economic growth.

  • Bill le Breton 16th Sep '12 - 5:12pm

    Joe, as you suggest , what Kervick calls Shaminism others would call the management of expectations. But that view has some good history behind it.

    Here’s David Hume from ‘On Money’ in 1752:

    When any quantity of money is imported into a nation, it is not at first dispersed into many hands; but is confined to the coffers of a few persons, who immediately seek to employ it to advantage. Here are a set of manufacturers or merchants, we shall suppose, who have received returns of gold and silver for goods which they sent to CADIZ. They are thereby enabled to employ more workmen than formerly, who never dream of demanding higher wages, but are glad of employment from such good paymasters. If workmen become scarce, the manufacturer gives higher wages, but at first requires an encrease of labour; and this is willingly submitted to by the artisan, who can now eat and drink better, to compensate his additional toil and fatigue. He carries his money to market, where he, finds every thing at the same price as formerly, but returns with greater quantity and of better kinds, for the use of his family. The farmer and gardener, finding, that all their commodities are taken off, apply themselves with alacrity to the raising more; and at the same time can afford to take better and more cloths from their tradesmen, whose price is the same as formerly, and their industry only whetted by so much new gain. It is easy to trace the money in its progress through the whole commonwealth; where we shall find, that it must first quicken the diligence of every individual, before it encrease the price of labour.”

  • Bill,

    for more good historty see Eccles explanation of the Wall Street stock market crash of 1929:

    “As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth … to provide men with buying power. … Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. … The other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”

  • Richard Dean 16th Sep '12 - 5:56pm

    The problem with Shamanism is that it’s all bluff. Prick it and it collapses like a housing bubble. Good for armchair politicians, couch potatoes on crack, but the real world needs fundamentals that can usefully include solid expectations but not con tricks or witchcraft.

  • The economy will return to growth. They always do. The worst thing that can happen is that the govt. thinks it can spend money it hasn’t got and make everything better. This lead to a second crisis. But don’t worry – things get better again, it just takes an extra decade.

  • “The economy will return to growth. They always do.”

    This seems like a fallacy on many levels. The recovery could take decades by this logic and the idea that because a never ending recession has has not happen before does not even imply it will not happen again.

  • There are, of course, good scientific explanations (without resorting to “shamanism”) of this kind of behaviour. The so-called Hawthorne effects were researched in the 1930s, when “scientific management” (industrial psychology, if you like) was looking for environmental factors which would increase people’s productivity. Was it light levels? Music at work? temperature adjustment? etc In the end they showed that people improved their productivity when something changed, something was done. The key factor was thought to be the management taking an interest in the staff, their welfare, and their work. This work (not coincidentally, I shouldn’t think) was going on at the same time as Roosevelt’s New Deal was being implemented, and people were trying to get through the 30s slump.

    My concern is that the environment in which we work is sending out increased signals, through commodity prices etc that a generalised attempt to increase demand across the board would quickly come up against limits. This, IMO, means we need to adapt to a new paradigm of living worldwide, and our most important work now is to develop strategies for getting used to it. Rapid decarbonisation is one key, of course, but there would be all sorts of others to adapt. Another key is to start equalising incomes – people will not tolerate these changes without genuine “we’re all in this together”. So, if I tried to summarise this, in terms of the technical debate, this is not, repeat not, a topic just for, or even primarily for, the economists. The thinking is too narrow, despite the material jedi linked to the other day, suggesting that economists study the allocation of scarce resources, therefore, the author implied, we can deal with these issues. Sorry, they are too wide in their implications.

    In the World of the 1930s, there was still slack in the system that could be cured by rapid upward demand shifts, a World War etc. We don’t have that luxury this time around. Rapid upward movement in demand will quickly hit the buffers, and a world war? No thanks.

  • Bill le Breton 17th Sep '12 - 8:52am

    Stephen, that said, why is the MPC (which targets the 2 year forecast for inflation) presently setting monetary policy to hit 1.5% in 2014?

    Another question; if the index rises because of a one-of increase in say a commodity price like oil and will drop out next year is that ‘inflation’ when inflation refers to a rise in the general price level?

    The MPC is like the HAL9000 in 2001 A Space Odyssey. It has taken control of the ‘ship’.

    Note that the FOMC is now targeting up to 3% inflation and no greater than 7% unemployment and the marjets like it.

  • Matthew Green 17th Sep '12 - 11:40am

    Criticism that the BoE has let inflation out of the bag misses the point. Wage inflation has stayed in the box, and this is what matters in order to prevent an uncontrolled spiral. The problem is that coonsumer price inflation is sucking demand out of the system because pay isn’t keeping pace.

    Personally I am deeply sceptical of QE and aggressive monetary policy in the moder age. It simply tends to create asset bubbles without doing much to promote the sort of investment the economy needs. In the US share prices are already unsustainably high. Here property prices still need to adjust downward. These policies only show ho weak the underlying economy is – and that is hardly an incentive to invest. Instead people play money games with financial instruments that do no inject demand into the real economy. This is not the 1930s.

  • Bill,

    some very astute comments here that go to the crux of the problem.

    Tim13 notes the resource constraints on increased global demand. There is also considerable evidence that the output gap in the UK is not as much as we would like to think. Do we have, in the right places, the underutilised factories, offices, retail outtlets or idle plant and equipment and trained workers with the right skills to quickly step up domestic production or will increased credit-fuelled demand simply suck-in more imports and create asset bubbles?

    Stephen W makes the important point “… here, if not in America, the monetary transmission system through the banks is so broken that standard QE is not going to to do much good to change that regardless of how much money is printed.

    Matthew Green reiterates a point made by Dave Thorpe in an earlier article “The problem is that consumer price inflation is sucking demand out of the system because pay isn’t keeping pace.”

    Professor Crafts in his paper on the 1930’s measures notes the following caveats:

    “It must be accepted that, while implementing these reforms envisaged in this paper would stimulate growth, the outcome is most unlikely to be a repeat of the 4 per cent growth rate seen in the 1930s. The output gap is probably smaller now, consumer spending will surely be less buoyant and the Eurozone crisis threatens to undermine business confidence and exports. Although these are important caveats, the fact that we cannot rely on consumers or the international economy for demand growth strengthens the case for a policy response as it makes an early spontaneous recovery less likely.”

    In my view monetary policy in the form of NGDP targeting is useful only to the extent it supports and enhances a fiscal stimulus that should be undertaken in the form of major public investment in housing and economic infrastructure.

    Both monetary and fiscal stumulus have their limits as once the outgap gap is closed the benefits are quickly eroded by inflation. Only structural reform in the underlying economy that generates productivity gains and a rebalancing of the economy toward export led growth can produce a sustainable increase in the general standard of living across the population as a whole.

  • Bill le Breton 17th Sep '12 - 2:50pm

    Joe thanks for the excellent distillation.

    Bernanke also makes the point that ‘… monetary policy as I’ve said many times is not the panacea, it is not by itself able to solve these problems. We (the FOMC) are looking for policymakers in other areas to do their part. We will do our part and we will try to make sure that unemployment moves in the right direction but we can’t solve this problem by ourselves.’

    At present, as Matthew suggests, the deflator is taking us along the aggregate demand curve with a resulting impact on real GDP. I want a change in expectations that *shifts* the AD curve to the right.

    So, some fiscal stimulus and some supply side reform that involves a deal or a quid pro quo between these and then some head room provided by the monetary policy makers …

    … all wrapped up in a communications package to sell it to the British people, strengthens the moves that are necessary in expectations and inspires a conviction that it will work.

  • Liberal Eye 17th Sep '12 - 3:24pm

    I’m with Joe and others here.

    Note that Bill’s David Hume quote (third comment) refers to the actions of ‘manufacturers or merchants’ who get more money (in other words who are experiencing buoyant demand) and not to bankers which is what QE does without doing anything for demand in the real economy. All the evidence is that the money transmission mechanism from bankers to the real economy is broken so that QE funds either pile up uselessly at the banks or are used by their investment banking arms to fund speculation in food and energy commodities so driving up prices and making the situation worse.

    To me this suggests that there is no clever way or combination of ways the Treasury can pull on the puppet strings (a.k.a. macroeconomic variables) to make the real economy dance to the desired tune. For the real economy to work requires, as Joe says, structural reforms and these the ivory-tower types of the Treasury (and indeed the wider Westminster Village) are constitutionally unable to address. Doing so would require tackling powerful vested interests, including ones prominent in funding the Conservatives.

    Then there is ‘Shaministic economics’ which can be more succinctly stated as a belief that the Confidence Fairy must be around for the economy to work properly and that if she goes AWOL it falls into recession. This is nonsense which deflects attention away from the genuine reasons the economy isn’t working well and, in any case, could only work if Bernanke had the only microphone but he doesn’t. His approach is widely despised and derided in the US and beyond. More and more countries are moving to dump the dollar as a reserve currency because of its growing debasement under Bernanke.

    When judged by actions rather than electioneering rhetoric, it is clear that Obama’s main aim is to save the TBTF banks even to the extent of actively helping them avoid the consequences of fraud on an industrial scale. We should not copy the US example.

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