Happy Holidays

A group of conservative economists have written a scathing rebuke of Ben Bernanke and the Fed. Their general premise is that the Fed’s QE2, the printing of money (which by the way is how regular easing works), is no substitute for pro-growth policies. What these agenda-driven economists either do not realize, or refuse to acknowledge for political reasons (I’m betting on the latter) is that the Fed is not making the claim that QE2 or any of its policies are substitutes for pro-growth policies. Mr. Bernanke is trying to buy time until pro-growth policies are put into place and the glut of homes on the markets (foreclosed or otherwise).

In today’s Wall Street former Fed vice chairman Alan Blinder writes a spirited defense of Ben Bernanke (with which I agree) and of Keynesian policies (with which I do not agree in principle). Mr. Blinder responds to Mr. Bernanke’s critics by stating:

“The Fed's plan is to purchase about $600 billion of additional U.S. government securities over about eight months, creating more bank reserves ("printing money") to do so. This policy is one version of quantitative easing, or "QE" for short. And since the Fed has done QE before, this episode has been branded "QE2."”
“Here's the first Economics 101 question: When central banks seek to stimulate their economies, how do they normally do it? If you answered, "by lowering short-term interest rates," you get half credit. For full credit, you must explain how: They create new bank reserves to purchase short-term government securities (in the U.S., that's mostly Treasury bills). Yes, they print money”.

“But short-term rates are practically zero in the U.S. now, so the Fed wants to push down medium- and long-term interest rates instead. How? You guessed it: by creating new bank reserves to purchase medium- and long-term government securities. “
“That sounds pretty similar to garden-variety monetary policy. Yet critics are branding QE2 a radical departure from past practices and a dangerous experiment.”
“The next charge is that QE2 will be inflationary. Partly true. The Fed actually wants a bit more inflation because, now and for the foreseeable future, inflation is running below its informal 1.5% to 2% target. In fact, there's some concern that inflation will dip below zero—into deflation. The Fed, thank goodness, is determined to stop that. We don't want to be the next Japan now, do we?”
“But might the Fed err and produce too much inflation? Yes, it might, leaving us with, say, 3% inflation instead of 2%. Or it might err in the opposite direction and produce only 1%. Neither outcome is desirable, but each is quite tolerable. To create the fearsome inflation rates envisioned by the more extreme critics, the Fed would have to be incredibly incompetent, which it is not.”
“Finally, there's that old hobgoblin: consistency. Critics tell us that QE2 won't give the U.S. economy much of a boost but will lead to rampant inflation. Both? How does that work? “
“If buying Treasurys is a weak policy tool, a view with which I have some sympathy, then it shouldn't be very inflationary. There is no magic link between growth of the central bank's balance sheet and inflation. People, businesses and banks have to take actions—like spending more, investing more, and lending more—to connect the two. If they don't, we will get neither faster growth nor higher inflation, just more idle bank reserves.”



I agree with Mr. Blinder on all of this, but he loses me with the following:

“Somehow, additional government spending actually reduces employment—even when the economy has huge amounts of spare capacity and unused labor desperate for work; even when the central bank will prevent interest rates from rising to "crowd out" private spending. Really?”


Does Mr. Blinder really believe that there are huge amounts of “spare capacity? I don’t believe that. I believe that much of the spare capacity is really spare capacity. I think it is superfluous, unneeded, at least not given the current structure of the U.S. economy. This is not to be confused with the current state of the U.S. economy. The state of the U.S. economy is not likely to improve much until the structure of the U.S economy changes.

No longer can the U,S. economy rely on high-tech start-ups with no business plan. Nor can it rely on cheap lending irresponsible lending standards to drive housing prices and home building. U.S. leaders are going to have to institute policies which promote business activity, expansion end hiring. Without that, look for the Fed to do whatever it takes to keep the U.S. economy in a semi-alive state. Now matter your political beliefs structural changes need to occur,’’

Americans need to realize two things.

1) There is no going back to the years of the 1990s or early 2000s.

2) There is no need for the U.S. economy to be in its current doldrums. Let home prices reset. Let wages and benefits adjust (unfortunately low, at least initially).

Our trading partners are critical of Fed policy. Not just because it may weaken the U.S. dollar and ruin their exchange rate party, but also because structural changes to the U.S. economy could (if done right) make U.S. consumers less willing to purchase cheap foreign goods.


We will have to wit until next year to see if the new Congress is willing to make the necessary and possibly painful changes to make the economy healthy, long-term. I will be watching and waiting as well, but I will not be doing much writing. I am taking a hiatus for health reasons. Happy Holidays and Happy New Year to everyone.