Regular readers will know that I have spent quite a lot of time reading the…
Things that bothered me today
Three happenings in the last 24 hours confirm to me that neo-liberalism is alive and well in the US and the rest of the World. The first of those happenings is the almost grotesque statements coming out of the EMU about Greece. The second is the 70/30 vote supporting the re-appointment of Ben Bernanke as the US central bank boss; and the third is the US President’s State of the Union speech. I wonder how the millions of unemployed around the World would feel about any of those happenings?
1. Greece and the Euro
First, to Greece and the EMU.
While I have analysed the Greek situation before – please see this blog A Greek tragedy …, I thought the Guardian article by Joseph Stiglitz (January 25, 2010) – A principled Europe would not leave Greece to bleed was worth reading.
In the last days, there have been stories about how Greece is trying to do bi-lateral deals with France or Germany because the EMU treaty forbids any system-wide bailouts. The ECB President has repeatedly said that “No government or state can expect from us any special treatment”. Tough talk like that circulates within Europe a lot lately.
The Greek government denies that they have been seeking bi-lateral support to get around the ridiculous failure of the “federal” system to support one of its “states”. They have vowed to cut cut cut – welfare, services, education, pay … like just about everything that actually helps its citizens live.
Stiglitz at least can see the repugnance of the EMU’s position. He pointed out that the larger EMU economies were not treated like Greece when they broke the 3% budget deficit to GDP rule. He notes the rules are all weighted against the small, peripheral Eurozone nations even though “Greece’s large deficit has implications for the future of the citizens of Greece, but not for the stability of the euro – unlike a similarly large deficit on the part of one of the larger countries.”
He also noted that a “a large part of Greece’s deficit is the result of the global recession, whose impact was felt acutely by many countries who were not responsible for causing it”. And for Greece it “among the poorest of the European family”.
In this sense, the lack of a federal fiscal support mechanism in the EMU for states that are in trouble is a principle weakness of the system. I have written about this before – please see this blog España se está muriendo.
But Stiglitz’s message is that:
While Europe may not yet have an overall budgetary framework that can fully address weaknesses in one part or the other of the EU, it should at least adopt the principle of “do no harm”. For the ECB to announce that it will not accept Greek bonds as collateral would be counterproductive. For the ECB to delegate judgments about the credit-worthiness of Greek bonds to the rating agencies would be more than just irresponsible; it would be reprehensible. Delegation of effective regulatory responsibility to the rating agencies is partly what got the world into the present mess; and the rating agencies’ judgments have proven to be deeply flawed – underrating the risk of mortgage backed securities, but consistently overrating the risk of certain sovereign debts.
I think this is one of the better pieces of commentary that you will read on the Eurozone crisis and the economic problems in the World generally. Stiglitz noted that the fiscal retrenchment being forced on the Greek government by the ECB bullies (my words) will worsen their unemployment situation and further drive up poverty in an already poor nation. Why on Earth would the Greeks want to go along with any of this?
The other point he makes is that the basis on which the ECB assesses whether a nation is “behaving” – that is, whether its budget deficit as a percentage of GDP is below 3 per cent – is deeply flawed because they include both the automatic stabilisers which will reverse once growth resumes but will worsen if discretionary cut backs cause a deeper recession and the interest payments.
On the interest servicing payments Stiglitz says that “even the IMF has reframed most countries’ budgetary targets in terms of the primary deficit – net of interest payments, recognizing that volatile financial markets mean that interest payments are not really within a country’s control.”
It beggars belief that the ECB forces the Greek government to pay higher interest rates on its debt because the former has a stupid (made-up) rule that it won’t accept Greek bonds as collateral, and then tells the Greeks they have to further cut support for the poor because their budget just went up again. Humans make up the most ridiculous rules to punish each other. But in this case, the Greeks can leave the EMU and as I have argued, while it might be painful to do so, they are going to hurt anyway.
Stiglitz also proposed a fiscal support mechanism within the EMU to help resolve these highly damaging imbalance. He said:
… institutions like the European Investment Bank should undertake countercyclical investments in the country, to offset the deflationary impacts of the budget cuts. Europe should show that it will stand behind Greece, much as the IMF provides support funds for developing countries. The provision of such support might lower interest rates, and make it easier for the country to reach budgetary balance. The EU, the euro, and the premise of European solidarity is being tested again. The measure of Europe will not be in the harshness of its actions, but in the spirit of solidarity that it shows in assisting its neighbour.
I disagree with him that the IMF has done very much that is positive for developing countries – please read this blog on that – IMF agreements pro-cyclical in low income countries .
I also disagree with the implication that a “budget balance” is the necessary goal to aim for. It all depends on the trade balance and the saving desires of the private Greek sector. I suspect a budget deficit is required indefinitely as a nation building strategy to improve the lives of the poor citizens in that country.
But in terms of the use of the EIB as a fiscal support mechanism across the Euro federation this would have some advantages. The system is clearly failing now through lack of such a mechanism that can redistribute demand. However, if it was to become a mini Euro-style IMF then forget about it. That would just be the start of a new institutionalised tyranny in the zone.
The Wall Street Journal reported that Bernanke Wins New Term but that the “Fed Chief on Shaky Footing After Confirmation Fight; Tough Calls Ahead on Rates”.
So this is evidence that 70 per cent of federal politicians in the US Senate are not acting in the best interests of their nation. 70/30 seems like a lot but in the twisted world of US politics it appears that the 30 per cent was a very loud voice.
Four more years of Bernanke who didn’t see the crisis coming; actively helped it along with his policies positions relating to reducing market oversight; and who is also firmly on “the US President’s fiscal consolidation advisory panel” (having told various committee hearings that the deficit has to come down, by which he meant the discretionary component).
Many mainstream commentators are arguing that the issue is “the Fed’s cherished independence to change interest rates without political interference. That independence is key to retaining financial markets’ confidence in the central bank.”
I just love this sort of talk. The financial markets were in like flynn when they needed federal funds to bail them out of their self-made crisis. There was no loss of confidence in treasury and central bank coordination in bailing all these characters out then.
But of-course once the crisis is over and public anger dies down again as the consumers get fat again on debt pumped into them by the same financial markets – then the central bank has to operate they way they want it to – which should be read as leaving banks etc to self-regulate (joke) their own industry and having the central bank push rates up at will to keep inflation down, irrespective of the damage it might do to the unemployed.
I have already indicated that I think the US government should not have re-appointed Ben Bernanke as the US central bank boss. Please read my blog – Bernanke should quit or be sacked – for more discussion on this point. Nothing has changed my mind since I wrote that blog. In fact, after reading a lot more about his early days I cannot believe they now have actually done it – that is, re-appointed him.
I thought I might share some of that reading with you. On November 21, 2002, Ben Bernanke spoke to the National Economists Club in Washington on the theme – Deflation: Making Sure “It” Doesn’t Happen Here.
As an aside, the Club must be a pretty happening place – just imagine assembling a bunch of mainstream economists in one room. I have seen it often and its ugly.
The speech was one of the self-congratulatory statements of faith in (a) the value of the self-regulate market economy; and (b) in the efficacy of inflation-first monetary policy; and (c) how policy can solve any crisis.
He started by talking about the expulsion of the “inflation bias” in advanced countries in the 1990s because there was a “heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability.”
Having “solved” that problem, he wondered whether deflation might be the next big thing – referring to the problems that Japan was going through at the time.
… I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small, for two principal reasons. The first is the resilience and structural stability of the U.S. economy itself. Over the years, the U.S. economy has shown a remarkable ability to absorb shocks of all kinds, to recover, and to continue to grow. Flexible and efficient markets for labor and capital, an entrepreneurial tradition, and a general willingness to tolerate and even embrace technological and economic change all contribute to this resiliency. A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape …
The second bulwark against deflation in the United States … is the Federal Reserve System itself … I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.
Repeat after me: “Mild and brief”. Put a note on your refrigerator door “Mild and brief”. Or better still, seeing as nearly every second person I see these days is sporting a tattoo you might consider getting “Mild and brief” adorned across the back of your hand.
[As a cultural note, Australians, at least, put notes on their fridge doors to remind themselves of all sorts of things].
But you see the arrogance of an economics profession in his statement – they considered they had won the battle and relegated the business cycle to history – markets and inflation-first aggregate policy (meaning very little fiscal discretion) – that was the mantra and it dominated policy which in many ways became lax in its oversight of what was actually happening.
And further – not Bernanke claims the robustness of the financial system – was a “particularly important factor” in overcoming the business cycle.
I wonder if he ever goes back and reads this rubbish and reflects a little bit about it. Perhaps in the Senate process that has led to his re-appointment he might have been asked to do that and come back with some answers.
Bernanke then talked about the problems are deflationary episode might present – emphasising that deflation “is in almost all cases a side effect of a collapse of aggregate demand–a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers”.
In this context, he said that a deflationary episode tests “conventional monetary policy” because of the “zero bound on the nominal interest rate”. He said:
Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate … and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.
In this context, he noted that at this point most commentators believe the “central bank has “run out of ammunition” — that is, it no longer has the power to expand aggregate demand and hence economic activity”.
The rest of his talk is an outline of the other policies tools available – “a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition”. Most telling is the following:
… under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.
I will come back to this.
Then followed a story about how the “U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation”.
He then outlined a series of measures – all of which we have now seen in action – zero interest rates; large-scale purchases of financial assetst to lower “rates further out along the Treasury term structure”; “announcing explicit ceilings for yields on longer-maturity Treasury debt” and enforcing those “interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields”.
Further, “offering fixed-term loans to banks at low or zero interest” (through the discount window) would be another option.
He claimed that all these operations would provide reduce rates and stimulate aggregate demand.
But the central bank could also cooperate with treasury by buying debt back that the treasury has issued to match (he uses the term fund which is of-course not technically correct) the net spending (either from tax cuts or direct spending). I won’t go into his description of this process which is fairly flawed.
However it leads him to reassert that “the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound.”
So the consolidated US government (treasury and central bank) had according to Bernanke all the tools necessary to prevent a damaging deflationary situation that was generated by deficient aggregate demand. The financial sector was strong. Markets were resilient – and driven by effective entrepreneurship. There were strong financial institutions (read banks and oversight).
Any real disruption caused by a demand failure would be “both mild and brief”. Very reassuring indeed.
Given all that – the question that I would have asked in the Senate process is this: How come the US has now been in a deep recession for nearly 2 years with unemployment rising to 10 per cent and 17 per cent if you add in those that have given up looking?
We can even forget about his complicity in the deregulation of the financial markets and all the rest of the arguments that have been made against his re-appointment on those grounds. Those arguments and the complicitiy are not unimportant – leopards don’t change their spots after all (not often anyway). But we can leave those arguments aside.
If the federal reserve really had such effective tools – why haven’t they worked?
If he thought then that the treasury could also guarantee no prolonged failure in aggregate demand because it could spend as much as it needed and Bernanke would buy back all the debt that was stupidly issued by the treasury then:
- Why is the economy still in a deplorable state after 2 years? 2 years of very high unemployment and collapsing wealth (except among the bankers!) is not mild nor brief.
- But moreover, why has been advocating fiscal conservatism throughout the crisis? Why wasn’t he telling the US government committees that he has been appearing at that he believed the treasury should be spending as fast as his electronic “printing presses” could credit bank accounts with the funds?
The point is obvious: (a) Talk was cheap when there was no crisis; and (b) Monetary policy has been demonstrated beyond doubt not to be an effective policy instrument for stimulating aggregate demand. Fiscal policy clearly works but hasn’t been applied sufficiently because the deficit terrorists (which include Bernanke) have bullied the US (and other) governments into putting the brakes on too early.
Bernanke’s blind belief that monetary policy was king has been exposed as cant. He has pulled all the levers he discussed in this 2002 speech and while the central bank actions have restored functionality to the financial system very little aggregate demand stimulus has resulted.
These reasons should have been sufficient in my view for the US Senate to deny his re-appointment, quite apart from the fact that he was part of the process that created the mess in the first place.
3. State of the Union speech
I was going to mention the State of the Union speech but I have run out of time and so we will leave it for you – the kind reader – as homework. The following dot-points encapsulate my views on it. It is up to you to fill in the blanks. About 200 words per dot-point please.
- It was terrible because …
- It sucked because …
- He has abandoned his leadership role because …
- There is not a job in sight because …
- Unemployment will persist because …
- His support for Bernanke was reprehensible because …
- He should sack his economic advisors but won’t because …
Back tomorrow – another harrowing challenge being prepared! Look out for it sometime tomorrow.
This Post Has 10 Comments
I would like to know how Obama might have reasonably performed better in his SOTU address. Unlike those in the blogosphere, Obama operates under political constraints, and I find that a lot of the incessant criticism from the left assumes that he can easily advocate a non-mainstream agenda which is clearly out of tune with legislators, mainstream economists, and public opinion as well.
In his SOTU address, Obama proposed a new jobs bill. He lambasted the actions of Wall Street and proposed new banking reforms, with the promise that he will stand firm and not sign a bill just for the sake of doing so. He proposed new investments in green energy and in high speed rail. He excoriated the recent Supreme Court decision allowing unlimited corporate campaign contributions, right in the faces of the 9 Justices sitting in the front row. And he reiterated his support for the healthcare reform bill which is vastly unpopular in the eyes of the public.
Sure, I wish Obama would have used the forum to repudiate mainstream economics, to argue that government policy should serve the people and not be subject to arbitrary and counter-productive fiscal constraints, and to then announce the firing of his entire staff of economic advisors. But given the political constraints he must operate in, it is fantasy to assume he could do that.
Many of Obama’s critics on the left argue that he has betrayed his message of change by appointing advisers from the Clinton era. This is true, but his critics forget that his agenda was change through reconciliation and finding common ground. So sure, he could have abandoned his support of Bernake and announced his desire to put John Galbraith at the helm of the Fed, but does anyone realistically think such an action would be seen as a credible attempt to change by find common ground?
Obama’s critics often point to Roosevelt’s leadership and the fight he led against the great financial powers and conservative interests of his day. It is indeed true that Roosevelt fought long and hard to promote his agenda, but critics also forget that Roosevelt’s ideas had an incredible groundswell of popular support long before he was even elected. Many conservatives of the day were worried about a socialist revolution in light of the rampant street demonstrations and strikes which often turned violent. There were literally millions of people waiting in breadlines and living in tents out on the street. Roosevelt did fight hard for reform, but he also had the cards to play with.
In light of the political realities Obama must deal with, I thought he delivered a good speech. He could have been a bit more explicit about the nature of his proposals, but in the end, the speech should give him some capital which he can use to make a credible push on banking reform and another stimulus package. Odds are good something positive will come out of it, but I don’t expect anything sweeping. In the end, it is about the best one can expect given a truly honest assessment of public opinion and the political climate of today.
This is a bright idea for solving Greece’s problems:
The idea, if I’ve got it right, is that Greece re-introduces its own currency which runs alongside the Euro. This new currency would not be much use for firms selling stuff in Greece imported from elsewhere (inside or outside the Eurozone). On the other hand, the new currency would boost trade amongst Greeks themselves, and would thus boost employment a bit.
This is similar to the way in which individual towns sometimes create their own currencies, e.g. “Ithaca hours” in New York state.
re EMU, would you say that budget deficit less the effects of automatic stabilizers could be a solution to the existing EMU set-up? It should be very easy to do.
Nice piece today as always. I would like to respond to the comments of DS (an aside, DS: John K Galbraith, rest his soul, is no longer with us sadly; I believe you were referring to his son, James Galbraith). Nitpicking aside, we always hear that the President operates under significant “political constraints”, but the mark of a transformational politican (which Obama claims to be) is to shift the parameters of debate. Whatever one thinks of Reagan or Thatcher (and personally, I loathed their policies), they did radically transform the terms of the debate. Indeed, in the case of Reagan he did so with a House of Representatives that was still dominated by the Democrats and still managed to enact a large chunk of his domestic program. We most certainly didn’t elect him to perpetuate the policies of his predecessors, neither Bush, nor Clinton (whose Administration bears as much responsibility for this mess as the GOP under Bush).
This is a government in which the Democrats have huge majorities in Congress and a Democrat in the White House, yet Obama continues to negotiate against himself in search of a faux bipartisanship (assuming he really wants to move in a more progressive direction). And the notion that he has done anything for his “leftist base”, let alone “the furthest left elements” of the Party is ludicrous in the extreme? As Ezra Klein says, the Left “ha[s] gotten exactly nothing they wanted in recent months.” The Left wanted a single-payer system, then settled for a public option, then an opt-out public option, then Medicare expansion — only to get none of it, instead being handed a bill that forces every American to buy health insurance from the private insurance industry. Nor was it “the Left” — but rather corporatist Democrats like Evan Bayh and Lanny Davis — who cheered for the hated Wall Street bailout; blocked drug re-importation; are stopping genuine reform of the financial industry; prevented a larger stimulus package to lower unemployment; refuse to allow programs to help Americans with foreclosures; supported escalation in Afghanistan (twice); and favor the same Bush/Cheney terrorism policies of indefinite detention, military commissions, and state secrets.
As far as the speech itself goes, a State of the Union address is always a good place for an incumbent President to set out his priorities, and in that regard, Obama’s speech is most revealing. He rightly argues that everything “begins with our economy” and then curiously emphasizes that “our most urgent task upon taking office was to shore up the same banks that helped cause this crisis.”
No, Mr. President. Your most urgent task upon taking office was to shore up employment. Over the past year it has become obvious that the policy to shore up the banks has been a dismal failure in this regard. It has done nothing to pull the economy out of its deepest slump since the late 1970s. The single most important thing Washington can do to help the vast majority of American citizens who do not work on Wall Street is to create jobs – tens of millions of them.
The President was right about one thing: “If there’s one thing that has unified Democrats and Republicans, it’s that we all hated the bank bailout. I hated it. You hated it. It was about as popular as a root canal.”
But at least a properly executed root canal solves the problem once and for all. The President and Congress have administered the economic equivalent of pain killers, without addressing the underlying problems in our financial sector. If we’re going to undergo root canal, then let’s fix the damaged nerve and prevent a recurrence of the problem. Tens of trillions of dollars have been committed to deeply insolvent institutions (the extent of which we still do not understand due to persistent stonewalling from the Treasury and Federal Reserve). These institutions continue to pay out massive bonuses to their staff on the basis of fraudulent accounting. And many of these institutions are still engaging in activities which continue to worsen household balances in order to maximize their own profitability. Households and non-financial institutions have hitherto received very limited assistance. If this is how the President measures success, God help us when we have failure.
In a nutshell:
BillM: He [Bernake] has pulled all the levers he discussed in this 2002 speech and while the central bank actions have restored functionality to the financial system very little aggregate demand stimulus has resulted.
“Let them eat cake ….”
MarshallA: Households and non-financial institutions have hitherto received very limited assistance. If this is how the President measures success, God help us when we have failure.
Presumably, that universal energy is preoccupied evolving an infinite creation – and does not take a hand in the pickles we create for ourselves. (One glance in our direction though and I am sure peals of laughter would resound throughout the stars!!). On the other hand we were given a brain, the power to think: – we will just have to clean up our own mess (sigh)!!
Pretty good argument why neither bernanke nor greenspan should have been chairmen of the fed.
The real question is how should a “supply shock” be handled.
“Many mainstream commentators are arguing that the issue is “the Fed’s cherished independence to change interest rates without political interference. That independence is key to retaining financial markets’ confidence in the central bank.”
I just love this sort of talk. The financial markets were in like flynn when they needed federal funds to bail them out of their self-made crisis. There was no loss of confidence in treasury and central bank coordination in bailing all these characters out then.”
How about replacing financial markets’ confidence with “the spoiled and rich’s ability to ‘steal’ from the lower and middle class using negative real earnings growth and more debt on the lower and middle class”?
Divide an economy into three groups (spoiled, rich; gov’t; and lower and middle class). Now assume the spoiled, rich are only out for themselves and have “captured” the gov’t sector. The spoiled, rich will exploit the lower and middle class until almost nothing of it is left.
“He then outlined a series of measures – all of which we have now seen in action – zero interest rates; large-scale purchases of financial assetst to lower “rates further out along the Treasury term structure”; “announcing explicit ceilings for yields on longer-maturity Treasury debt” and enforcing those “interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields”.”
Didn’t he leave at least one out? Wouldn’t positive real earnings growth and positive nominal earnings growth lead to price inflation?
From bernanke’s deflation speech:
“The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand–a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.1 Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending–namely, recession, rising unemployment, and financial stress.”
“1. Conceivably, deflation could also be caused by a sudden, large expansion in aggregate supply arising, for example, from rapid gains in productivity and broadly declining costs. I don’t know of any unambiguous example of a supply-side deflation, although China in recent years is a possible case. Note that a supply-side deflation would be associated with an economic boom rather than a recession.”
I believe there is where the problem lies. A supply shock happens that is big enough to lower interest rates. Some of the lower and middle class not realizing what is going on start borrowing (in other words, does the ‘economic boom’ occur because of rising debt levels that do not produce price inflation). Eventually, most of the product and labor markets get somewhat oversupplied. Now some people can’t get a raise and can’t work more hours. They default. The fed thinks this an aggregate demand shock. They lower interest rates to create more debt. The supply shock continues. The cycle repeats with debt defaults. Where does it end?
Plus, I can’t believe people think bernanke is an expert on the Great Depression. How about was there a supply shock in the 1920’s?
The talk about Greece and EMU allows me to jump in with a question that I have been chewing over a bit.
I hope I’m beginning to see that a country, such as the US, is not revenue constrained :
G-T>0 creates net financial assets (a); a necessary condition for the non-gov sector to save. Usually, the Fed+Treasury fused entity offsets this creation of money by selling/issuing bonds, to maintain a target rate. (b) does not eliminate the net assets created in a), it changes the composition of bank holdings after the fact. Correct?
In the Euro-zone, while stability pact theoretically imposes a 3% bound on deficits, that is a ‘soft’ constraint, and even if it was, I don’t see that it challenges the above at its core (after all G-T >= c > 0). What would, if my understanding is correct, is if the German government, say, had to borrow from the banking system, *before* it can net spend, a horizontal transaction. As a consequence, G-T must equal zero, on average, as is the case for a household. Is this the case? More importantly, are net financial assets never created under the Euro regime, or are they via a different channel?