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| "Helicopter Ben" |
“Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.” Ben Bernanke, Chairman of the US Federal Reserve Bank, 31 August 2012
The Chairman of the US Federal Reserve, Ben Bernanke, is in a hole in more senses than one. The first sense is that he has just spent a weekend in Jackson Hole, Wyoming at the annual symposium organised by the Kansas City Federal Reserve Bank to discuss the big economic issues of the day and the response of monetary policy. Every year, the Federal Reserve, just before the end of vacation period and US Labour Day, various central bankers in the world and other invited guests come to this ski resort under the Grand Teton mountains, one of the most spectacular set of peaks in the American Rockies, to hear various academic papers and the Chairman of the Fed deliver a keynote speech on the state of the US economy and what to do.
The participants must pay their own board and lodging, there are no special facilities for security and central bankers must mingle with ordinary guests at the ski lodge. After sessions on various papers, they all take a walk on slopes of Tetons to clear their minds. It all sounds very egalitarian and humbling. Well, Bernanke needs to clear his mind because, in another sense, he is in a hole. He is being assailed on all sides of the pro-capitalist economic spectrum to do something about the state of the US economy.
The economy is not in a technical recession (two consecutive quarterly contractions in real GDP), as is much of Europe including the UK. But this recovery after the Great Recession is the weakest ever. As I described in a previous post (QE, the euro and the monetary option, 4 August 2012), John Taylor, the right-wing economist from Stanford University and a close follower of Fed monetary policy described the US recovery: “From the start it was clear that the recovery was very weak. By its second anniversary the recovery was weak for long enough to call it ‘a recovery in name only, so weak as to be nonexistent.’ Now we are just past the third anniversary, and it is still at best a recovery in name only. It’s now the worst in American history—a tragedy that should not be minimalized.”
Bernanke himself is very worried about the economy, particularly the level of unemployment that stubbornly refuses to come down some three years since the trough of the Great Recession in mid-2009. As he put it to the Jackson Hole participants: “The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.”
If we look at some of the key forward indicators of the state of the economy, then the picture is pretty dire. In a capitalist economy where production and investment is for profit, it is always profits and investment not consumption and employment that tell you where an economy is going. I have already shown in previous posts that US profitability (not total profits) remains below its peak in 2006 and even more below 1997 and it has now peaked again (see US profitability: which way?, 30 June 2012). As for investment, one key forward indicator is the level of new orders for investment in the productive sectors of the economy. Despite very high profit levels (although they have peaked), core capex new orders (excluding aircraft and defence) are in negative territory for the first time since the Great Recession.
So if corporate investment in productive sectors is set to fall or remain stagnant, that does not bode well for getting unemployment down and household incomes up. Indeed, real household incomes are suffering their most significant decline since the recession of the early 1990s and for the key group of households headed up by 45-64 year olds, the fall has never been greater.
Now Ben Bernanke made his name as an economist on the study of the cause of the Great Depression of the 1930s and what should be the appropriate policy response by a central bank like the Fed. He famously argued in 2002 that a depression could always be avoided because the Fed could take action to increase the money supply indefinitely when interest rates could no longer be lowered. For this, many have called him ‘Helicopter Ben’, following the idea first muted by his mentor Milton Friedman, the Chicago University economist of the quantity theory of money, that, if necessary, the economy could be revived by dropping notes from helicopters all over the US and so boost demand in a depression.
Friedman had argued that the Great Depression of the 1930s had been caused by excessive credit in the economy engendered by the Fed in the period before the 1929 crash and then by an arbitrary withdrawal of credit by the same Fed after the crash. The Fed was ‘pro-cyclical’. What was needed was a judicious use of Fed money powers and depressions can be avoided. This explanation of the causes of depression and their solution has been swallowed hook, line and sinker by Friedman’s disciple, Ben Bernanke. As he famously said at a celebration of Friedman’s 90th birthday, ten years ago, “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again”. In his Jackson Hole speech, Bernanke reiterated his longstanding claim that “purchases of longer-term securities by the Federal Reserve during the Great Depression could have helped the U.S. economy recover despite the fact that short-term rates were close to zero”.
Bernanke reminded us that “Friedman argued for large-scale purchases of long-term bonds by the Bank of Japan to help overcome Japan’s deflationary trap.” Since the onset of the Great Recession, Bernanke has attempted to employ Friedman’s theory to the US economy. The Fed first cut interest rates to zero and then from autumn 2008, launched its first quantitative easing (QE) through purchases of government and corporate bonds, in order to boost cash flow into the banks, drive up stock prices and hopefully help the wider economy. Then in 2010, after Ben Bernanke made a keynote speech at Jackson Hole in that year, the Fed started a new round (QE2). The banks were supposed to use this cash to lend onto the ‘real economy’ of businesses and households, or failing that, reduce interest rates on government bonds and mortgages, making it easier for corporations and households to borrow their way out the slump. QE2 was followed up what is called Operation Twist (or QE2.5) in September 2011, where the Fed sold its holdings of short-term government bonds to buy longer term ones to try and lower interest rates in key areas. All these Fed purchases were mainly financed by increasing the monetary base of its balance sheet (printing money).
Was this policy successful? Well, it certainly has not restored trend growth in the US economy. But the Jackson Hole participants heard from Bernanke that it had been successful in lowering interest rates. He said studies show the Fed’s two previous rounds of QE plus Operation Twist had lowered Treasury yields by 80 to 120 basis points. They had also led to “significant declines in the yields on both corporate bonds…[and] substantial reductions in MBS yields and retail mortgage rates. QE also appears to have boosted stock prices, presumably both by lowering discount rates and by improving the economic outlook.”
Here, Bernanke seems to argue that QE helped boost financial asset prices (bonds and stocks) and this had increased the wealth of household and corporations. From this there was a ‘wealth effect’, allowing households to spend more. It is ironic that the Fed should now measure its success in policy by how much the stock market and government bond prices go up! This Fed ‘success’ raises wealth for the very rich who own most of these stocks and bonds, but does nothing for the average household that has little or no financial wealth. Their only wealth is in their homes. Although house prices are no longer flagging, the loss of accumulated wealth in real estate for the average household has been considerable.
As one commentator in Bernanke’s policy put it, the idea of ‘trickle down’ economics where tax cuts for the rich are supposed to lead to increased spending that eventually trickles down to jobs and incomes for the average household has been discredited. And yet, the Fed now claims benefits from a ‘trickle down’ monetary policy. But if the aim of ‘unconventional’ monetary measures like QE was to boost the wealth of the average household and raise confidence among small businesses and households, it has miserably failed as the main confidence indexes show.
Markets were eagerly waiting for Bernanke to announce QE3 at Jackson Hole with a new round bond purchases designed to give yet another kick to the economy. Bernanke did not do so, but he gave pretty strong hints that the Fed may well do so this month or by the end of the year. The questions now raging on all sides is whether QE has worked and will work and what is the best policy for the Fed to adopt.
The Keynesians want more QE, big time. In one of the academic papers presented at Jackson Hole, Michael Woodford of Columbia University presented a hugely long presentation called Methods of policy accommodation and the interest rate lower bound (http://www.kansascityfed.org/publicat/sympos/2012/mw.pdf?sm=jh083112-4). Woodford basically argues that when interest rates cannot be lowered further (i.e. they are ‘lower bound’), then QE is an effective policy in easing credit terms by raising ‘expectations’ that money is always available. By doing so, that helps boost transactions. Woodford reckons that if the Fed increased money creation with a target for nominal GDP growth, that would do even more in boosting ‘confidence’ among households and businesses so that economic growth would follow like magic pixie dust. This paper was greeted with enthusiasm by the likes of Paul Krugman, while supporters of Modern Monetary Theory prefer fiscal action and government spending and dismiss (correctly in my view) the efficacy of QE. But both want more government spending and money creation in tandem, dismissing fears of rising debt and inflation down the road.
But there is the another group baying at Bernanke from the other side of the economic argument. William R. White is currently the chairman of the Economic Development and Review Committee at the OECD in Paris. He was previously Economic Advisor and Head of the Monetary and Economic Department at the Bank for International Settlements in Basel, Switzerland. White was one of the few economists (as early as 2002) who forecast that’ excessive credit’ expansion could lead to a financial crisis (see my paper, The causes of the Great Recession). White is clearly influenced by the Austrian school of economics that sees crises as the result of interference by central banks like the Fed. In a new paper for the Dallas Fed, called Ultra easy monetary policy and the law of unintended consequences (http://www.dallasfed.org/assets/documents/institute/wpapers/2012/0126.pdf), White argues that there are limits to what central banks can do. Indeed, ultra easy monetary policies can eventually threaten the health of financial institutions and the functioning of financial markets and can encourage “imprudent behaviour” on the part of governments.
JR Hummel is even more upset with Bernanke. He reckons he has distorted the legacy of Friedman’s quantity of money theory. There are “significant differences in Friedman’s and Bernanke’s approaches to financial crises. Bernanke has so expanded the Fed’s discretionary actions beyond merely controlling the money stock that it has become a gigantic, financial central planner. In short, despite Bernanke’s promise, the Fed did do it again.” http://www.independent.org/pdf/tir/tir_15_04_1_hummel.pdf .
So Ben Bernanke is down in a hole and being shot at from both sides. The Keynesians reckon he is not doing enough to get asset prices up and create confidence and rising expectations. To achieve that the Fed must be “credibly promise to be irresponsible” (Krugman). The Fed must also lie (Mark Thoma at http://economistsview.typepad.com/economistsview/2010/06/the-credibility-of-monetary-and-fiscal-policy.html):
“[The effectiveness of policy] relies upon changing expectations of future inflation (which changes the real interest rate). People must believe that the Fed will actually be willing to create inflation in the future when it comes time to do so. The best policy is to promise to create inflation, then renege on the promise when it comes time to follow through. “ In contrast, the Austrians and monetarists reckon he is stacking up a load of disasters for the economy down the road by expanding ‘unproductive credit’.
The Keynesians think that the economy can be revived by the Fed raising ‘expectations’ (falsely), along with more government spending. The Austrians reckon that more money creation caused the crisis in the first place and so must be stopped immediately. The reality is that Bernanke and his critics are all wrong. That’s because they continue to focus on the financial sector as the root cause of the slump and not on the productive sectors that create (not enough) value. You can tinker with more or less money creation, but it will have little effect if the productive sectors of the economy are not recovering sufficiently to get investment and employment up. In the meantime, the economy remains in depression.
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