Should the Federal Reserve Go into the Muni Market?

Jun 18, 2012Mike Konczal

It seems likely that the Federal Reserve will provide additional easing in reponse to a declining economic environment when it meets later this week. But what form will this easing take? Tim Duy does the Lord's work in trying to read the tea leaves here. He ultimately concludes that nobody has any idea, and that this is a major communications failure on the part of the Federal Reserve.

It seems likely that the Federal Reserve will provide additional easing in reponse to a declining economic environment when it meets later this week. But what form will this easing take? Tim Duy does the Lord's work in trying to read the tea leaves here. He ultimately concludes that nobody has any idea, and that this is a major communications failure on the part of the Federal Reserve. "We really have no idea what the Fed is going to do or why they are going to do it.  Reasonable analysis ranges from nothing to massive quantitative easing."

Cardiff Garcia of FT Alphaville also tries to make sense of the possibilities, including discussing this decision tree (why aren't there more decision trees on blogs?) from Credit Suisse:

That's a pretty good list of ideas; Garcia has more, including a chart with pros/cons of each option.

What else could it do? Here's a suggestion Richard Clayton, the Research Director of Change To Win, emailed me after my interview with Joe Gagnon, that I haven't seen as part of the discussion:

One question that Gannon doesn’t deal with directly: under Section 14 b 1 the Fed has the authority to purchase any obligation of a state or local government of 6 months maturity or less. This provision seems clearly to permit a mass refinancing of state and local government debt at the current 6 month interest rate (very close to 0), which would save state and local gov’ts approximately $75 billion a year (going by the flow of funds #s for state and local interest payments). Moreover, since state and local govts do the bulk of infrastructure investing, the fed could create a program to fully fund such investment through purchases of newly issued 6 month bonds, for projects that meet criteria the Fed sets out (such as being approved by a small committee of civil engineers appointed by the regional fed branches for that purpose). Finally, under section 24 of the Act, the fed can buy from national banks loans to finance residential construction, which in effect would give the fed the ability to spur new multi-family construction (sorely needed, as evinced by rising rents) by enabling lending banks to effectively sell the loans off their books.

Should we be pushing the Federal Reserve to purchase from the muni market, buying short-term state or local government debt? Asking around, a big practical issue is how much to buy from each state, but the Federal Reserve could come up with a solution. If the estimate is correct, that $75 billion would make a major difference to weak state and local budgets, which is a major form of austerity and a major check to recovery during this Great Recession. Clayton's other suggestion is similar to buying MBS, which has a high probability of going through in the flowchart above. The mortgage rate is low but could be much lower, and the Federal Reserve can make that happen.
 
But I haven't heard this discussed much. What is your take - should the Federal Reserve purchase short-term state and local government debt?
 
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Reagan Redux: The Truth About Romney Economics

Jun 15, 2012Jeff Madrick

The oversimplification of Romney’s economic plan avoids calling it out for what it really is: an extension of failed Republican economic policies.

In the home of Sarah Jessica Parker and Matthew Broderick this week, The New York Times reported that President Obama described Romney’s campaign attacks, which claim all current problems are “the fault of the guy in the White House,” as “an elegant message. It happens to be wrong.”

The oversimplification of Romney’s economic plan avoids calling it out for what it really is: an extension of failed Republican economic policies.

In the home of Sarah Jessica Parker and Matthew Broderick this week, The New York Times reported that President Obama described Romney’s campaign attacks, which claim all current problems are “the fault of the guy in the White House,” as “an elegant message. It happens to be wrong.”

This is as clear an example as we have of Obama’s inability to make a powerful message in a few words. Sounding professorial, he uses the word “elegant” as if referring to a mathematical proof. Clean and simple, I suppose. But to many a listener and reader, elegant only has positive connotations. Why this loftiness when plain, honest, focused language will do the job?

The fact is that almost all of our current situation is a result of economic policies that were put into effect before Obama took office. Not only is Romney’s message not elegant, but his economic plan will boldly extend these failed policies. His central message is simplistic, ignorant, and, to use a lofty word, ahistorical. In actuality, the plan has been underway since the 1980s and even before, and look where it’s gotten us. It serves the interests of the wealthy very well, but has it served America at all? It’s not the collapse of the welfare state, but the ravages of a rising oligarchy, that are undoing America.

Which brings me to another New York Times piece, today’s David Brooks column. Brooks’s methodology as a “thinker” is to develop arguments that he knows will sound plausible to his readers and maybe to a significant swatch of centrists. He is good at these over-simplifications. Today’s column is as unaware or deliberately neglectful of history as ever. What Democrats don’t understand is that the system is broken, he says. Republicans understand this and want to return us to some early (if mythological) economic state. The welfare state is on the cusp of failing; he quotes a Weekly Standard piece on this idea that he thinks definitive. This welfare model, he goes on, “favors security over risk, comfort over effort, stability over innovation.”

This is breathtaking nonsense. The so-called welfare state—whose main features are benefits to the elderly, by the way—favors opportunity for those who have no access to it,  substantial government investment in education and research, which are the great sources of innovation, adequate transportation to enable business to operate efficiently, and fewer and more moderate recessions so that the nation does not lose investment, human capital, and many good businesses due to short-term fluctuations.

And, oh, yes, the welfare state does promote some compassion for the less fortunate—those thrown out of work through no fault of their own—and a sense that all of us owe something to each other. And, yes, it does require government.

What’s truly mind-numbing about the Brooks view, which clearly represents a Republican body of what is considered highly sensible thought, is that all the Romney proposals have been on the ascendancy since Ronald Reagan, and some of them before. These include lower progressive tax rates (Reagan and Bush); deregulation and weak regulatory implementation (Reagan, Bush I and II, Carter, and most important for financial regulations, Clinton); reduced social spending on many categories, notably welfare (Reagan and Clinton); few new programs even as social needs change; and inordinately tight monetary policy since Paul Volcker’s chairmanship at the Federal Reserve, to keep inflation and therefore wages in check. And what happened? Stagnating wages, modest capital investment, unequal public education, and collapsing infrastructure. These are the results of Romney economics.       

If there is theory at all in the Brooks view, it is of course the spurious generalization that individualism will win the day. Just make everyone take care of him or herself. Republicans love this notion. The other idea is that if business is just allowed to do its job, free of most regulation and taxes, everyone will do just fine.  The historical evidence clearly points to the opposite. Look at the levels of inequality in the good old regulation-free and low-tax days of post-Civil War America. Do you we need a better example?

Returning to Obama—he better fight this battle head on, not in professorial dignities, but on the sweaty mat where victory is won. He better understand that the Brooks's over-simplifications are appealing because they blame victims and relieve the rest of responsibility. Call these things what they are, Mr. President. Make America the responsible society once again. The Romney policies failed not just since George W. Bush, but since Ronald Reagan and even Jimmy Carter. 

Roosevelt Institute Senior Fellow Jeff Madrick is the Director of the Roosevelt Institute’s Rediscovering Government initiative and author of Age of Greed.

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Do I Need to Get Healthy to Save For Retirement? A Response to Peter Orszag's Barbell Approach

Jun 15, 2012Mike Konczal

Why the argument that we can't have short-term stimulus without long-term deficit reduction doesn't hold up.

Let's say there are two obvious things I should be doing to make my life better: being healthier now and saving more for retirement. We'll say that it is hard to disagree with these two items, and that these are obviously smart moves for me to make.

Why the argument that we can't have short-term stimulus without long-term deficit reduction doesn't hold up.

Let's say there are two obvious things I should be doing to make my life better: being healthier now and saving more for retirement. We'll say that it is hard to disagree with these two items, and that these are obviously smart moves for me to make.

Given that they are the smart things to do, I should try to do both at the same time, right? I shouldn't let my failure to do one prevent my ability to do the other. It would be weird for me to tell my doctor I was going keep on eating multiple triple bacon cheeseburgers because I wasn't maxing out my 401(k) contributions; my accountant would be puzzled if I told him I wasn't going to invest my savings for retirement until I dropped some weight. There could be convoluted situations in which I could only do both -- no point in saving for retirement if I'm not going to make it there -- but it would have to be backed up by undeniable facts, since it would involve not trying to do something I believed was a good idea.

Yet this is how elite, center-leaning policy intellectuals think on the issue of deficits. The Very Serious People, if you will. They think we need to increase the size of the short-term deficit. They also think that we need to reduce the size of the long-term deficit. But they think that these two actions can only move together and, like I told my doctor and accountant, if one doesn't happen the other can't either. This is often known as the two-deficits problem, which I last talked about in The Nation.

Take the Domenici-Rivlin Restoring America's Future plan. In the overview it states, "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt ... These two challenges must be addressed at the same time, not sequentially." (The deficit hawk Comeback America Initiative report is similiar, with $500 billion dollars in infrastructure over two years tied to focusing on long-term deficit reduction.)

It's never very clear why these two must move together. The more aggressive argument is that the market will panic and raise interest rates if the long-term deficit is not addressed, immediately canceling out the stimulus. The more widely used version is that stimulus now would increase the longer-term debt, hence making the longer-term challenges worse and the crises and challenges occur more quickly.

This is why something like Delong-Summers paper "Fiscal Policy in a Depressed Economy" is so important. It finds that "under what we defend as plausible assumptions of temporary expansionary fiscal policies may well reduce long-run debt-financing burdens."

As Seth Ackerman noted, there's something gleeful in seeing Delong-Summers, in their focus on hysteresis in Europe, dismiss the "principal alternative theory was that high unemployment in Europe in the 1980s and 1990s" as "principally a supply-side phenomenon...and rigid labor market institutions... See Krugman (1994)" in a footnote (!), as if that's not a major reversal or anything. But the argument that, from the debt-to-GDP point of view, fiscal stimulus in a depressed economy is a smart investment by itself, is important for countering the idea that it must be linked to something else in the long term.

Here's where Peter Orszag's "Barbell Approach Only Way to Lift Heavy Economy" enters the picture. Orszag argues that that Delong-Summers approach is flawed because it ignores this two-deficits (or what he calls the barbell) problem, which argues that even if short-term stimulus is a good idea it should be linked to long-term deficit reduction. To use the opening analogy, even if getting healthy is a good idea, we should only try it if we save more for retirement. Why is this?

But these stimulus-only proposals, by not lifting the other side of the barbell, are incomplete for three reasons: First, substantial stimulus-only proposals have no chance of being enacted. Second, even if they could be, they would accelerate the date at which we again run up against the debt limit -- and their proponents have no strategy for dealing with that impediment. Finally, even if the debt limit were simply assumed away (an ivory-tower approach that might prove appealing to some stimulus-only proponents), the impact of any stimulus would be stronger, and our international credibility enhanced, if it were combined with specific, but delayed, actions to reduce the deficit.
The first is a political problem, not an economic one. It should be noted that the barbell strategy, as enacted in 2011 by President Obama, lead to his lowest approval ratings and the sense that he was being politically destroyed by his Republican counterparts. The Republican presidential primary debates featured all candidates saying that they wouldn't accept a 10-to-1 cut-to-tax ratio; it doesn't seem like this strategy is likely to have a political edge anytime soon. Also politics is a matter of elite opinion, and elite opinion isn't an asteroid that falls out of the sky. It is a series of assertions made and defended by elites like Orszag. He can choose to try and change that, like Summers is, if he'd like. Elite opinion is often wrong, and I believe it is wrong here. But one can't create and defend it while arguing it is a constraint.
 
The second, referring to the debt ceiling, is also a political problem, but I'd argue that nobody seems to have a particularly good strategy for dealing with it. Even so, if the problem is Republicans refusing to vote to increase the debt ceiling in a time of crisis, that needs to be addressed as a political problem; it doesn't refute the smart economic idea of fiscal stimulus in a depressed economy. (Sometimes the limit is referred to as a debt-to-GDP limit where, once past, growth slows. See Josh Bivens tear apart those kinds of arguments here.)
 
The third is an economic argument, which says long-term deficit reduction measures would increase the credibility of the United States. Normally that translates into lower long-term interest rates for government borrowing. Would that help? Here's Peter Orszag arguing against QE2 in December 2010: "a modest reduction in long-term interest rates will not have much effect on economic activity at a time when corporations are flush with cash and worried about the future." Would a few basis points gained through credibility help now, especially if the long-term effects were painful? Even if it did, it may bolster the case for the barbell approach, but it still doesn't necessitate it.
 
That 2010 editorial is fascinating because it argues that we need "more fiscal expansion (read: more stimulus) now" and "much more deficit reduction, enacted now, to take effect in two to three years." It's one and a half years later, and we still need the same exact thing according, to common wisdom: more fiscal expansion now, and deficit reduction in two to three years. That a bond vigilante revolt that was scheduled starting in 2012-2013 turned into a bond vigilante rally; Treasuries are at record lows, even lower than in 2010. Which is to say that our credibility hasn't been in play -- even a ratings downgrade hasn't changed anything. Rather than being terrified of the United States' fiscal position, capital markets are desperate for the U.S. to find something productive to do and are willing to loan us the money to do it at ultra-cheap rates. It would be great for us to take advantage of this smart economic move without holding it ransom to the possibility of challenges in the distant future.
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Mike Konczal is a Fellow at the Roosevelt Institute.

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The Senate’s Dimon Hearing Was Sadly No Pecora Commission

Jun 14, 2012David B. Woolner

Rather than digging up the truth behind Wall Street's behavior, Congress seems content to let the possibility of another crash loom.

Rather than digging up the truth behind Wall Street's behavior, Congress seems content to let the possibility of another crash loom.

Jamie Dimon’s testimony before the Senate Banking Committee yesterday has led some critics to charge that the Senators tasked with getting to the bottom of what led to JPMorgan Chase’s staggering $2-to-$5 billion dollar loss in the derivatives market have dropped the ball. In spite of Mr. Dimon’s frank admission that JPMorgan Chase, like the nation’s other big banks, was sometimes led astray by “greed, arrogance, hubris [and] lack of attention to detail,” and his additional observation that the instigation of the yet-to-be imposed Volcker Rule could have reduced the losses, Dimon faced few really tough questions. As a result, we learned little, if anything, from the hearings about the true nature of the decisions that led to the loss, or how Mr. Dimon and the CEOs of our nation’s other too big to fail banks might avoid such large losses in the future. This is particularly important if what he calls the “vague and unnecessary” Volcker Rule is ultimately watered down to the point of ineffectiveness.

Given the level of campaign contributions members of the Senate Banking Committee—on both sides of the aisle—have received from the banking industry, perhaps we should not be surprised by the coddling Mr. Dimon received in the Senate hearing room. But things were not always so cordial. Roughly 80 years ago, in the wake of the 1929 financial sector crash, the very same Senate Banking Committee, under the leadership of the committee’s indomitable chief counsel Ferdinand Pecora, excoriated members of Wall Street’s financial elite. The result was a series of revelations about the behavior—what Mr. Dimon accurately calls the “greed, arrogance [and] hubris”—of Wall Street that outraged the nation and shocked Congress into action.

In the spring of 1933, for example, under the grilling many top executives received at the hands of Pecora, who cut his teeth as a prosecutor as the Assistant Attorney General for the State of New York, the Senate Banking Committee learned that top executives at National City Bank (now Citibank) had bundled a series of bad loans to Latin American countries into securities and sold them to unsuspecting investors. The Committee also learned that these same executives had received large interest-free loans from National City’s coffers and that, as J.P. Morgan, Jr. admitted, it was fairly common practice among the members of Wall Street’s banking and financial elite to keep a list of influential “friends” who were given the opportunity to purchase stocks at drastically reduced prices. Most shocking, however, was the revelation that Mr. Morgan, who as head of the nation’s largest bank was the Warren Buffet of his day, had paid no income taxes between 1930 and 1933. Nor was he alone, for the committee soon learned that many of the nation’s other top bankers had also paid little or no income tax in the years since the 1929 crash.

These disclosures, coupled with additional revelations about excessive salaries and bonuses, outraged the public and helped inspire the incoming Roosevelt administration and Congress to push through some of the most important banking and financial reforms in American history. It is thanks in part to the work of the Senate Banking Committee, then, that the nation benefitted from such reforms as the Glass-Steagall Act, which separated commercial from investment banking and gave us the Federal Deposit Insurance Corporation; the 1933 Truth in Securities Act, which required the securities industry to provide potential investors with complete and accurate financial information about any financial product individuals or firms might wish to purchase; and the 1934 Securities and Exchange Act, which created the Securities and Exchange Commission.

Of course, the vast majority of the financial sector in 1933 and '34 vehemently opposed these reforms. But thanks to the willingness of the Senate Banking Committee to root out and expose many of the unethical practices that contributed to the collapse of the American economy, all Americans, from Wall Street to Main Street, were able to reap the benefits of a properly regulated financial sector for decades to come.

Today, most mainstream economists agree that it has been our return to the reckless and largely unregulated financial practices we saw in the 1920s, coupled with the dismantling of such key New Deal reforms as the Glass-Stegall Act, that led to the 2007-08 collapse of the world’s economy and the onset of the Great Recession. Yet the gentle treatment Mr. Dimon received at the hands of the current Senate Banking Committee pales in comparison to the penetrating line of inquiry pursued by its predecessors. This is unfortunate, for it represents yet another lost opportunity at the hands of our dysfunctional government to provide the kind of leadership required to bring about meaningful financial reform. Sadly, it seems that we would rather run the risk of another financial collapse than confront the truth about the unsustainable nature of an industry driven solely by the desire to accumulate vast quantities of wealth by whatever means necessary, no matter what the cost to the millions of Americans who still believe in an honest day’s pay for an honest day’s work.

David Woolner is a Senior Fellow and Hyde Park Resident Historian for the Roosevelt Institute. He is currently writing a book entitled Cordell Hull, Anthony Eden and the Search for Anglo-American Cooperation, 1933-1938.

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Public Sector Layoffs and the Battle Between Obama and Conservative States

Jun 12, 2012Mike Konczal

The government job losses that are holding the recovery back are directly related to the Republican state legislators who were swept to power in 2010.

Last Friday, both presidential candidates had a back-and-forth over the issue of public sector jobs. President Obama said that the private sector is doing fine but the public sector needs help and is threatening the recovery, and Mitt Romney attacked the idea that "we need more firemen, more policemen, more teachers.”

The government job losses that are holding the recovery back are directly related to the Republican state legislators who were swept to power in 2010.

Last Friday, both presidential candidates had a back-and-forth over the issue of public sector jobs. President Obama said that the private sector is doing fine but the public sector needs help and is threatening the recovery, and Mitt Romney attacked the idea that "we need more firemen, more policemen, more teachers.”

This has lead to new interest in the decline of public sector workers over the past three years. Two major economists from Yale, Ben Polak and Peter K. Schott, just wrote a post at at Economix titled "America’s Hidden Austerity Program."

Polak and Schott argue that "there is something historically different about this recession and its aftermath: in the past, local government employment has been almost recession-proof. This time it’s not... Without this hidden austerity program, the economy would look very different. If state and local governments had followed the pattern of the previous two recessions, they would have added 1.4 million to 1.9 million jobs and overall unemployment would be 7.0 to 7.3 percent instead of 8.2 percent."

But why is this happening? Polak and Schott:

One possibility is that we are witnessing a secular change in state and local politics, with voters no longer willing to pay for an ever-larger work force. An alternative explanation is that even though many state and local governments are constrained not to run deficits, they can muddle through a standard recession without cutting jobs. But when hit by a huge recession like that of 1981 or the latest one, the usual mix of creative accounting and shifting in capital expenditures cannot absorb the shock, and jobs have to go.

This drop in public-sector workers is well documented, and it is great to get more economists ringing the bell on it. But I think there needs to be more research into how this has happened. As my colleague Bryce Covert notes over at The Nation, "the massive job loss we’ve been experiencing in the public sector is no random coincidence or unfortunate side effect. It is part of an ideological battle waged by ultra conservatives who were swept into power in the 2010 elections."

As we've written before (article, white paper), the 11 states that the Republicans took over during the 2010 midterm elections – Alabama, Indiana, Maine, Michigan, Minnesota, Montana, New Hampshire, North Carolina, Ohio, Pennsylvania, and Wisconsin – account for 40.5 percent of the total losses. By itself, Texas accounts for an additional 31 percent of the total losses. So these 12 states account for over 70 percent of total public sector job losses in 2011. This is even more important because there was a continued decline in public sector workers in 2011 even though the economy was no longer in free fall.

The 11 states that the Republicans took over in 2010 laid off, on average, 2.5 percent of their government workforces in a single year. This is compared to the overall average of 0.5 percent for the rest of the states. So while it is a nation-wide event, it is concentrated in states that went red in 2011:

Wisconsin, for instance, lost nearly 3 percent of its workforce in 2011 alone, which shows how high the stakes are. Conservatives are tearing down and rebuilding state governance during this Great Recession. There is an element of state and local layoffs that is strictly budgetary, as the average for all the groups is negative. But there is also an element that is about a face-off between President Obama and new conservative state legislatures.

There's two things worth considering about this dynamic. The first is that any stimulus offered from the federal government could be refused or re-directed to other purposes by state governments. The fighting over getting conservative states to accept stimulus money, which was a battle in 2009-2010, would have been much more heated after the 2010 election. And if money did come in under the rubric of helping retain teachers it may, without a political battle, just go to reducing corporate taxes. We are already seeing this with the AG foreclosure fraud settlement money, which is being redirected to other purposes in many states.

The other is that this should be viewed through the lens of the series of standoffs the administration has with conservatives at the state level. The administration has been fighting with Arizona over its "papers please" immigration law, Florida over voter record purges, and several states in battles over GLBTQ rights and reproductive freedom. Trying to keep red states from slashing their workforces in a time of economic weakness is another front in this battle for those trying to steer the economy toward full employment.

Mike Konczal is a Fellow at the Roosevelt Institute

 

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Layoffs image via Shutterstock.

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At Netroots Nation with a Panel Thursday

Jun 7, 2012Mike Konczal

I'll be at Netroots Nation for the next several days. If you are here and want to say hi, shoot me an email or a twitter message.
 
Today, Thursday at 4:30pm in room 552, I'll moderating a panel on progressives and the Federal Reserve with Matt Yglesias of Moneybox, Karl Smith of Modeled Behavior, and Lisa Donner of Americans for Financial Reform. If you are there you should check it out.
 
I believe it will stream online, so you can watch it even if you weren't able to make it. Hopefully it'll be viewable in the box below.

 
After the fact it should be viewable online. You can stream other panels at this webpage.
 

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Austerity Replaces Economics With Disciplinarian Ideology

Jun 6, 2012Jeff Madrick

Ludger Schuknecht's insistance on continued austerity is merely a discipinarian's argument, which has already been proven wrong time and again. 

Ludger Schuknecht's insistance on continued austerity is merely a discipinarian's argument, which has already been proven wrong time and again. 

The letter in today’s Financial Times, "Jointly Agreed Strategy is Good for Germany and Europe," from Ludger Schuknecht, the Director General of the German Ministry of Finance, will likely live in infamy. In any case, frame it for your children as a symbol of the folly of mankind. In the sternest terms, Mr. Schuknecht chastises Martin Wolf for demanding a reversal of fiscal austerity. Why? “The public and markets have been led to believe in short-term measures for far too long.” Goodbye to Keynes, and even Friedman.

Moreover, he argues, “it is expansionary policies and weak fiscal positions that created the current problems of high debt and low competitiveness.” Of course, the Eurozone deficit was only 0.5 percent of GDP before the crisis. In Spain, fiscal policy was clearly restrained before the crisis. Few could argue the European Central Bank practiced loose monetary policy over these years.  

According to Mr. Schuknecht, we need “a combination of fiscal consolidation and structural reforms.” And all of this with the goal of rebuilding confidence. How can we be hearing this again, after the failure of austerity in country after country?  Now even the conservative Spanish government is admitting failure.

Evidence is not the issue here. Surely the impressive IMF research on the failure of austerity time and again cannot be simply dismissed. But dismiss it Mr. Schuknecht clearly does. Heaven forbid we introduce Eurobonds, which will undermine the confidence being built.

Clearly the German government sees confidence somewhere, but it is surely not in the financial markets.

I long to ask Mr. Schuknecht what he believes caused the Great Depression. He may have written about this somewhere; I assume he thinks uncertainty and government spending were the causes. I wonder if he can point to one credible case where austerity worked without a concurrent devaluation of the currency.

But such arguments do not seem to turn on evidence or theory.  They come from the stern gut of a schoolmaster, and they come from a nation that has yet to suffer the consequences of the current crisis. The inability or refusal to see ahead is the sure sign of an ideologue. But I think this is not even ideology; it is the instinct of the disciplinarian. And it is mixed with a desire to diminish government. Another rap on the knuckles with the ruler will bring confidence, confidence will bring investment, and investment, prosperity. We were told the same in the 1930s, but never mind all that.  

Roosevelt Institute Senior Fellow Jeff Madrick is the Director of the Roosevelt Institute’s Rediscovering Government initiative and author of Age of Greed.

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Mike Konczal on “Fireside Chats”: Tough Times make Liberal Reform Tougher

Jun 5, 2012Danielle Bella Ellison

In the latest episode of “Fireside Chats,” Roosevelt Institute Fellow Mike Konczal talks with David Frum, Daily Beast writer and author of the new novel Patriots. In the clip below, they take on why Democrats have had trouble gathering support for stimulus programs during the current recession. “We’ve gone from Speaker Pelosi and the new Obama presidency and the idea of this wave of progressive energy to really trying to fight between the center and the center right,” Konczal notes.

In the latest episode of “Fireside Chats,” Roosevelt Institute Fellow Mike Konczal talks with David Frum, Daily Beast writer and author of the new novel Patriots. In the clip below, they take on why Democrats have had trouble gathering support for stimulus programs during the current recession. “We’ve gone from Speaker Pelosi and the new Obama presidency and the idea of this wave of progressive energy to really trying to fight between the center and the center right,” Konczal notes.

As Konczal explains, “The real New Deal that we think of – the core economic security and managing the business cycle and so on – occurred in ’35,” when the economy was expanding. Meanwhile, “the conservative agenda to roll back the Great Society and the New Deal” unfortunately becomes more feasible in tough economic times like ours. The public becomes more risk averse and prefers austerity policies to big and potentially risky spending programs. Major liberal reforms, however necessary and beneficial they may be, are just very hard to pass during bad economic times.

The current grim economic condition, as well as the increase in media culture and accelerating ethnic change, have caused a transformation of American politics. Watch the full conversation below in which Konczal and Frum discuss this transition, what a Romney budget would look like, and the future of Obamacare.

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Mike Konczal: Why We Should Go "All In" on the Volcker Rule

Jun 4, 2012

Last week, CNN International's Felicia Taylor invited Roosevelt Institute Fellow Mike Konczal for a night of poker, pizza, and beer. But this wasn't your typical card game -- it was actually a lesson on what the Volcker Rule is and why we need to ban proprietary trading. In the video below, watch Mike and other experts explain how letting banks gamble with their own money leaves all of us on the hook when they're dealt a bad hand.

Last week, CNN International's Felicia Taylor invited Roosevelt Institute Fellow Mike Konczal for a night of poker, pizza, and beer. But this wasn't your typical card game -- it was actually a lesson on what the Volcker Rule is and why we need to ban proprietary trading. In the video below, watch Mike and other experts explain how letting banks gamble with their own money leaves all of us on the hook when they're dealt a bad hand.

Mike says that the Volcker Rule would draw a bright line between the banks' own reserves, which it wouldn't be allowed to bet with, and its clients' money, which "can be used with adequate permission to go and gamble in the financial markets." Why the need for this distinction? Mike explains that "when you're betting with your own money, as we see with poker and as we see with any other gambling game, sometimes you lose big. You lose big very quickly out of nowhere, and those kind of immediate collapses out of nowhere cause panics, cause contagion." And once the downward spiral begins, it's not just the banks that suffer -- it's the American taxpayers who are forced to step in and cover their losses.

For more, check out Mike's explainer on the Volcker Rule at The Nation.

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What Constrains the Federal Reserve? An Interview with Joseph Gagnon

Jun 4, 2012Mike Konczal

There's a growing consensus right now that the Federal Reserve could be doing more to bring about a stronger recovery given its current powers. It's even more relevant in light of the recent weakening of the recovery, as shown in the poor job numbers that came out last Friday. But there's a lot of disagreement and confusion about the constraints that prevent the Federal Reserve from taking more action.

There's a growing consensus right now that the Federal Reserve could be doing more to bring about a stronger recovery given its current powers. It's even more relevant in light of the recent weakening of the recovery, as shown in the poor job numbers that came out last Friday. But there's a lot of disagreement and confusion about the constraints that prevent the Federal Reserve from taking more action. It's even more confusing given Federal Reserve Chairman Ben Bernanke's past research, where he described the Bank of Japan falling into “self-induced paralysis.” Some believe the constraints are political, others believe they are related to fighting among the various governors, and there are those that believe Bernanke is comfortable with monetary policy as it is.

In order to make sense of the various constraints the Federal Reserve faces, I spoke with Joseph Gagnon, senior fellow at the Peterson Institute for International Economics, over the weekend. Gagnon was an associate director for the Federal Reserve’s Division of Monetary Affairs and Division of International Finance, where he was involved with the execution of QE1. I last spoke with Gagnon on the issue of QE3 last summer.

Mike Konczal: Let's start with the basics. Does a random person -- not at the highest levels, but among those who make up most of the researchers and workers -- at the Federal Reserve think that the Fed is "out of ammo"? What are their opinions on how well previous expansionary monetary policy at the zero bound, like QE2 and Operation Twist, have worked to bolster the economy?

Joseph Gagnon: Let me start by linking to a blog post from a former classmate at his new blog, Miles Kimball’s Balance Sheet Monetary Policy: A Primer, that spells out what the Fed could do and why it would work. However, he ignores some of the legal restrictions on what the Fed can do. (See below.)

My sense is that most Fed economists believe that the Fed does have substantial, though not unlimited, ammo. They also believe QE1, QE2, Operation Twist, and the language concerning future policy intentions (staying near zero interest rates through late 2014) had significant positive economic effects, but not apparently large enough to achieve the rapid recovery that is desired.

Basically, the Fed has run out of ammo in terms of language about future policy intentions because it cannot credibly signal its intentions for more than two to three years ahead. It can extend the “late 2014” horizon into 2015, but that is fairly minor.

In terms of the asset purchases, the Fed is limited by law to the Treasury, agency, and agency MBS markets plus foreign exchange. Buying foreign exchange would be viewed as economic warfare by many countries, so it is probably ruled out even though it reflects rank hypocrisy on the part of foreign governments that are massively buying dollars. In the Treasury market, yields on three-year notes are only 0.3 percent, so the Fed must buy five-year to 30-year bonds to have any effect. With the 10-year yield at 1.5 percent, the scope for further effects is modest. Even if the Fed bought every 10-year Treasury, it would be hard to get the yield much below 1 percent, because the risks on such a bond become tremendously skewed toward future losses. There is more scope to buy agency MBS to lower the mortgage rate, but already mortgage rates are at a record low of 3.75 percent. At some point between 2 and 3 percent we are likely to reach the limit. So, the Fed has quite a bit of ammo left, but we can see that it is not inexhaustible.  

Research I am doing suggests that it would be much more attractive for the Fed to buy a broad basket of U.S. equities to support the stock market than to try to push down bond yields from these already low levels. Sadly, the Fed is not authorized to buy equities, even though other central banks are allowed to do so.

MK: A story is circulating that there has been a lot of internal disagreements among the members of the Federal Open Market Committee (FOMC), and this has prevented Bernanke, who wants to have consensus on the votes, from expanding further. You see this idea in the series of three dissenting votes against more action throughout much of 2011 and the lack of dissenting votes for more action until Charles Evans' in late 2011. Is it your sense that the FOMC composition has held the Federal Reserve in check on expansion?

JG: The hawks will never get more than three votes. This year only one hawk has a vote. Chairman Bernanke and his close allies (Yellen, Dudley, Pianalto, Williams, Tarullo, Stein, and Raskin) have a comfortable majority.

MK: A lot of economics writers assume that Bernanke is uncomfortable with non-unanimous votes and just the presence of vocal, hawkish votes has constrained how far he is willing to go with expansionary actions. Have those divisions held expansion in check in the past, even if there are fewer hawks now? And would more doves on vacant FOMC seats have made a difference in 2009?

JG: I think Bernanke had some preference for unanimous decisions, but not a strong preference. I expect there will be dissents all year. I don’t think mere voting support would have made much difference in 2009 because Bernanke knew he could get whatever he wanted. But a strong discussion leader in favor of greater ease might have made some difference if he was persuasive enough. I believe Bernanke is intellectually much closer to the doves than the hawks, but he and some of the other doves are more cautious than the hawks.

MK: What's your sense of how the economics profession broadly reacts to the idea that the Federal Reserve could be doing more? Do you think a generic economist thinks the Fed could be doing more and isn't, or that the Fed is "out of ammo" in how it can expand the economy?

JG: I think the average economist outside the Fed thinks the Fed has less ammo than the average economist inside the Fed. I frequently hear people say the Fed has done all it can do. I do not agree, but I do see a limit approaching. Note that that limit arises from legal restrictions on the Fed. If the Fed were empowered to buy all assets, it would never run out of ammo.

MK: Others point to political pressure, especially from the right. There have been rhetorical moves, such as Rick Perry saying he’d treat the Federal Reserve "pretty ugly." There is the blocking of nominees, such as Peter Diamond being blocked because “[h]e supports QE2.” And it also has to do with conservative political infrastructure. The Club for Growth put whether or not Republicans supported Peter Diamond for the FOMC on their checklists for proper Republican behavior.

How much does political pressure place a constraint on the Federal Reserve's ability to do more expansion?

JG: Chairman Bernanke would deny that political pressure influences his vote, and he even went out of his way to make a public appearance in Texas after Rick Perry made his threat. But FOMC members all read the papers. They see the virulent opposition to their policies on the right and the silence on the left. (Paul Krugman is a big exception, but he is not a politician.) They want to avoid any Congressional action that would reduce their independence in the future, in part because they think this might lead to even worse economic outcomes than we are currently experiencing.  I think they should stick to achieving their current mandate and not fail to achieve it out of fear of what a future Congress might do. In my view, Congress and the president are solely responsible for making laws and the Fed is solely responsible for achieving its mandate. But I am pretty sure some FOMC members either consciously or unconsciously disagree with me and shade their actions out of this concern.  

MK: Is it a question of balance? I've noticed that there is little political pressure from liberals on the Fed for more expansionary policy. Is it a matter of there being little countervailing pressure?

JG: I think it would help if politicians on the left criticized the Fed more strongly for failing to achieve its employment mandate.

MK: A very popular theory in the financial blogosphere is that the inflation target functions as a ceiling, not an actual target. Ryan Avent has argued that the Fed goes into action to prevent deflation, but once inflation expectations approach 2 percent it pulls back. Matthew O'Brien at the Atlantic Monthly has referred to a 2 percent ceiling as the new cross of gold. And Greg Mankiw has written, “If Chairman Bernanke ever suggested increasing inflation to, say, 4 percent, he would quickly return to being Professor Bernanke.”

Is the 2 percent "ceiling" a serious constraint, and why?

JG: The Fed has said 2 percent is the target, not the ceiling, but I agree that their actions over the past three years are not consistent with their statements. I think we should be willing to accept temporarily higher inflation if that would help to reduce unemployment faster. Indeed, combining actions like QE with an announced willingness to accept temporarily higher inflation could create a synergy that would increase the potency of QE (by reducing the real interest rate). But I fear that announcing a goal of higher inflation, either temporary or permanent, will not actually do anything unless it is backed by actions.

Also, I do not think we should permanently raise the inflation target. It is not necessary to do that to get more monetary stimulus and it would jeopardize the hard-won war on inflation of the past two decades.

MK: There’s the idea that, in the past, economists believed a lack of explicit inflation target gave central banks flexibility, but it doesn't seem that we've seen this flexibility.

JG: The general view is that you do not make up periods of being above or below target, you simply always strive to get back to the target. The problem is that the Fed is not taking this approach equally to unemployment and inflation.

Some have argued for a price path target or a nominal GDP path target. In that case you do make up for past deviations in inflation. But I think it is difficult to explain to the public how the specific path is chosen. Why should the CPI be 105 in 2013, 107 in 2014, 109 in 2015, and so on indefinitely? People care about the inflation rate not, some arbitrary price level. And it means that after booms you must have deflation. Indeed, if one had started the path in the early 1990s, the late 1990s boom would have put us way above it. Then the Fed would have had to make the 2001 recession much more severe to get us back on the path. That would have been a tough sell politically.

MK: There are those that think Bernanke should be much more explicit in declaring expectations. This became a big idea recently after an article by Paul Krugman said that Ben Bernanke has abandoned the insights of Professor Bernanke. Bernanke is essentially doing things that the Fed can't fail at instead of the things he proposed Japan should do in a similar downturn. What's your take on this disagreement?

JG: I think it is sensible for the Fed to stick to statements about things it is confident it can achieve, provided that it feels it is doing enough to achieve its objectives. For example, it can talk about purchasing MBS and pushing down the mortgage rate, thus stimulating the economy. The problem is that it has not achieved its objectives over the past three years and its own forecast shows it does not expect to achieve its objectives over the next three years. My advice is to take stronger actions of the type already taken. But if the scope for doing that runs out, then the Fed has to try riskier actions, including those of the type Paul Krugman described. Among those actions, I would tend to favor those for which the Fed has direct tools, such as buying foreign exchange to push down the dollar, rather than trying to raise inflation expectations by verbal jawboning.

MK: Finally, there are those who think that Bernanke is pretty happy with the rate of recovery and is mostly focused on downside risks. As Bernanke said at his recent press conference, "the question is does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very reckless." Is this, by itself, a significant barrier to future monetary expansion?

JG: Yes, this is a significant barrier. I think it reflects ill-defined concerns about the costs of taking more action to reduce unemployment faster. Some Wall Street economists fear that more aggressive Fed action now will give rise to more inflation in the future, but no Fed economist I know agrees with that. The Fed knows how to fight inflation and there is no reason that policy actions now need to cause excess inflation later. Another concern might be that expanding the Fed’s balance sheet will expose it to greater losses in the future when interest rates eventually rise (because higher interest rates will reduce the value of the bonds the Fed holds).

But the Fed’s mandate does not include maximizing profits. From the point of view of the United States, what matters is the consolidated government balance sheet (Fed + Treasury), and there is no way that QE can do anything but reduce our national debt burden. Any future losses by the Fed would be more than matched by gains to the Treasury.

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