Fed Watch: This Train Doesn’t Stop

How will the Fed respond to recent evidence of heightened inflationary pressures and slower economic growth?

This Train Doesn’t Stop, by Tim Duy: Dual mandate, but one policy tool. A choice has to be made in the short run. Focus on inflation, and hold policy relatively tight? Or focus on growth, hoping that soft economic growth will tame inflationary pressures? The Fed continues to choose the latter path. In truth, at this point they have no other choice. It was unlikely that the Fed could bring a halt to this easing cycle as long as economic data point at recessionary conditions; this was always the danger of moving so quickly early in the cycle. And it became unthinkable to back away from the current set of policies after Congress followed up on Fed Chairman Ben Bernanke’s push for fiscal stimulus. The die is cast. Look for another 50bp in March and then two more 25bp cuts at subsequent meetings to bring the Fed Funds rate to 2%.

Bernanke’s Senate testimony left unchanged market expectations for additional easing. The overall tone was, as expected, in line with the dour assessment offered by Vice Chair Donald Kohn. The encouraging signs – low inventories, solid balance sheets in nonfinancial corporations, solid export growth – were few, while weakness was abundant. It read as an extended version of his February 14^th testimony. That said, there are heightened inflation concerns. This sentence from February 14:

A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability and, in particular, whether the policy actions taken thus far are having their intended effects.

Has evolved to:

A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures.

While not saying so outright, the new sentence implies stagflation. Not surprising, as incoming price data are difficult to ignore, and left the Fed revising upward their near term inflation expectations despite a downwardly revised growth outlook:

The central tendency of the projections for core PCE inflation in 2008, at 2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some higher-than-expected recent readings on prices.

Still, the expectation is that inflation will moderate in the months ahead, allowing Bernanke to succinctly define the near term path of policy:

Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast. Although the FOMC participants' economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.

Insurance against downside risk + benign inflation outlook = more rate cuts. While interesting to dissect, the relevance of Bernanke’s testimony for near-term policy was something of a forgone conclusion. Consider this:

However, the recently enacted fiscal stimulus package should provide some support for household spending during the second half of this year and into next year.

I don’t think it should be forgotten that the stimulus package was arguably custom designed by Bernanke:

I agree that fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone. But the design and implementation of the fiscal program are critically important…

To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next twelve months or so.

In other words, “DO IT NOW.” Congress and the President obliged, spilling red ink to get the checks in the mail in time for the summer driving season. If Bernanke fails to deliver additional rate cuts as expected, it will be perceived as a negative policy shock. I have got to imagine that Fed action to offset the fiscal stimulus that Bernanke supported would not go over well on Capitol Hill. The Senate would be inclined to crack open the Federal Reserve Act and make an omelet.

Not surprisingly, Bernanke’s inclination to continue pushing rates lower is resonating throughout financial markets. Inflationary pressures are building globally (note that China is completing the chain that leads to an inflationary spiral, setting the expectation that high inflation will be matched by higher wages), reflected in surging commodity prices and the freefall of the dollar. The former is weighing heavily on US consumers. Indeed, I am amazed that this story is only starting to capture the attention of the press. So much attention is placed on the housing market as the source of declining consumer confidence, but over the last three months, headline CPI has surged 6.8% annualized. Sure doesn’t look like nominal wages gains are keeping up. No wonder confidence is collapsing.

And I sense it’s going to get worse – the Fed’s policy stance is giving additional impetus to commodity prices as investors pile into the asset class as an inflation hedge and a response to the weaker dollar.  Moreover, low US risk free returns (a measly 2% on a 2 year Treasury) are forcing market participants to search out higher returns, and commodity prices look like a safe bet for the time being. The new asset bubble? Perhaps – but this one will have a primarily inflationary impact on the US economy. Moreover, it will weigh against the deflationary impact of the housing/credit market turmoil. Swamping it if the policy response is to continue propping up an unsustainable level of domestic demand. (I wonder when someone in Congress is going to realize that higher inflation is rapidly chipping away at the recent minimum wage hike?)

Not a pretty combination of events. And Bernanke knows it:

Upside risks to the inflation projection are also present, however, including the possibilities that energy and food prices do not flatten out or that the pass-through to core prices from higher commodity prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month.

But the bottom line is that he can’t stop the rate-cutting train now. He can only hope that inflation expectations remain reasonably well anchored while his attention is focused on the deteriorating growth outlook. To pull this off, Bernanke will have to hope for minimal nominal wage growth. I don’t know if this will be a political feasible outcome after the period of real wage stagnation experienced during the Bush Administration.

Sidenote: CR found the silver lining to higher inflation – it will accelerate the housing correction in real terms.

Comments

[Inflation]

TD..."And I sense it’s going to get worse – the Fed’s policy stance is giving additional impetus to commodity prices as investors pile into the asset class as an inflation hedge and a response to the weaker dollar."

This sounds about right. The seasoned investors I converse with are increasingly concerned with inflation. This is forcing them to pay less attention to increasing domestic productivity, as they turn to inflation hedges for protection. If this goes on a long time, GDP growth may suffer.

TD..."To pull this off, Bernanke will have to hope for minimal nominal wage growth."

The middle class will receive yet another inflation mediated decline in their standard of living. Middle class retired workers are toast, as their pensions are being rapidly confiscated by inflation.

[Worker]

Everytime I here Bernanke talk about how inflation expectations are anchored, I flashback to a time when subprime was "contained".

I have a tough time thinking that someone so smart is really so dumb.

Does he really not get it or is he just priming the pump for the next bubble? Or maybe he is just sweet-talking the market with little white lies?

http://www.harpers.org/archive/2008/02/0081908

[Callahan]

Have faith in the great ownership society, globalization, and those wonderful tax cuts, they'll fix it, just you wait.

[David Pearson]

"To pull this off, Bernanke will have to hope for minimal nominal wage growth."

Let's see...

-Bernanke cuts rates to reduce downside risks
-rate cuts increase inflation
-Bernanke hopes for wage increases below inflation
-if he gets his wish real wages decline
-declining real wages increase downside risks

Do I have that right?

[Robert Bell]

Note to be totally clueless, but it seems that you copy and paste, rather than link, Tim Duy. Is he behind a firewall?

[James]

The limiting factor on the Fed will be the Bond and the Dollar.

[Gerard MacDonell]

Why ON EARTH would he describe having eased early as a "risk" when the current economic outlook is weaker than the desired. What a very bizarre way of thinking about it.

[Organic George]

Or the fed is poring gas in the inflation fire

[Ironman]

Following up the CR sidenote at the bottom of the article - this is the key to understanding what's been the motivating factor behind Fed policy in the past year that has led to higher inflation today.

Bernanke is a student of the Great Depression, where a lot of President Hoover's policies sought to sustain large numbers of people working at the relatively high wages of the late 1920s, when instead, the level of wages needed to come down in real terms to move to a more stable equilibrium with other prices. In that respect, the real bubble of the 1920s was in wages (as opposed to in the stock market, as is often mistaken.)

People weren't willing to accept lower wages, and with the Fed of the day intent on following an extremely tight money policy, the combination propelled the country into the deflationary Great Depression. This combination of factors ensured that high rates of unemployment would result, because the status quo could not be sustained.

Let's flash forward to today. We've gone through a period where housing prices have skyrocketed from their previous level of equilibrium. Major financial institutions underwrote the bubble, and are now on the hook because the value of the assets against which they loaned money need to come down to move into that more stable equilibrium with other prices.

Except they can't. If these asset values drop as substantially as they would need, these institutions will (not might) fail. As we're already seeing to an extent, even with the actions the Fed has already taken.

If you're the Fed, here's what you see. You have prices in housing that you cannot afford to have come down because the impact on financial institutions would ensure that the resulting recession would be, in understated terms, severe.

So, with your hand on the levers of U.S. monetary policy, you choose to spark off higher inflation, because the only alternative to the widespread failure of major financial institutions stemming from falling asset values is to make all the other prices in the economy higher - that's what you can do to establish the relative equilibrium between these prices at a new, more sustainable level.

And that appears to be what the Fed has chosen to do.

So, here's how this situation plays out. The Fed's inflationary monetary policy continues until the asset values of real estate have returned to a more sustainable level of equilibrium with other prices. That protects the financial institutions from mass failures. After that, the Fed gets serious about reducing inflation.

And that's a whole other can of worms to deal with!

[howard]

i have said for a long time that stagflation lite was the logical outcome of bush-league economics, so nothing is surprising me about events unfolding - other than this rather bizarre belief that the nature of the weakening we see in the economy is going to moderate inflation.

i get that bernanke has no real choice, but still, wishes, ponies, you know the drill....

[robertdfeinman]

I hate to bring up the crazy cousin that is kept hidden in the basement, but the US is currently engaged in two simultaneous wars.

The Stiglitz book is getting into the news cycle today with his claim of a cost of $3 trillion and its effect on the overall economy. The US has behaved like a gambler who has just lost all the rent money at the track. This means that the country is actually poorer. The inevitable result of this is that our standard of living has to decline either absolutely or relative to other countries.

No amount of fiddling with interest rates and tax adjustments is going to get the squandered money back. The best that can be hoped for is that policies will be put into place so that the most vulnerable members of society won't be thrown overboard. This does not seem to be a current concern of either the Fed or Congress.

There are already many anecdotal stories of food banks running out of supplies, people losing their jobs and health care and similar indicators of economic distress.

Both parties are trying to placate the middle class (which votes) rather than dealing with the lower class (which doesn't vote). This may help win elections, but won't make for a pleasant society.

Why is it that the mistakes of the 1970's have taught us nothing?

There is no policy that can bring back that $3 trillion. The US either has to raise taxes and use the money to repay foreigners and cause more widespread unemployment, or it has to allow the dollar to sink further which will make it easier to pay of the foreign debt, but will also increase prices and, once again, increase unemployment.

There is no cost free way to get out of the folly of the past eight years. The best that can be hoped for is that the pain doesn't become too severe for those least likely to be able to cope.

How about it Mr. Bernanke? Stop talking about economic models and start talking about the effects of the wars. Oh, I forgot, one never bites the hand that feeds you. So much for an "independent" Fed.

[Callahan]

This just in, Bush sez it's not a recession, it's jest a slow growth period.

Probably unca Arnolt would say "don't be girly man bout da slow growth".

No worries.

[paine]

"Dual mandate, but one policy tool. A choice has to be made in the short run"

but
who sez we gotta play by one tool only rules here ??

have we forgotten the alternatives that began to emerge
just before the volcker dammerung

only the boys on the corporate
wage control board
really like this
slave to the niaru gimmick

[groucho]

"Focus on inflation, and hold policy relatively tight? Or focus on growth, hoping that soft economic growth will tame inflationary pressures? The Fed continues to choose the latter path."

Uhh, not exactly.

From Gary North:

"The FED has been deflating!

This is not what the public is being told by the financial media, including the "hard money" media.

Then why is the FedFunds rate in the 3% range? Because the T-bill rate is at 2.2%. Short rates are falling because there is a move to safety. It is the fear of recession, not the FED's non-existent policy of inflation, that is driving the credit markets.

Why is the FED deflating? There is no public explanation. I don't think the general investing public knows that the FED is deflating. So, the FED offers no explanation.

My guess: fear of a falling dollar internationally. If it is not this, then I do not understand the policy.

Those who expect near-term price inflation to continue at 3% or higher will be disappointed."

Lee Adler at the Wall St Examiner concurs that the FED is shrinking the base.

BTW, the "emergency" 125bp rate cuts this year were to limit the FED's treasury selling. Basically, the FED has been trying to counteract their discount(and TAF) purchases with Treasury selling.

The monetary base has been shrinking..........stay tuned.

[paine]

you know when corporate amerika has the policy wonks by the balls
when their very own tower titan spirits and guess work
are the key policy ingredient

whether its confidence to invest (37-38)
or
expectations of further inflation (now)

macro policy needs to empower uncle sam
not turn him into
some ivy league hierophant
call on us to just keep
racing around
the wall street kaba stone

[Francois]

Ironman wrotes:

"The Fed's inflationary monetary policy continues until the asset values of real estate have returned to a more sustainable level of equilibrium with other prices. That protects the financial institutions from mass failures. After that, the Fed gets serious about reducing inflation."

Except in the meantime, low and middle income Americans will get deeper into the hole. There is already widespread resentment among many people about falling behind while some are getting wealthier every year, and high inflation can only worsen and crystallize said resentment toward unrest and activism of the sort politicians dread.

Politically, something is going to give sooner than later. If inflation eats the wages of the many, guess where the money will have to come from to compensate the drop?

Here are some obvious sources:

1) tightening regulations of the financial industry would put a stop to wealth confiscation in form of ever increasing fees and dirty practices leading to surcharges.

2) raising caps on FICA taxes while lowering/freezing contribution rate from low/mid level incomes.

3) Repeal Bush's tax cuts. I have yet to read a convincing analysis (arguments abound and need not apply) for them to be maintained.

4) Have the IRS read "Free Lunch", "Perfectly Legal" and close the egregious loopholes described in these books.

5) The country has neglected its infrastructure for way too long. Time to invest in ourselves, in hard assets that will last and serve everyone for a change.

[paine]

"The monetary base has been shrinking..........stay tuned"

if so
now that's worth a whistle... eh ???

but if its just a "natural rate drop"
do to cyclical emerging market "risk reflux "
to keep up the shrink while fighting the shrink
no policy need intervene
just make paltry feckless
"well intentioned " counter moves
to the massive spontaneous run
to uncle's brand of
"safe liquids"

[paine]

"The monetary base has been shrinking..........stay tuned"

if so
now that's worth a whistle... eh ???

but if its just a "natural rate drop"
do to cyclical emerging market "risk reflux "
to keep up the shrink while fighting the shrink
no policy need intervene
just make paltry feckless
"well intentioned " counter moves
to the massive spontaneous run
to uncle's brand of
"safe liquids"

[paine]

to deflate or inflate
that is the question
but either way
price level sorcery abounds
in our nite mares
these days

such cross purposes
such diametric oppositions
no more or less
but go north no no go south
shows
the intersectoral price level contradictions
between products
commodities
land lots
and paper assets
that have suddenly surfaced
in so ugly and brutal a fashion
are quite unlikely
to resolve themselves
or be resolved by policy
without dire side effects
no matter where we go from here

[groucho]

"no policy need intervene
just make paltry feckless
"well intentioned " counter moves
to the massive spontaneous run
to uncle's brand of
"safe liquids""

paine, that's basically it for now.

Bernanke is giving the congress a con job right now. Says his monetary "expansion" policy plus Treasury deficit issue will stimulate.

Polls show the checks will be saved(or equivalent)and since he's currently shrinking the base, FED is obviously not expanding(the market's doing all the work).

What does this all mean? I believe Bernanke is currently in INFLATION FIGHTING mode. He knows that the legacy of a CB is tied to their ability(or not: remember Miller?) to keep inflation at bay.

He's giving the appearance of doing something, but the facts show otherwise.

[bakho]

Time to rain on the monetarist parade.

Yes, it is important to get the monetary policy correct. However, for some sets of fiscal and economic conditions ALL the monetary policy options are far less than ideal.

It is time to change FISCAL policy in a way that brings economic conditions back into an area where monetary policy can be effective with good, clear choices. Quit pretending that there is an optimal monetary policy for every situation. If the fiscal policy is misguided, monetary policy, however good will be inadequate.

[don]

I think the Fed has been deliberately obtuse in sticking with the 'core inflation' goal when inflation in food and energy prices seem clearly to be rising steadily at rates above the core base. I wouldn't be surprised if they weren't just trying to generate inflation without the attendant increase in inflationary expectations. This would allow home prices to adjust without causing long term interest rates to rise. Neat trick, if it can be brought off.

I doubt if the Fed is trying to maintain the value of the dollar. Dollar depreciation is needed to undue the unsustainable current account deficits of recent years. The only problem is, Asian countries seem unwilling to accept their share of the needed adjustments. Unless they do, we may simply drag down the other trading partners, rather than having them lift us up.

My old question, for any who may have noted my other posts - why is our only solution to the current slow-down to spur demand, when we already have so much excess demand? Much of our current trade deficit is not the result of natural forces and comparative advantage, but of absolute advantage created by foreign exchange rate policies abroad. Why do we accept this so readily? For example, what kind of credibility can the U.S. Treasury maintain when it refuses to brand China as a currency manipulator?

[Mark Thoma]

Robert:

Tim is a colleague and he writes for this blog, so this is the original link.

I indent them (I didn't at first) because people tend to think I wrote them if I don't and I wanted to be sure that Tim gets the credit.

Mark

[groucho]

Found this on the Miller wiki.

Does anybody think that Bernanke wants something similar to be written about him in the future?

Bernanke has gone from "scribbler" to policymaker, all eyes are on him and he knows that historians will have a field day if he lets inflation get away.

His personal legacy is more important to him than employment or consumer assets. For now, his helicopters are grounded.

"under G. William Miller, who was was chairman from January 1978 to August 1979, the Fed provided the monetary fuel for an inflation that began as a flicker and grew into a fearsome blaze... If Nixon appointee Burns lit the fire, Miller poured gasoline on it during the administration of President Jimmy Carter. Without question the most partisan and least respected chairman in the Fed's history, this former Textron executive worked in tandem with fellow Carter appointee, Treasury Secretary W. Michael Blumenthal, in pursuit of monetary policies that were expansionist domestically and devaluationist internationally. The goals were to spur employment and exports, with little thought to the dollar's value. By early 1980, inflation was running at 14 percent.[6]
—Steven Beckner, Back from the Brink: The Greenspan Years

[paine]

For example, what kind of credibility can the U.S. Treasury maintain when it refuses to brand China as a currency manipulator?

alpha question

[Fred]

What we are about to see is the final discrediting of monetary policy and the other modern neo-classical synthesis shibboleths. Household balance sheets are about to sink by something like $10 trillion. This must be compensated for by something like $6 trillion in additional Federal debt. That means deficits on the order of $2 trillion a year for the next few years. This $150 billion stimulus just isn't going to do the trick.

Those aggregate demand implied by those $2 trillion deficits will leak away because of the trade deficit unless we impose an across the board tariff. Alternatively, impose a selective tariff on those countries with which we have excessive trade deficits. That will sock it to the oil exporters and is VERY politically feasible.

Huge budget deficits will allow the Fed to RAISE interest rates, thereby crushing all this hedge-fund drive commodity speculation and pushing the dollar back up, thereby bringing cost-driven price inflation completely under control and opening the door to still higher budget deficits. Higher interest rates will also crush Wall Street and the banks, which need crushing bad. Assuming budget deficts are truly massive, there will plenty of cash rich private investors like Warren Buffet to step in and create new banks. We don't need to protect the existing boobs and incompetents.

We are facing a classic Keynesian crisis of collapsing aggregate-demand as everyone shifts from spending to saving. Massive budget deficits are the only answer.

[donna]

"Why is it that the mistakes of the 1970's have taught us nothing?"

Damn fine question. I seriously think that at least half of this country is learning impaired.

For those of us in this economy who have remembered how to manage our money, maintain savings in our credit unions (which did not make any outrageously idiotic loans), and live within our means, not moving up to the big house we didn't need, this is all very entertaining to some extent, but we know we're the ones who will eventually fott the bill for the bailout.

And guess what kids? When we do it, we're taking you down, big boys! Say goodbye to those tax breaks you love and those big salaries and bonuses.

Oh, we didn't mention we're your stockholders, too?

Details.

[paine]

fred i love you

reading your stuff reminds me
of one of those early 70's
street percussion bands

if we did everything you suggest
the earth's market economy would look like
a human face accelerating at 6 g's

[don2]

The key here is whether wages rise/stagnant/go down. And the key here is whether unemployment increases. I suspect it will, and with that one will assume also that inflation, especially combined with a speculative unwinding due to deleveraging, unfolds.

The Fed will get its decline in inflation, I believe, and along with that a severe recession. The Fed is gambling by walking a tight rope between inflation and recession, with a economic slowdown keeping in check inflation but not getting so bad as to drop into a recession. m

says...

Hurrah!

If anyone had any doubts that Bernanke works for the Bankers, this should lay it to rest.

http://www.forbes.com/markets/2008/02/28/bernanke-bankruptcy-bill-markets-econ-cx_md_0228markets33.html

Bernanke Won't Back Loan-Modifying Bill
Maurna Desmond, 02.28.08, 5:15 PM ET

Ben Bernanke doesn't want people to lose their homes, but won't condone changing the rule of law to save them. The head of the Fed also said a bill allowing mortgages to be changed to save people's homes would be more of a cost to the U.S. economy than a benefit.

Federal Reserve Board Chairman Ben Bernanke said Thursday that altering U.S. law so that judges could modify the terms of a mortgage would most likely add to the cost of mortgages. In a Senate Banking Committee meeting, Bernanke said, "I don't know how much it would add," but it would "probably add something, because collateral would be less secure."

[esb]

When I returned from Davos a couple of weeks ago I traveled with a Shanghai-based banking consultant who operates what we in the west would call a "think tank" and then hosted him (and his lovely translator who usually accompanies him for accuracy purposes) at my California wine country home for a week.

I spent some time with him last night by telephone to obtain whatever current insights he was willing to share regarding the the "mess" which is the subject of this and other related threads in this space.

Now this gentleman never provides the answers that one is anticipating but always amazes in his revelation of the vast difference between Judeo-Christian Anglo-Saxon thinking/planning and the Chinese nature of same.

What he said that is most striking (direct without translation) was that "your stupidity will result in our having your Pacific Fleet out of the Southern Western Pacific by 2025 not 2045."

He also recommended that although he would be delighted were I to see the Summer Games, I should not be on ANY vacation during the third quarter of this year, "for obvious reasons."

Message reveived.

The plug will be pulled.

[Robert Bell]

Mark: thank you.

[One Salient Oversight]

We are facing a classic Keynesian crisis of collapsing aggregate-demand as everyone shifts from spending to saving. Massive budget deficits are the only answer.

There is no room for massive budget deficits. The third largest Federal Government expenditure (after military and health) is interest payments on money borrowed - a number that is equivalent to 3% of GDP.

Moreover, running big deficits will push net debt to between 75 - 100% of GDP. Any benefit arising from such deficits will be quickly swallowed up. America has already been mortgaging the future in order to run deficits in the present... but now the future has begun to arrive and the payments are due.

The solution is austerity. The Fed should raise rates to control inflation (preferably keeping inflation at zero over the course of the business cycle) while the Federal government cuts spending and/or raises taxes to run a surplus. This, of course, will result in a very bad recession... but that's what is needed - you can't avoid it, you can only postpone it and make it worse. You might as well get it over and done with while committing yourself to tighter monetary and fiscal policy in the future.

[Patricia Shannon]

I'll bet "One Salient Oversight" doesn't anticipate being out of work during the recession.

[Fred]

The debt to gdp ratio in Japan is way over 100% and many other countries have debt to gdp ratios near 100%. The US can easily take on $6 trillion of new debt and even more.

We WILL get massive deficits, there is no question of that. The voters will rebel against the Professor Pigou option. The question is whether these deficits and the corresponding debt buildup occur due to tax holidays for the middle class and poor (my preference) or whether they occur due to a bailout of the banks and hedge funds (what I'm worried about).

To clarify the situation. If a typical household loses, let's say, $50,000 of net worth due to a collapse in house and stock prices, then the natural response of that household is to stop spending and start saving. This causes a collapse in aggregate demand. Business profits plummet because no one is buying, so businesses lay off workers. Now the households are even more worried, and so in addition to trying to shore up their balance sheets by saving, they also start to save in preparation for possible layoffs. More losses for business, and hence more layoffs, and hence the system spirals down to nothing. To prevent this, the government must allow the households to quickly restore that $50,000 of net worth. What was lost by collapsing house and stock prices must be restored by government bonds, implying a huge increase in government debt. This is the situation and the solution discussed by Keynes in his General Theory in 1936.

To reiterate, given that the Professor Pigou option (also discussed in Keynes) will not be acceptable to modern voter, a huge increase in government debt MUST occur, because of a combiantion of simple bookkeeping logic together with some uncontroversial assumptions about household psychology, such as that households tend to save until their net worth reaches a certain multiple of income, and then to stop saving thereafter. The only question is how this debt buildup occurs. Do we favor the middle class via tax cuts, or do we favor the wealthy via a bailout of Wall Street and the banks?

[jo6pac]

Well Crazy Ben has done it saved us, all little people that is and I for one can hardly wait to get my greedy little dirty hands on the money so I can turn in to a couple of 6 pacs. I think what bothers me most is the money that was spent on the educations of the ones that caused/created this. It might suprise them when they loss to because every one has a boss (not who you think).
jo6pac
The race to the bottom continues.

[Mace]

"Have faith in the great ownership society, globalization, and those wonderful tax cuts, they'll fix it, just you wait."

Yeah, let's raise taxes in the middle of a recession, just like Michigan. That ought to produce wonderful results for the economy.

[bullbust]

The only question is how this debt buildup occurs. Do we favor the middle class via tax cuts, or do we favor the wealthy via a bailout of Wall Street and the banks?

Exactly.

But you underestimate the illusion the middle-class is under. They fully think that they as home-owners and their retirement investments are part and parcel of the in-crowd of Wall Street.

The Wall Street bailout is viciously supported by the middle-class itself.

[groucho]

"He also recommended that although he would be delighted were I to see the Summer Games, I should not be on ANY vacation during the third quarter of this year, "for obvious reasons."

esb, care to conjecture on what your Chinese friend was leaking?

The Summer Games start 8-8-08 and run to the 24th. Clearly in the 3rd quarter. I'm guessing he means a terrorist attack or a new war(Iran?), between the end of the games and Nov 4.

Care to share?

[groucho]

esb,

I can't see a Taiwan invasion coming any time soon.

[groucho]

From the Wall St Journal:

"That '70s Show
By ALLAN H. MELTZER
February 28, 2008; Page A16

Is the Federal Reserve an independent monetary authority or a handmaiden beholden to political and market players? Has it reverted to its mistaken behavior in the 1970s? Recent actions and public commitments, including Fed Chairman Ben Bernanke's testimony to Congress yesterday -- where he warned of a steeper decline and suggested that more rate cuts lie ahead -- leave little doubt on both counts.

An independent central bank is supposed to maintain the value of the currency and prevent inflation. In the 1970s and again now, Federal Reserve officials repeatedly promised themselves and each other that they would lower inflation. But as soon as the unemployment rate ticked up a bit, the promises were forgotten."

Looks like Meltzer is trying to influence the FED's policy, again. He tried to convince Greenspan(with no luck) that the potential deflation that might occur after the Tech bust would be benign.

Of course, Greenspan followed Bernanke's playbook(making sure deflation doesn't happen here) and the rest, as they say, is history.

Meltzer's and Bernanke's positions were polar opposites, so it's not surprising that Meltzer would criticise Bernanke now.

[Expat]

Ironman and Francois are right. This global credit bubble (the next person who calls it the Sub-Prime Crises gets shot)needs to deflate. House prices are simply too high, but few, other than non-owners, want prices down. This problem extends to commericial real estate, commodities, and equities, which is to say all asset classes.

If we let the bubble pop there will be blood. Tens of trillions in "ficticious" (I put it in quotes because it is getting hard to tell what it real and what is not these days) wealth will disappear, banks will fold, corporations will go bankrupt, tens of millions will lose their jobs and homes, cats and dogs will mate, and the Stay-Puft Marshmallow Man will wreak havoc on NYC.

On the other hand, if we cut rates, bail out the banks, put lipstick on the monolines, crush the USD and let inflation run to double digits, we can push this horror into the lap of the next president, probably a democrat, who will take the blame while Bush and Greenspan sniff coke off the ass of an Argentinian hooker on the Bush family ranch down there (no extradition, you see).

Of course, wages won't follow the inflationary spiral. Joe Six-Pack will lose his job or simply get 1% raises at best. His real income will accelerate its 30 year decline. Ultimately something will happen, like another war (three of them have not helped yet, though).

I hope to God I am well positioned for this (no home and lots and lots of Euros), so I can continue to bitch-slap all the frickin' idiots who droned on and on about their stupid real estate investments. Bring on Bird Flu, I say!