A mammoth stimulus package being crafted by President-elect Barack Obama could give the economy a much-needed lift, but other steps must be taken to bolster the wobbly financial system and for any recovery to stick, Federal Reserve Chairman Ben Bernanke said Tuesday.
Specifically, Bernanke suggested the government inject more money into banks. He also offered options to deal with rotten mortgages and other bad assets held by financial institutions, a problem that has contributed to a lockup in lending. Bernanke also again called for the government to do more to curb home foreclosures.The Fed chief's extensive remarks, in a speech at the London School of Economics, come at a critical time as the U.S. gets ready to change its political and economic guard from President George W. Bush to Obama next week.
Bernanke said the roughly $800 billion recovery plan — a blend of tax cuts and increased government spending — now being worked on by Obama and the Democrat-controlled Congress could provide a "significant boost" to the crippled economy. But he made clear that such a plan must be part of a broader, multi-pronged government response to fight the worst financial crisis the hit the U.S. and the global economy since the 1930s.
"Fiscal policy can stimulate economic activity, but a sustained recovery will also require a comprehensive plan to stabilize the financial system and restore normal flows of credit," Bernanke said. "History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively."
To help on that front, the Fed is lending billions to financial companies and buying mounds of companies' debt to help bust through the debilitating credit clog. And the Treasury Department is overseeing a $700 financial bailout program that has pledged to inject $250 billion into banks in return for partial government ownership. Some government money also is being used to guarantee against possible losses from risky assets held by Citigroup Inc.
Bernanke said "more capital injections and guarantees may become necessary" to stabilize financial markets and spur more lending.
Question: Would it be any more subversive of America's economic constitution if the government just mailed $5000 worth of new money to every American? To "inject capital" into banks is to partially nationalize them, and, more generally, it is to do unknown things to the incentives of all concerned. What incentives does a bank that is partly government-owned and is getting regularly cash infusions and asset guarantees from the government to prevent its breakdown have to seek creditworthy borrowers and productive investments? The point is not that the answer is "none." The point is: Does anybody know?
A general giveaway of $5000 per head would be a lot more transparent. But might it not also be a better way to shore up the banks, too? Given the climate of fear prevailing today, people would probably save a lot of that money. Where would they save it? Surely the banks! So that would also be, in effect, a capital injection into the banks. The difference is that the banks would get lots of small depositors-- whose behavior is relatively predictable by the law of large numbers-- as opposed to getting one enormous depositor, and having to read the political tea leaves.
Bernanke is trying hard. But I wonder whether the regime uncertainty he's creating with all his weird new approaches is doing more damage than whatever liquidity he manages to create does good. Hoover and FDR, too, were big experimenters and activists. That's likely a major reason why the 1930s were the worst decade in US economic history.
MORE: "We're All Keynesians Again" (George Melloan)
With a federal-funds interest-rate target near zero, the Fed has pumped tons of newly created dollars into the economy over the last four months. This has doubled the monetary base (bank reserves and currency), a phenomenal increase that has shocked market watchers and raised fears of inflation. But all economic indicators are flashing recession.
Last week brought the dispiriting news that the U.S. suffered a net loss of 2.6 million jobs in 2008, the most since 1945. Now 7.2% of the work force is idle. New factory orders, housing construction and retail sales have shriveled. Mortgage foreclosures are rising...
[T]he Fed is again in the position of "pushing on a string" and finding that nothing happens. Some economists describe this as a "liquidity trap." Money creation loses its stimulative power -- vastly overrated even in ordinary times -- because public demand for loans is weak. Americans are too strapped financially, too short on investment opportunities, or too concerned about the future to borrow. They prefer to save instead.
Some economists argue that "trap" is an inappropriate description. The new money the Fed has pumped into the economy to replace the financial-sector liquidity wiped out by the collapse of the bubble has to go somewhere, they point out. It has to end up in someone's bank account and banks have to quickly convert deposits (liabilities) into investments or go broke even faster than some have by loading up on polluted, mortgage-backed securities. Maybe "liquidity malfunction" is a better term than "trap."
With 30-year mortgage rates now hovering near 5%, banks are spending a lot more of their time and resources responding to householder demands for refinancing at the lower rates. That doesn't do much for bank profits, but it does improve household balance sheets, cushioning to some degree the impact of the recession.
But what the Fed has mainly been doing since Black September has been transferring economic resources to government from the private sector on a massive scale. There is one thing the banks can do with their deposits if they can't find willing and qualified borrowers -- the word "qualified" was rather neglected when Fannie and Freddie stood ready to buy any cats and dogs offered. They can put those deposits into U.S. Treasury securities.
Banks and investors around the world fleeing for safety have been doing just that, holding down federal borrowing costs, at least temporarily. The global flight for the presumed safety of Treasurys has also shored up the U.S. dollar in foreign-exchange markets, sending crude oil prices plunging. Because of the Treasury mania, 30-year Treasury bonds were yielding only 3.06% and the popular 10-year bond 2.39%.
So the Treasury has a good deal. The Fed pumps money into the economy by buying Treasurys with checks written on thin air. The Treasury quickly spends those dollars on the huge ongoing expenses of a government running a trillion-dollar deficit. Recipients of its spending put the money into bank accounts and, presto, the money comes right back to the Treasury to finance yet more government spending.
The government is thus the main beneficiary of the phenomenal rise in the monetary base. The base remained relatively stable through the ups and downs of Fed interest-rate policies in this decade, until it went on its fourth-quarter skyrocket trip.
Fascinating. One thing I should mention. I keep advocating variations of "print money" on this blog. I should acknowledge that that is what Bernanke is trying to do. Bernanke has, of course, no authority to just mail checks to the populace. Congress does. The collapse of credit has, in effect, given the US government a license to print money without-- for now-- sparking inflation. Of course, they could refuse to do so, letting final intermediation unravel and the money supply and prices fall until the economy bottomed out. But price stability is a good thing because prices are written into all manner of contracts: sudden price changes involve arbitrary redistribution, undermining the social contract and causing many economic plans in the economy to miscarry for reasons unrelated to their merit. It should be avoided if possible.
Given that the government enjoys this windfall, however, what should it do with it? My priors are that the government should spend the seigniorage windfall in the same way it should spend an oil windfall: distribute it equally to the populace. The technical implementation of that simple formula is, of course, more complicated, but that's the idea.
Also -- if anything, I think the government's comparative advantage in spending is less in times of economic distress than at other times. Entrepreneurs are quick-witted and adaptable, but perhaps selfish. Government bureaucracies probably are more attentive to the public good, ultimately, but they are slow. When the state or trend of the economy is stable for a long time, a government bureaucracy may have time to analyze and develop the structures and traditions to deal with some kind of market failure in a way that creates net value. When the nature of the economy seems to be transforming itself before our eyes, private entrepreneurs are far more likely to figure out how to create value and thrive in the new circumstances quickly, than government bureaucrats are.
As Melloan notes:
Keynesians were banished in the 1980s by Reaganomics but made a comeback years ago and again control U.S. levers of power. They argue that massive deficit spending by the federal government is the right policy for these times. Paul Krugman of the New York Times has asserted that the Great Depression lasted 10 years because the New Deal didn't spend enough.Japan tried to spend its way out of its postbubble malaise in the 1990s but ended up with a mountain of debt and a "lost decade" of little or no economic growth.
By contrast, when the Asian crisis of 1997-8 hit, the IMF imposed austerity policies on countries like Thailand and South Korea, requiring them to cut spending in the midst of a recession. As a result, they were vilified and burned in effigy, but they did exactly the right thing and Asia was booming again within a couple of years. Asian countries were in a different situation than we are because, on the one hand, they could devalue and ride an export boom to recovery-- with the whole world weak right now, there's no one for us to export to-- and, on the other hand, they didn't own the world's reserve currency and so didn't have a seigniorage windfall, rather the opposite. (We have to deal with the seigniorage windfall somehow, that's why I'm recommending currency giveaways.) Still, the Japan/rest of Asia contrast is a useful display of the comparative merits of Keynesianism and austerity.
Instead of writing a check to everyone, it would be better to just cut taxes, if giving people money is the goal.
Ron Paul on the campaign-trail advocated getting rid of the IRS and income tax altogether, and cutting government discretionary spending by 80%. I don't know if I'd go that far, but I like that direction better than the one we're going in right now.
Posted by: Tom | January 13, 2009 at 02:39 PM
Well, not exactly. First of all, giving money away $5,000 per person would be *redistributive.* That may be good or bad; anyway, it's an important difference. To the extent that anything came through of Obama's program, I think it's probably that he's going to be a bit more redistributionist: more taxes on the rich, tax cuts for the poor. You can't, properly speaking, cut taxes on those who pay no taxes. If you want to give money to people at the lower end, you have to just write checks. And to minimize the resulting perverse incentives and means-testing etc., just write it to everyone.
Now, there's an argument that people who pay more taxes do so because they earned more, so they deserve to get the relief. There's something to be said for that. In this case, though, it seems like the government has the ability and a reason to throw a lot of money around for the simple reason that the money multiplier is collapsing and American democracy is the only institution left that people really trust. That's why I'd prefer to think of it as a windfall and just distribute it equally to all citizens.
I would also like to set a precedent for this kind of redistribution, because it could then be used for my immigration schemes. Once people realize that it's nice getting checks from the government, they might be willing to open the borders in order to get more immigrant tax dollars to finance them with. I should say that I'm still not totally comfortable with the idea of people getting checks from the government for nothing. It just seems a lot less harmful than a lot of other policies that it might be able to displace. People have votes and they'll use them self-interestedly. Writing a check is a less destructive bribe than immigration restrictions or bailing out the UAW or most of the other things people want the government to do for them.
Posted by: Nathan Smith | January 13, 2009 at 06:07 PM