ECONOMIC HEADWINDS STRENGTHEN AS CALLS FOR ACTION INCREASE

By Bill Breakstone, August 29, 2010

This morning’s New York Times lead editorial is a call for action on the economic front, and it is addressed to President Obama. It is worth quoting in its entirety:
“If President Obama has a big economic initiative up his sleeve, as he hinted recently, now would be a good time to let the rest of us in on it.

News on Friday confirmed that the economy was far weaker in the second quarter than originally believed, growing at 1.6 percent versus an initial reading of 2.4 percent. Grim reports on housing sales indicate that the slowdown has continued. In a normal recession, housing would lead the way up from the depths. Today, it appears to be leading the way back down.

Which brings us back to Mr. Obama. The fiscal stimulus of 2009, coupled with low interest rates and other Federal Reserve interventions, kept the recession from being much worse. But it has not been enough to revive hiring, without which a real recovery is impossible. In the meantime and even more ominously, economic policy making has all but ground to a halt.

Congress is gridlocked. For nearly two months, Republicans blocked an extension of unemployment benefits, a basic recovery measure. They are still holding up a bill to spur more lending to small businesses.

In a much-anticipated speech on Friday, Ben Bernanke, the Federal Reserve chairman, reiterated his vow to do more to boost the economy if conditions worsened. He did not seem particularly convinced that anything the Fed could do would be enough.
The question then is whether Mr. Obama will lead. He cannot force Congress to act, but he could pre-empt Republicans’ diatribes — on the deficit, on small business, on taxes — with tough truths and a big mission that would tie together the strategies and the sacrifices that will be needed to put the economy right.

First, he needs to keep driving home that he is committed to addressing the deficit, and that he will call for widespread sacrifice to do so — starting with letting the Bush tax cuts for the richest Americans expire at year end. Mr. Obama must tell Americans that claims from Republican leaders that the country can both cut taxes and tackle the deficit are absurd and cynical.

Next, he needs to explain why too much sacrifice, too soon, especially from the middle class, would do more harm than good while the economy is weak. More government support is needed until conditions improve.

Mr. Obama also needs to inspire Americans who have been ground down by the economic crisis and Washington’s small-bore sniping. He needs to rally the nation around a big idea — a project that is worth sacrificing for, worth paying for, worth working for. One that lets them know that there is more ahead than just a return to a status quo of lopsided growth in which corporate profits surge while jobs and incomes lag.
That mission could be the “21st century infrastructure,” that Mr. Obama mentioned on a multi-city trip this month, “not just roads and bridges, but faster Internet access and high-speed rail.” It could be energy independence, with high-tech green jobs and a real chance for addressing global warming. Either of the above would make sense, economically and politically.

Mr. Obama and his economic team had clearly hoped for an economic rebound in time for the midterm elections. They are not going to get it. The economic damage they inherited was too deep, and the economic stimulus they pushed through Congress, for all of the fight, was too small. Standing back is not doing the country or his party any good. We believe Americans are ready for hard truths and big ideas.”


What follows below are comments made by several economists at the Jackson Hole Conference:


Paul Krugman

“What will Ben Bernanke, the Fed chairman, say in his big speech Friday in Jackson Hole, Wyo.? Will he hint at new steps to boost the economy? Stay tuned.

But we can safely predict what he and other officials will say about where we are right now: that the economy is continuing to recover, albeit more slowly than they would like. Unfortunately, that’s not true: this isn’t a recovery, in any sense that matters. And policy makers should be doing everything they can to change that fact.
The small sliver of truth in claims of continuing recovery is the fact that G.D.P. is still rising: we’re not in a classic recession, in which everything goes down. But so what?

The important question is whether growth is fast enough to bring down sky-high unemployment. We need about 2.5 percent growth just to keep unemployment from rising, and much faster growth to bring it significantly down. Yet growth is currently running somewhere between 1 and 2 percent, with a good chance that it will slow even further in the months ahead. Will the economy actually enter a double dip, with G.D.P. shrinking? Who cares? If unemployment rises for the rest of this year, which seems likely, it won’t matter whether the G.D.P. numbers are slightly positive or slightly negative.

All of this is obvious. Yet policy makers are in denial.
After its last monetary policy meeting, the Fed released a statement declaring that it “anticipates a gradual return to higher levels of resource utilization” — Fedspeak for falling unemployment. Nothing in the data supports that kind of optimism. Meanwhile, Tim Geithner, the Treasury secretary, says that “we’re on the road to recovery.” No, we aren’t.

Why are people who know better sugar-coating economic reality? The answer, I’m sorry to say, is that it’s all about evading responsibility.

In the case of the Fed, admitting that the economy isn’t recovering would put the institution under pressure to do more. And so far, at least, the Fed seems more afraid of the possible loss of face if it tries to help the economy and fails than it is of the costs to the American people if it does nothing, and settles for a recovery that isn’t.

In the case of the Obama administration, officials seem loath to admit that the original stimulus was too small. True, it was enough to limit the depth of the slump — a recent analysis by the Congressional Budget Office says unemployment would probably be well into double digits now without the stimulus — but it wasn’t big enough to bring unemployment down significantly.

Now, it’s arguable that even in early 2009, when President Obama was at the peak of his popularity, he couldn’t have gotten a bigger plan through the Senate. And he certainly couldn’t pass a supplemental stimulus now. So officials could, with considerable justification, place the onus for the non-recovery on Republican obstructionism. But they’ve chosen, instead, to draw smiley faces on a grim picture, convincing nobody. And the likely result in November — big gains for the obstructionists — will paralyze policy for years to come.

So what should officials be doing, aside from telling the truth about the economy?
The Fed has a number of options. It can buy more long-term and private debt; it can push down long-term interest rates by announcing its intention to keep short-term rates low; it can raise its medium-term target for inflation, making it less attractive for businesses to simply sit on their cash. Nobody can be sure how well these measures would work, but it’s better to try something that might not work than to make excuses while workers suffer.

The administration has less freedom of action, since it can’t get legislation past the Republican blockade. But it still has options. It can revamp its deeply unsuccessful attempt to aid troubled homeowners. It can use Fannie Mae and Freddie Mac, the government-sponsored lenders, to engineer mortgage refinancing that puts money in the hands of American families — yes, Republicans will howl, but they’re doing that anyway. It can finally get serious about confronting China over its currency manipulation: how many times do the Chinese have to promise to change their policies, then renege, before the administration decides that it’s time to act?

Which of these options should policy makers pursue? If I had my way, all of them.

I know what some players both at the Fed and in the administration will say: they’ll warn about the risks of doing anything unconventional. But we’ve already seen the consequences of playing it safe, and waiting for recovery to happen all by itself: it’s landed us in what looks increasingly like a permanent state of stagnation and high unemployment. It’s time to admit that what we have now isn’t a recovery, and do whatever we can to change that situation.”


Nouriel Roubini

Nouriel Roubini, the New York University professor who forecast the U.S. recession more than a year before it began, said the Federal Reserve is running out of effective ways to stimulate the economy. We cannot prevent slow economic growth for a number of years,” Roubini said an interview on Bloomberg Radio. “We are running out of policy bullets.”

“Banks are “sitting on” $1 trillion of excess reserves and cutting the interest rate on excess reserves to zero from 25 basis points isn’t going to make them lend money. Additional quantitative easing through purchases of securities also won’t jumpstart economic growth. The point is monetary policy is becoming ineffective.”


Mohamed El-Erian

U.S. economic data are “alarming,” signaling the recovery is losing momentum, Mohamed A. El-Erian, Pacific Investment Management Co.’s chief executive officer, wrote in an opinion piece in the Washington Post.

Unemployment is high, consumer credit is shrinking and small companies are having trouble obtaining bank lines of credit, wrote El-Erian, who is also co-chief investment officer at Pimco, which runs the world’s largest bond fund. Increased government spending and additional debt purchases from the Federal Reserve are unlikely to spur a rebound, he wrote.

“Throughout the summer, data signals have become more alarming,” wrote El-Erian, who is based in Newport Beach, California. “Current policy approaches here and abroad are unlikely to deliver a durable and robust U.S. recovery.”

Housing is waning and home values are set to fall further as foreclosures increase, El-Erian wrote in the article.

There is a need for tax reform, housing-finance reform, infrastructure investment, support for education, job retraining, removal of barriers to interstate competition and stronger social safety nets, he wrote.

Sovereign bonds are rallying globally as economists trim their growth forecasts and stocks tumble.

“The equity markets are again under pressure while yields on Treasury bonds have collapsed, reflecting that market’s growing concerns about the weak economic outlook,” El-Erian wrote.

Economists who decide when recessions begin and end in the U.S. are divided over the odds of a renewed downturn, underscoring the challenge faced by Federal Reserve Chairman Ben S. Bernanke as he vows the Fed “will do all that it can” to sustain growth.


Martin Feldstein

“There’s still a significant risk, maybe one chance in three, that there will be a double dip,” said Harvard University Professor Martin Feldstein, who sits on the Business Cycle Dating Committee of the National Bureau of Economic Research. Fellow panel member and Princeton University Professor Mark Watson said those odds are “way too high” and puts them instead at “one in 10 or maybe one in 20.”

Such differences over the outlook marked discussions of policy makers and economists gathered in Jackson Hole, Wyoming for the Kansas City Fed’s annual symposium. The tone was set by a reduced estimate of second-quarter growth and then by Bernanke’s speech Friday outlining possible options the Fed could take to ensure the recovery continues.


Henry Kaufman

“There is a searching as to where events are going from here because there has been a slowing in the pace of economic growth,” Henry Kaufman, president of New-York based Henry Kaufman & Co., said in an interview at the conference. “The Fed is at a stage where it is tilting to further accommodation, but it’s not guaranteed.”


Carmen Reinhart

As a seven-year-old in Cuba, Carmen Reinhart memorized the routes of ships carrying silver from Peru and Bolivia to Spain. By 16, she had moved to Miami and got a job at a Sears Holdings Corp. store reviewing credit applications and payment records.
That fascination with history and data has propelled a career at Bear Stearns Cos., the International Monetary Fund and the University of Maryland in College Park. Now Reinhart, 54, is using a paper studying 15 economic crises since World War II to warn Federal Reserve Chairman Ben S. Bernanke and fellow policy makers that sluggish growth and high unemployment in the U.S. might persist through 2017 or longer.

“Whether one looks at advanced economies or a whole sample that includes emerging markets, the picture is one of lower growth during the decade that follows the crisis,” she said in an interview from Washington this week. “We are already three years into this post-crisis window. The clock starts ticking in the summer of 2007.”
Reinhart’s work has made her the female economist most frequently cited by other economists. Her latest paper, “After the Fall,” co-written with husband Vincent Reinhart, is being presented today at the Fed’s annual symposium in Jackson Hole, Wyoming.

An unemployment rate of 8 or 9 percent over the next seven years is not “outside of the experience that we have documented,” she said. Her studies of crises in Finland, Japan, Norway, Spain and Sweden that started between 1977 and 1992 show median per-capita economic growth declined by 1 percentage point in the decade following the shock.

The pessimistic outlook in her paper presented at Jackson Hole contrasts with the view of Treasury Secretary Timothy F. Geithner, who said this month that the U.S. economy is “gradually healing.”

The nation has more than a 50 percent chance of experiencing a lost decade like Japan, when a collapse in land and stock-market prices gave way to economic stagnation and deflation starting in the 1990s, according to Reinhart. To avoid that outcome, policy makers should immediately announce a plan to increase taxes and cut spending in about a year, she said, adding her husband generally shares the same position.

“We have the pretty clear view that you want to not necessarily implement austerity right now, but you certainly want to announce it right now, with plans to deal with the deficit and debt in a realistic time frame,” she says.

“Our recovery still leaves a great deal to be desired,” Carmen Reinhart said. “My concern is that because the U.S. is the world’s reserve currency, we can still borrow in bad times, and that a more Japan-like scenario lies in store. A lot of the forces are already in place.”

With the U.S. government’s gross debt rising to about 90 percent of gross domestic product as tax revenue declined during the recession, “we have to pay future attention to the debt.”

“You don’t want to pull the plug out completely on stimulus,” Reinhart said. Still, “you have to start thinking about what measures are required to curb the deficit, and cap or reduce the debt. You don’t have the luxury to focus on the choice of one or the other. You have to deal with both.”


Alan Blinder

Federal Reserve Chairman Ben S. Bernanke may be reluctant to ease monetary policy further with unconventional steps in the near term, former Fed Vice Chairman Alan Blinder said.

Bernanke’s speech Friday on policy alternatives stressed “if necessary,” Blinder, a Princeton University economist, said in an interview on Bloomberg Radio’s “The Hays Advantage,” with Kathleen Hays. “He is not on the verge of doing anything. I thought he was relatively pessimistic about the efficacy of the actions.”

Bernanke said the U.S. central bank “will do all that it can” to ensure a continuation of the economic recovery and said more securities purchases may be warranted if growth slows.

“If it were just Ben Bernanke acting on his own, some further action might be closer,” Blinder said. “He has some significant resistance from within the FOMC.”
Lowering the interest rate on banks’ deposits at the Fed to below zero may be the “best option” to support growth, Blinder said. Still, “the heavy artillery has already been fired,” he said.

The Fed two weeks ago decided to keep its bond holdings at $2.05 trillion by reinvesting the proceeds from maturing mortgage-backed securities into Treasuries. The Federal Open Market Committee, seeking to spur economic growth, held the main interest rate at zero to 0.25 percent, where it’s been since December 2008, and affirmed a pledge to keep rates low for “an extended period.”
Blinder said he continues to back additional federal spending by Congress to support the recovery, especially directed at jobs programs.


Olli Rehn and Joseph Stiglitz

Those who oppose watering down the various stimulus packages that are keeping the economy alive see warning signs everywhere. Europe is looking anxiously to the East, concerned that China will be too successful at reining in growth. Olli Rehn, the European Union’s economics chief, says that slowing Asian economies would have a “serious negative impact” on his region.

The U.S., meantime, frets that Europe will slide back into a recession, making the dreaded double dip a reality. “Cutting back willy-nilly on high-return investments just to make the picture of the deficit look better is really foolish,” Nobel Prize-winning economist Joseph Stiglitz told Dublin-based RTE Radio in an interview broadcast on Aug. 24.

And almost every supporter of doing more, not less, to resuscitate animal spirits is looking to the recent history of Japan as the chief reason why austerity should not be the new black. “What we’re doing is setting ourselves up for a longer- term Japanese-style malaise of weak growth for an extended period of time,” Stiglitz says.


Conclusions

Although Fed Chairman Bernanke, Treasury Secretary Geithner, and various Administration officials are trying to put a positive spin on economic data and recovery efforts, it flies in the face of all the deteriorating conditions that continue to emerge day after day. The general consensus among economists is that things will only get worse during the third and fourth quarters of this year.

Paul Krugman’s suggestions noted above make perfect sense to this writer. I would add to those by saying that a drastic shake up is needed in the Administration’s economic team. A firm signal needs to be sent that current economic conditions are NOT acceptable. Chief economic advisor Larry Summers should be relieved of his post and replaced with an economist more committed to a pro-active approach towards growth creation. Bernanke should be persuaded to take the Fed in the direction outlined by Krugman. And, finally, taxes on business investment should be cut. This would spur job creation, and is the only politically viable course to take at this point in time.