Friday, June 26, 2009
stimulus or unrest
What President Obama, Fed Chairman Bernanke, and Treasury Secretary Geithner must say is that until the government deficit spending and the improvement in the trade balance exceeds desired net private sector saving, we can create all the money we want - it simply will not be enough to driver final product prices higher unless and until we succeed in restoring aggregate demand to sufficiently high credible levels where a self-sustaining economic recovery can take place.
and as for mopping it up when that glorious day comes, read paul mcculley:
I’m perplexed that so many pundits put so much emphasis on the importance of the Fed soaking up excess reserves, as if it is a necessary condition for hiking the Fed funds rate. It is not. To be sure, it used to be, before the Fed had the legal authority to pay interest on reserves, which Congress granted last fall. Before then, the only way the Fed could achieve a meaningfully positive Fed funds rate target was to constrain the supply of reserves relative to the banking system’s demand for reserves, essentially required reserves. ...
It is ... simply wrong to get wrapped around the axle about the amount of excess reserves in the system. The Fed now has the ability to hike the Fed funds rate, despite a huge reservoir of excess reserves, because it now has the legal ability to pay interest on those reserves.
and so, continues auerback:
The key is building a political case for the stimulus. This means getting people around a common objective where everybody is perceived to be benefiting and that the sacrifices are being borne fairly. This was clearly the situation in WWII when the budget deficit as a percentage of GDP got as high as 30.3% of GDP, yet nobody complained about the “sustainability” of government expenditures. The upshot was that by 1946, the GDP per capita was 25 percent higher than it had been in the last peace years before the War. GDP per capita continued to grow during the Marshall Plan years. Despite giving away two percent of U.S. GDP, American residents (and taxpayers) experienced a higher standard of living each year. And nobody spoke about us running out of money.
By contrast, the current bonanza for banks is neither economically efficient, nor politically sustainable.
What is driving the change in portfolio preference shifts is not only a misguided paradigm, but also an inability for the Obama administration to make a sensible, coherent case in what they are doing and why they are doing it. Their actions, in fact, seem to suggest that everything is ad hoc and that they are operating out of their depth, in effect continuing the same policies of the Bush/Paulson period, but on a much greater scale. ...
In the meantime, beyond automatic stabilizers, the door appears to be shutting to further active fiscal ease. I wonder if the stage is already being set for tax hikes, as rumors of a federal VAT (value added tax) have been floating around of late. Add this to rising commodity prices and interest rates, and the profile of any recovery may become increasingly in question, a la 1937-8. Add to that additional bank write-offs, further credit contraction and a minimalist welfare system which leaves nothing in the way of social cohesion, and the prospects for major social upheaval look dangerously likely. What is missing is a vision of a new growth path for the US. If a public backlash is to be marshalled to something more than retribution, that needs to come to the fore. Once you get beyond the pothole and school patching, what industries can be pushed forward through public seed capital or public private partnerships? The economist Hy Minsky pointed out a better way to solve both the liquidity and the income problem, while also providing full employment: by channeling government expenditure through an employer-of-last-resort program.
The current crisis could have been mitigated if increased household consumption had been financed through wage increases and if financial institutions had used their earnings to augment bank capital rather than employee bonuses.
The current system has failed because it was built on an incentive system that did just the opposite.
I grant that it is nice to assume a certain nefariousness on the part of the banks, (lord knows they seem to deserve it) but I suspect the new rules regarding their use of SPE's and securitization has them worried that if they appease congress and the general public now with increased lending, they may have a steep price to pay come 1Q 2010.
Of course that can change at the whim of congress now as we saw with marking to market rules.
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Of could it be that there is something worse than deflation? :>)
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