The Fed Could Use Some Help

Glenn Hubbard says the Fed can't do it alone:

We're Asking Too Much of the Fed, by R. Glenn Hubbard, Commentary, WSJ: The combination of eye-popping headline inflation of 5% year over year and dramatic expansions of the Federal Reserve's lending activities to limit the credit crunch raise a key question: Are we asking too much of monetary policy?

The simple answer is yes. The expansion of the Fed's lending has been extraordinary in scale and scope. But it is not the best response to the present credit crunch, and may bring unwelcome side effects. ... moral hazard. ... ... inflationary pressures. ...surging commodity prices ... weakness in the foreign-exchange value of the dollar. ...

It is asking a lot for monetary policy alone to carry the burden of supporting aggregate demand. Fiscal policy can play a role. Congress and President Bush did pass an economic stimulus package centered on tax rebates. But clarity about a positive future for the 2001 and 2003 tax cuts which bolster collateral values -- along with a cut in corporate tax rates to promote investment -- would offer a much more potent tonic. ...

I agree that Fed policy alone may not be enough to get the economy back on track, I've argued that for a long time. But tax cuts are not the only option for stimulating the economy, government spending can also be used, and in theory on short-run stabilization policy, a one dollar increase in government spending has a bigger impact on GDP than a one dollar tax cut. Infrastructure is an obvious target for spending, it's surely needed, but there are other areas that could use help as well.

If the worry is that the spending will be permanent, Democrats can play the Republican game, but actually mean what they say. A stimulus should be temporary, so - just like the Republicans do with tax cuts - put clauses in the legislation that say the spending expires at a certain date. There will be x dollars per year for y years to do z, and that will be it. That way, there's no long-run impact on the budget (unlike the real intent of the tax-cut advocates who, once the economy gets better, will argue against reversing the stimulus measures). If the goal is to stimulate the economy, there's just no need to limit the policies under consideration to some type of tax cut.

Comments

[Bruce Wilder]

". . . clarity about a positive future for the 2001 and 2003 tax cuts which bolster collateral values -- along with a cut in corporate tax rates to promote investment -- would offer a much more potent tonic."

And, most vitally, that tonic will go to the eponymous Russell L. Carson, the most important person in Glenn's universe.

[Michael McKinlay]

Actually nationalizing the privately owned and operated Federal reserve and replacing it with a public central bank that would create money without debt is what should happen.

The Fed got us into this mess through dereliction of their duty to regulate and police then using interest rate policy that produced negative real rates to promote Greenspan's selling of sub prime and negative amortization loans to enrich his buddies in the financial industry.

The private sector has encumbered the people with their greed, theft and incompetence since the privately owned and operated Federal Reserve was established. Their money making monopoly of leveraged debt fractional banking has only brought crashes and inflation since the beginning.

It is time we the people regained control of our money creation from the bankers.

[Regressive]

Eliminate regressive taxes, and keep the progressive ones. Inflation is one of the most destructive regressive taxes extant. An income tax on pensions is limited to maybe 1/3 of it per year. An inflation tax on pensions takes more of the pension each year, until the effective rate is well over 50%. Purchasing power can drop to near zero if the hapless person lives long enough. Inflation is a ridiculous tax.

[One Salient Oversight]

Michael,

While I would agree that the Fed needs to be under the complete control of the Federal Government, I do not see Fractional Reserve Banking as the issue. Most, if not all, nations around the world use Fractional Reserve Banking in the process of money creation.

The Fed is certainly to share much of the blame for the current mess, but I wouldn't say that Fractional Reserve Banking is the cause.

[One Salient Oversight]

Re: Mark's commentary.

There is no doubt that fiscal policy has the ability to stimulate aggregate demand, but there are a few problems with it.

The first concerns where the stimulus is directed. It is far too easy for government to divert stimulus in political directions. Throwing money at pork barrel projects under the name of fiscal stimulus is something not unheard of.

The second concerns America's Public Debt. I'm not one who believes that government can keep running deficit after deficit after deficit and not result in some sort of imbalance. If Federal Government net debt was low (or even zero or negative), then a fiscal stimulus plan would work very well. In America's case now, however, with net public debt is probably around 60% of GDP, there is little room to move. Any fiscal stimulus plan will incur even greater deficits that will come back to bite the US economy in years to come.

Debt repayment (paying back money owed) represents more than 3.1% of GDP. Debt repayment is the third largest area of government spending (after health and defense) and, in 2007, was $430 billion. By way of comparison, NASA spent $15 billion and the Department of Education spent $61 billion.

Oh, and US debt levels (60% of GDP) were measured before the current crisis. So you can then add into this calculation the lower tax revenue that will be generated during an economic crisis.

In actuality, there is no room to move. If the Federal Government chooses to increase the deficit the result will be a short term stimulation followed by a long term collapse. Increasing spending and thus increasing the deficit at the same time as government revenue has dropped because of a recession and at the same time as fiscal mismanagement by the government has led to net public debt of 60% of GDP, and the result will be horrific.

There are countries around the globe whose net public debt levels exceed 100% of GDP. The result of this is that increasing interest repayment is crowding out legitimate government spending. If the US wishes to pay back $1 trillion plus per year in merely interest repayments, then go ahead and run some more deficits.

Let me reiterate this point - in the face of one of the most damaging economic crises in the last 60 years, the Federal Government has absolutely no room to move in terms of fiscal policy because of its financial mismanagement to date.

The only real solution is counter-intuitive: cut spending in order to create an eventual fiscal surplus and order the Fed to focus on keeping inflation down. Then let the chips fall where they may. Painful? Yes. But it is the only solution.

[gordon]

As I pointed out in a recent comment (on Krugman's "L-ish Economic Prospects" post), there is a lot more that could be done to protect the "real economy" from the effects of the current Grand National Potlatch of dubious financial innovations. I suggested that people look at the EPI's Agenda for Shared Prosperity as an example of what I mean. But maybe the US Federal Govt. isn't capable of that sort of thinking. Maybe they should just outsource economic management to the EPI.

[Gerard Link to comment]

Gerard says...

Solution: Permanent tax cut. The problem may vary but the solution is always the same. It is truly AMAZING how good those permanent tax cuts are. They fix EVERYTHING.

[bakho]

Many ideologues truly believe that the government can do no good, that it makes no difference if the government spends money on X vs Y. To extend their argument, tax cuts for the wealthy has the same economic impact as government spending on school lunch or health care for children.

How the government spends and invests the public money does matter. It matters because the multipliers are different. It matters because where the money is spent (BMWs and foreign manufacturing plants) vs local schools or local doctors is different. It is absurd for them to pretend that it is the same. It isn't and that conclusion is backed by good data and good modeling.

[pgl]

Glenn seems to be saying that fiscal stimulus is not as inflationary as monetary stimulus. Over at Angrybear, I object.

[pgl]

BTW - if one checks out my post on this topic, one will see a really sad attempt by some character Movie Guy to say you are dishonest. It's an old game played by a few rightwing trolls (e.g., FA who is too much of a coward to do so over here) and I've decide to use our comment box to fire back at these jerks. If I knew how to delete comments at Angrybear I would and hopefully my colleague Rdan does. My apologies that our blog has become the outlet for the FAs, Movie Guys, and the like who think they have the right to attack you behind your back.

[Mark Thoma]

Yeah - I deleted one of his comments, deservedly so, and he's acting like a big whiny baby about it.

Figures.

As for FA, he can say what he wants, he's banned for good from this site. He knows why. I guess he's taking at well also. That's fine, it's his own doing.

I don't read the comments at other sites anymore, at least not much, I can hardly keep up here, so thanks for stepping in. It used to bother me, but they can be jerks if they want, there's nothing I can do about it. I figure I get trashed daily somewhere - that's part of doing this. But it's really nothing but a childish response to having a comment removed.

At first, I was going to post any reasonable comment Movie Guy made - one with actual substance - but in the many, many comments I've deleted since (after moderation), he's done nothing but keep it up. It irritated me to the point where I simply removed all of his comments from last night rather than deal with it any further.

He takes way, way too much time to deal with - if he wants to stay at your site, that's fine with me. He isn't banned, but no comments will be allowed through until the tone changes and there's an actual point being made that contributes positively to the conversation.

[Winslow R.]

pgl wrote" "...seems to be saying that fiscal stimulus is not as inflationary as monetary stimulus. Over at Angrybear, I object. "

I agree. Monetary policy is only inflationary if it creates bubbles that must be bailed out with fiscal policy.

Simply look at loans as putting money into the economy and interest and principal payments drawing it back out. If banks fail to collect those payments through a debtor bankruptcy, the banks capital is reduced offsetting the uncollected payments.

If a bank has insufficient capital that requires a fiscal bailout then monetary policy has become inflationary.

Fiscal deficits do lead to money being added to circulation. Since GDP grow as do savings desires, deficits are not necessarily a problem that need to be compensated for through taxes. Excessive inflation can indicate a need for increased taxes, but could also just indicate a need to allocate purchases based on cost.

[Michael McKinlay]

One Salient Oversight,

Fractional Reserve Banking cannot survive and will be ruinous to the survival of the United States and the rest of the world.

Current money supply is created and sustained through geometric debt accumulation and as the world's resources diminish there will be less debt creation as there will be fewer and fewer resources and products to underwrite. We are headed for world insolvency.

Since every year enough debt needs to be created just to pay the interest on the existing debt the money supply will either shrink or be extremely inflationary. Currently the money supply cannot exist without geometric leveraged debt increase.

The US Government should be the arbiter of credit creation by the production of money without debt so that over time debt can be eliminated. Stimulus plans only produce more debt ... the very problem that will crash our economy.

[2slugbaits]

Mark,

In one of your video lectures you talk about monetary policy being ineffective ("pushing on a string") if investment is not responsive to the interest rate; i.e., if the IS curve is strongly inelastic. I realize the old IS-LM framework is a bit dated, but doesn't the basic point still stand? The Fed's good at pulling on the string; not so good at pushing on the string.

[Mark Thoma]

2sl:

Yes - particularly since investment includes spending on hew homes. I don't expect housing is particularly interest rate sensitive right now.

I also have a Journal of Econometrics paper that argues monetary policy exhibits weak effects at the bottom of the cycle. Thus, it is most powerful at slowing an overheated economy than it is at stimulating the economy out of the doldrums. One caveat - in the current case, it is getting credit markets working at all rather than the interest rate itself that is the problem, so monetary policy may be able to forestall a bigger problem if it can keep credit markets working to a satisfactory degree. But preventing a disaster is different from returning the economy to potential.

[mrrunangun]

If an infrastructure program is to be the stimulus, it should be federally run and not via grants to states and local govs. In states like Illinois, NJ, and Louisiana half of the money will be wasted on and through well connected lawyers and consultants whose fixes with the state and local pols are necessary for the pols to discreetly get their shares. The current bill would facilitate just this kind of chicanery.

[Lafayette]

MT: a one dollar increase in government spending has a bigger impact on GDP than a one dollar tax cut.

Quite right. A tax cut can go unspent, which is not the case of government expenditure.

I would not reduce taxes. There is so much that can be done in terms of Social Investment to mend this country, gone awry after 8 years of mismanagement.

The boost would result in relaunching the economy (just like the New Deal did at its time) and the inevitable return in enhanced revenues will be required to pay the borrowing costs of those expenditures.

To reduce taxes AND increase spending would be sheer folly. I doubt this lame-duck of a lead-head would dare try. But, I would put nothing past these idiots.

says...

When I see and hear Glen Hubbard pontificating, I can't help but think he embodies what Grover Nordquist would be if he where educated. Clueless but with panache and the hubris that comes with a PhD, especially from the Ivy League.

I agree with Hubbard that the role of the Fed has been stretched out of proportion to it's mandate. The politics of the Fed has allowed them to justfy, to themselves, the use of high octane money to validate and support a radical, partisan fiscal policy that clearly began failing on day one. Increasing their powers and influence is foolish and dangerous. They have done enough. Let's try to limp into a new administration, clean house, and limit the further damage these assholes can accomplish before we usher them to the door.