How deep after Jackson Hole?
By Hossein Askari and Noureddine Krichene
In his weekend speech at Jackson Hole, Wyoming, home to an annual Federal
Reserve retreat, Fed chairman Ben Bernanke acknowledged that the United States
economy had indeed slowed down. He noted that monetary policy will remain
extraordinary aggressive until recovery becomes strong.
"The [rate-setting Federal Open Market] Committee [FOMC] is prepared to provide
additional monetary accommodation through unconventional measures if it proves
necessary, especially if the outlook were to deteriorate significantly. The
issue at this stage is not whether we have the tools to help support economic
activity and guard against disinflation. We do. Notwithstanding the fact that
the policy rate is near its zero lower bound, the Federal
Reserve retains a number of tools and strategies for providing additional
stimulus.
"I will focus here on three that have been part of recent staff analyses and
discussion at FOMC meetings: (1) conducting additional purchases of longer-term
securities, (2) modifying the Committee’s communication, and (3) reducing the
interest paid on excess reserves. I will also comment on a fourth strategy,
proposed by several economists - namely, that the FOMC increase its inflation
goals."
Bernanke's policy goal, as outlined in Jackson Hole, is to reduce interest
rates across the term-structure and expand domestic credit in any and every way
imaginable. The words that could well be his motto are: "inflate and everything
else be damned".
Bernanke and his supporters have firmly adhered to money unorthodoxy. He wanted
to fight deflation in 2002 when he joined the Fed, four years before being
appointed chairman. Since then, prices of real estate, food, oil, gold, and
other commodities and assets have skyrocketed.
In his Jackson Hole speech, Bernanke believed that the US economy was suffering
from price deflation. According to his reading, inflationary expectations
remained low and anchored. Since Bernanke has set interest rates at their
lowest level in US history, inflationary expectations, inferred from the
term-structure of interest rates, could only be low. However, looking at the
prices of gold and other commodities, inflationary expectations could be at
their highest level for the post-World War II era.
Bernanke has considered low inflation as a Fed success story and one that
affords the central bank hard-earned credibility. While the Fed may trumpet the
low level of core inflation its success story, for those who consume cheese,
pasta, meat, orange juice, and other food products, there is no success. In
fact, they wouldn't know what the Fed is talking about as the prices of food
products have been going up and up. For the average person if this is success,
it is success that they could live without. For the Fed to base its credibility
on having kept inflation low may be dangerous grounds.
The Bernanke approach is simple - only extraordinary monetary policy can pull
the economy out of recession. Similarly, President Barack Obama has set large
fiscal deficits as the way to pull the economy out of recession. Thus the
foundation of US national economy policy to achieve sustained and significant
economic growth is a combination of overly expansionary monetary and fiscal
policy. The market mechanism and the private sector be damned, at least for
now.
But it is these same policies, adopted since 2001, that have wreaked havoc on
the US and the other industrial countries since 2007. The global financial
system was saved at the cost of trillions of dollars in bailouts, but with the
burden simply shifted from banks to taxpayers, workers, and pensioners.
Increasing government expenditures and deficits to record levels in a bid to
restore economic growth can only lead to more intractable economic conditions
in the future, where real resources for financing large deficits become
limited. In the same vein, forcing extraordinary monetary expansion can only
lead to unsafe credit expansion, high inflation, and general bankruptcies. In
spite of the unsustainability of these policies, and the resulting economic and
financial chaos and misery, it has been near impossible to dissuade
policymakers from their super-expansionary path of short-run growth at any
cost.
Chairman Bernanke and his supporters have wanted to re-inflate the economy from
the outbreak of the crisis in 2007 until now, no matter what the attendant
cost. Trying to push housing prices above their boom levels of 2004-2006 and
rekindle the housing boom has been sheer madness. Despite the current record
low mortgage rates, housing sales recently fell by 27% after the tax incentives
for first-time buyers expired.
In economics, bygones are bygones. Bernanke and his supporters have not grasped
the simple fact that the world of the post-2007 financial collapse was
different than that of the housing boom years of 2004-2006.
In the boom years, Lehman Brothers and other giant investments banks were
riding high; AIG was issuing credit default swaps in trillions of dollars; the
securitization process was at its zenith; mortgage guarantors Fannie Mae and
Freddie Mac were selling "ninja"-backed securities as hot items snapped by
everyone around the world, including China, European banks, sovereign wealth
funds, you name them. And yes, Bernie Madoff was the darling of even
"sophisticated" investors.
Then it all fell apart. The Fed's cheap monetary policy intoxicated everyone,
which is persistent low interest rates and rapid credit expansion. Some died of
intoxication (Lehman Brothers, Merrill Lynch, etc); some had to be rescued at
the cost of trillions of dollars; and Madoff was put behind bars. The
securitization process basically died.
In the post-2007 era, only fools would buy Fannie and Fred securities or
securitized consumer loans. But Bernanke and his supporters still want to
restore the housing boom. Their quest is akin to the resurrection of Lehman
Brothers. But in 2010, no one is ready for another Bernanke served spell of
intoxication. However, by injecting over $1.5 trillion for mortgage loans, it
would appear that Bernanke continues to be convinced that he can re-animate the
housing boom and thus fuel an economic recovery.
It would appear that convincing politicians to renounce distortions and let the
housing market adjust to a different environment, and importantly with much
lower prices than those prevailing in the boom years, is as difficult getting
an alcoholic to give up alcohol. If the housing market had been allowed to
adjust freely in 2007, the housing crisis would have been much briefer and
construction industry may have already recovered.
Chairman Bernanke has all along claimed that he had the tools for boosting
economic recovery. It is not clear why he did not deploy all the required tools
a long time ago so that full employment could have been already restored. With
credit at 350% of gross domestic product and banks still suffering losses,
conditions for a credit boom are not there, irrespective of near-zero interest
rates across the term-structure. Much of the Fed actions amount to only
intensification of distortions - flooding the financial system with money,
flaring up speculation, redistributing wealth in favor of borrowers, and
impoverishing workers.
The debate between deflation and inflation has been raging since 2002. The
anti-deflation camp sees a fall of oil prices from $147 per barrel to $75 per
barrel as a catastrophe that has to be avoided, regardless that oil prices were
$15-$18 per barrel during 1986-2002; corn prices dropping from $780 per tonne
to $460 per tonne is another catastrophe since farmers' profits will fall even
though corn prices were only $160 tonne during 1986-2002.
It would appear that for Bernanke and the anti-deflationist camp a drop of
housing prices towards a long-term equilibrium should be fought at any cost;
and in like manner, a drop of stock prices from their speculative levels should
be prevented with every means, even if the issuing company is bankrupt and
distributes no dividends. The means of pursuing such foolish ends is an
unorthodox monetary policy of near-zero interest rates and massive liquidity
injections.
Many scholars in the past have rejected the index number theory for monetary
policy, starting with the currency school. Critics of index numbers portend
that millions of price indices could be constructed; each group would construct
a price index that would best fit its interest. Hence, central banks could
boast of price stability when there is high inflation; inflationists would cry
deflation when there is a high inflation.
Prominent scholars, such as the late professor Milton Friedman, advocated that
a central bank should only control money and credit aggregates and not
interfere with prices and market allocation of resources. Many economists in
the past have criticized the political use of monetary policy to solve problems
such as unemployment, housing, or exchange rate via money policy. They
preferred the use of sectoral policies that achieve direct results instead of
using monetary policy that acts indirectly. For instance, concessions from
labor unions to solve wage discrepancies would be preferred to inflation in
order to reduce real wages. Reducing costs and enhancing export competitiveness
is preferred to currency devaluation.
Bernanke's announcement in Jackson Hole of his intention to intensify monetary
unorthodoxy has been welcomed by financial markets. Speculators and investors
want free money to keep amassing speculative gains. Some pundits have even been
calling for the Fed to increase its balance sheet to $4-$6 trillion.
A new round of quantitative monetary easing may only further deepen the
economic crisis as the super-easy monetary policy followed by Bernanke since
2002 has so far produced only financial disorder and economic agony. Bernanke's
classroom model predicted that low interest rates and money printing would
bring economic prosperity and full employment.
This has not been born out by the facts. It has, however, resulted in a
short-lived boom followed by the worst post-World War II crisis, a crisis that
continues with no end in sight.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist with a PhD from UCLA.
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