Paralysis at the Fed by Krugman.

What’s going on here? Has Mr. Bernanke been intellectually assimilated by the Fed Borg? I prefer to believe that he’s being political, unwilling to engage in open confrontation with other Fed officials -- especially those regional Fed presidents who fear inflation, even with deflation the clear and present danger, and are evidently unmoved by the plight of the unemployed.

And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I’d argue that loose talk by some Fed officials is already having a negative economic impact. But while Mr. Bernanke doesn’t have the authority to stop that loose talk, he could make it clear that it doesn’t represent overall Fed policy.

Last, but not least, policy is suffering from an act of neglect by President Obama, who waited until his 16th month in office before offering a full slate of nominees to fill vacancies on the Federal Reserve Board. If he had filled those slots quickly -- his nominees still aren’t in place -- the Fed might be less passive.

But whatever the reasons, the fact is that the Fed -- which is required by statute to promote "maximum employment" -- isn’t doing its job. Instead, like the rest of Washington, it’s inventing reasons to dither in the face of mass unemployment. And while the Fed sits there in its self-inflicted paralysis, millions of Americans are losing their jobs, their homes and their hopes for the future.

Sewell Chan on the president of the Federal Reserve Bank of Kansas City Thomas M. Hoenig:

Peter N. Ireland, a professor at Boston College and a former economist at the Richmond Fed, said he was unconvinced. "While there are risks, certainly, of higher inflation down the road, I agree with the consensus that deflation is much more of a concern," he said. "The policy he is calling for is quite off the mark"

Professor Ireland said he feared that Mr. Hoenig’s comments might inadvertently complicate efforts by Mr. Bernanke and other officials to present a unified message. "There’s a tremendous amount of confusion right now, amongst the public and in the financial markets, as to what the Fed is seeing vis-à-vis the economy right now," he said. "This is not to say that dissent is not allowed, but just to say that the way the dissent is being presented to the public seems highly counterproductive right now"

Happy 75th Anniversary, Social Security!

Doug Henwood on Social Security and the campaign to privatize it.

Yglesias on Obama honoring the program in his weekly address.

You can tell the quality of a government program by its enemies.

What's the Scenario, Yo?

In July Krugman speculated:

Picture America in, oh, 2014: unemployment is still around 9 percent, prices are falling about 1 percent a year. Many economists might look at that situation and say, well, deflation is stable, not accelerating, so we must be at the natural rate of unemployment -- move along, folks, nothing to see here.

Today he blogs:

And this raises the specter what I think of as the price stability trap: suppose that it’s early 2012, the US unemployment rate is around 10 percent, and core inflation is running at 0.3 percent. The Fed should be moving heaven and earth to do something about the economy -- but what you see instead is many people at the Fed, especially at the regional banks, saying "Look, we don’t have actual deflation, or anyway not much, so we’re achieving price stability. What’s the problem?"

This isn't a gotcha. I like the way Krugman employs his blog to brainstorm and try out ideas.

I think guys like Hoenig will be saying unemployment isn't a problem, but hopefully the rest won't be. According to the FOMC's June minutes, their targets are:

In 2014 presumably they'd want unemployment to be at 5 to 5.3 percent not 9 percent and PCE inflation at 1.7 to 2 percent not -1 percent. In 2012 they're predicting unemployment of 7.1 to 7.5 not 10 percent and PCE inflation of 1.0 to 1.7 percent not .3 percent. So if they don't want the legitimacy of the institution to take another* major hit, they should move heaven and earth to hit those targets.

------------------------
* The housing bubble and Great Panic has cost the economy trillions of dollars thanks in part to Greenspan's misplaced faith in the magic of self-regulating free markets. That's trillions that could have used to pay down the national debt or it could have been invested in our childrens' future via education and cleantech spending.

For employment to pick up, consumer demand needs to pick up. For consumer demand - or aggregate demand, AD - to pick up the foreclosure crisis needs to be resolved.

Atrios blogs:

The only way through the foreclosure crisis was some sort of principal modification program. Judicial bankruptcy would have made the most sense, which is presumably why it didn't happen. Absent principal modification, the forgotten foreclosure crisis, and all of its associated impacts, will be with us for some time.

The New York Times has a piece which documents how borrowers are skipping out on their debts in a sort of DIY principle modification program.

Sewell Chan writes about the possibility of inflation and 1970s-style stagflation:

If banks were to withdraw the $1 trillion they hold at the Fed too quickly, it could generate inflation. Moreover, Mr. Walsh said, "changes in expectations about future inflation can influence current inflation, even if the economy is below its potential"

In the worst case, he said, the economy could return to the stagflation of the late 1970s, when prices rose as growth lagged.

Dean Baker comments:

[Walsh] warned that if banks suddenly withdrew the $1 trillion in reserves that they held at the Fed it could generate inflation.

While this is in principle possible, it would have been worth noting the mechanism through which inflation would be generated. The banks would have to lend out the money to firms who invest it, thereby increasing employment. This would lead to more jobs, higher wages, and then higher demand, which would allow firms to be able to raise prices.

This process takes time. The Fed would have ample opportunity to raise interest rates and slow growth before inflation got too high. Most people would probably be willing to take the risk that the economy might jump back to full employment too quickly.

Stagflation in the 1970s was a result of many different things, although economists don't seem to be in complete agreement on what caused stagflation. During that period there as an oil supply shock, the Vietnam War, the fall of the Bretton Woods system, increased competition from Germany and Japan which triggered a steel crisis, and unions were much stronger. Something Krugman points out about unions in the 1970s is that they were powerful enough to negotiate wage increases to keep up with price increases even as growth stalled. Unions no longer have that ability on the same scale.

Kirk changes course, votes against $26 billion jobs bill
 
Day before, GOP senate candidate said he was 'inclined' to vote for it.

Nobody expects the Invisible Bond Vigilantes.

Said Invisible Bond Vigilantes continue their Invisible Siege on runaway government deficits as the 10-year bond rate drops to 2.71 percent. Oh noes!

Amongst their weaponry are such diverse elements as fear, surprise, a ruthless efficiency, reverse psychology and invisibility.

Ezra Klein points to Neil Irwin who has an answer to my question about what will trigger the Fed to do more. What will cause Ben to fire up the chopper?

My best guess is that the decision of whether to resume asset purchases and expand the balance sheet is binary, not linear. If growth truly appears to be stalling out, with second half GDP growth coming in somewhere south of 2 percent (forecasts are in the 3 percent plus range now), and/or year-over-year core inflation gets below about 0.8 percent, the Fed starts to talk about the big guns. If they pull the trigger on those guns, it would be an announcement of another asset purchase program in the hundreds of billions of dollars, primarily of Treasury bonds.

What they're not likely to do is do ongoing adjustments to their target for the balance sheet, raising or dropping their goal for balance sheet size based on the latest data (though that's what at least one FOMC member, James Bullard of the St. Louis Fed, would prefer). I base this in part on how they've done these things in the past -- the previous installments of quantitative easing came in one-off announcements of very large numbers that are carried out over time. But more broadly, the exact impact of a larger balance sheet on economic growth and price levels is highly uncertain. It would be folly, many at the Fed would argue, to pretend that the tool is finely tuned enough to be constantly tweaking the size of the balance sheet in response to the latest data.

The FOMC's targets from June minutes:

Yeah but in the long term you're dead.

The Republican push to amend the 14th amendment may be good short-term politics but is horrible long-term politics, something Karl Rove and George W. Bush would probably agree with.

Likewise the long-term demographic trends are good for Democrats, but more old timers turn out for midterms, which is good for Republicans. Jonathan Chait blogs:

The second aspect is the old-ification of the Republican Party. 2009-2010 have been dominated by a health care debate that splits oldsters, who despise health care reform, from all other age groups, who approve of it. The generational split seems to have deepening partisan overtones. In the long run, this is a boon for Democrats. In the short run, it's a disaster, because old people vote in midterm elections and young people don't:

Exit poll data shows that the electorate skews older, particularly in nonpresidential election years. In 2006, 63 percent of those who cast ballots were 45 or older, and in 2008, that same age group made up 53 percent of the electorate, according to exit poll data from the National Election Pool. This group made up about half of the adult population in those years.

The thread connecting both these factors is a belief that the presidency is the end-all, be-all of American politics. Young people and liberals get very excited about presidential elections. When the other party holds the White House, they can get fired up about turning them out. When their party wins, they expect all their problems to be solved. When the problems don't disappear immediately, they get disillusioned.

A spectrum of quotes about the Fed's acknowledgment that the economy is struggling.

Ethan S. Harris, an economist at Bank of America, said he was "mildly surprised" by the Fed’s action -- "not that they did it but rather how quickly they decided." He added, "My expectation had been that the Fed would take a little more time to switch gears and prep the market"

The decision not to let the balance sheet shrink was a relatively easy one, Mr. Harris added. "To go back to big asset purchases is a much bigger step, and it would require clear signs that the economy is heading toward a double-dip recession."

Economists who work in the markets had a mix of reactions.

Bruce McCain, the chief investment strategist at Key Private Bank, said the Fed "steered the middle ground."

"Given the uncertainty, hopefully the middle ground calms nerves and keeps people confident enough to go ahead and spend the money that they have in productive ways," he added.

But a former New York Fed economist, John Ryding of RDQ Economics, said the announcement suggested "a bit of a feeling of panic by the Fed." And Joshua Shapiro, an economist at MFR Inc., said the Fed’s announcement "appears to mainly be designed to provide itself with political cover against a backdrop of a gut-wrenching economic correction that shows no sign of ending anytime soon."

I see the Fed as blasé  rather than "panicked." From the Fed's press release yesterday:

Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months.

Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.

Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls.

Housing starts remain at a depressed level. Bank lending has continued to contract.

Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

Nice lengthy post by Tobin Harshaw on Obama's endangered economists.

Bill Clinton's primary candidate loses in Colorado. 

Conservatives continue to cocoon hard:

But in this state’s Republican primary, a Tea Party-backed insurgent, Ken Buck, upended the candidate endorsed by Washington Republicans, Jane Norton, a former lieutenant governor.

If the businessmen drink my blood
Like the kids in art school said they would
Then I guess I'll just begin again
You say, "can we still be friends?"

If I was scared... I would
And if I was bored... you know I would
And if I was yours... but I'm not

All the kids have always known
That the emperor wears no clothes
But they bow to down to him anyway
It's better than being alone

I'm Ready to Start. 
(or we wish Bernanke was running the place)

No helicopter drop, but the Fed has signaled it's on alert and ready to do more. Krugman blogs:

What the FOMC announced was a slight change in policy: rather than allowing its balance sheet to shrink as the mortgage-backed securities it owns mature, it will maintain the balance sheet’s size by reinvesting the proceeds in long-term government bonds. Roughly speaking, it has gone from a completely crazy policy of monetary tightening in the face of massive unemployment and incipient deflation, to a policy of standing pat in the face of same. Whoopee.

...In effect, reinvesting the funds from expiring securities became a focal point, an essentially arbitrary location in the space of policy responses that nonetheless had come to have "salience", because it was what everyone was watching.

...

So why am I even slightly encouraged? Because the critics did, at least, succeed in moving the focal point. Not long ago gradual Fed tightening was the default strategy; but as I said, at this point the Fed realized that continuing on that path would have unleashed both a firestorm of criticism and a severe negative reaction in the markets.

What we need to do now is keep up the pressure, so that at the next FOMC meeting the members are once again confronted by the reality that not changing course would be seen as dereliction of duty. And so on, from meeting to meeting, until the Fed actually does what it should.

And via DeLong, Obama/Pelosi/Reid pass $26 billion aid to the states legislation. Not much but at least they're doing something.

What happened was that liberals were expecting unemployment to top off at 8 percent and then drift down again. Instead it hit 10 percent and might remain at 9 percent for a while. Liberals are depressed about this and what it might mean for November.

Krugman criticized Romer-Bernstein's chart and Atrios made fun of it.

At the time I thought they were being unfair. Yes they got it wrong, but economic forecasting is extremely hard and nobody foresaw the Greek debt crisis. The Fed and Congress are reacting to the change in circumstances but not enough.

Krugman pointed out that Romer had recommended a larger stimulus package but that Summers didn't include it in the presentation to Obama. I also liked how she would assert there is no "new normal" of lowered expectations so it is good to read speculation that she might be nominated to run the Federal Reserve Bank of San Francisco.

Sewell Chan on today's Fed meeting.

Not since 2003 has the prospect of deflation been taken so seriously at the Fed, and not since the 2008 financial crisis have the markets been looking so closely to it for guidance. With Congress unwilling to embark on substantial new stimulus spending, the Fed has the only tools likely to be employed anytime soon in response to the economic warning signs.

...

Mr. Greenspan said there had been "some evidence of a pickup in inflation" until the Greek debt crisis took hold in the spring. But the resulting uncertainty drove down long-term interest rates -- the yield on the benchmark 10-year Treasury note fell to 2.82 percent on Friday, the lowest level since April 2009, and barely budged Monday -- in a reflection of what Mr. Greenspan called continuing problems in the financial markets.

...

Mr. Kroszner said it seemed increasingly likely that the Fed could announce that it would reinvest the cash it receives [purchase?] as the mortgage bonds it holds mature, rather than letting its balance sheet gradually shrink over time.

In March, the Fed completed its purchase [reinvestment?] of $1.25 trillion in mortgage-backed securities. A decision to reinvest the bond proceeds in other mortgage-related securities [purchase?], or in Treasuries, would be largely symbolic but carry great weight, as it would signal concern about the economy, and also make clear that an "exit strategy" from easy monetary policy was not imminent.

...

But [Laurence H.] Meyer, the former Fed govenor, said the committee should take into account not just the probability of various outcomes, but the potential damage associated with each of them.

"Because the cost of a slowdown in growth is so dramatic relative to that of higher inflation, they should follow the risk-management strategy that Greenspan espoused during the last deflation scare," he said.

During that period, in 2002-3, the Fed kept interest rates low, as the economy recovered from the 2001 recession, to guard against deflation. Those fears did not come to pass. But some now say the Fed kept rates too low for too long, feeding the housing bubble.

"It is by no means a slam dunk," Mr. Meyer said of the Fed’s decision.

And perhaps the Fed had to keep interest rates low in 2002-2003 b/c Bush's tax cuts were not a very effective form of stimulus? And perhaps the bubblicious tax cuts to the speculative rich combined with low interest rates to bequeath us a monster housing bubble?

The Summer of Fear*

Yglesias in the Washington Post.

So far, the summer of fear has featured a charge, led by Newt Gingrich, Sarah Palin and former New York congressman Rick Lazio, to block the construction of the Cordoba House Islamic cultural center (which is to include a mosque) a few blocks from the site of the World Trade Center. Meanwhile, with frightening speed, we've gone from discussing the prospects for comprehensive immigration reform to watching congressional Republicans call for hearings to reconsider the 14th Amendment's guarantee of citizenship to anyone born in the United States.

Many liberals think they spy simple election-year opportunism. And of course, where there's an election, there's opportunism. But these prominent Republicans wouldn't be doing any of this if xenophobia weren't playing well politically.

Politicians are making hay out of the mosque only because public opinion seems to oppose it. They are reflecting, as well as stoking, a groundswell of public hostility toward outsiders. This hostility is not about the midterms; it is a consequence of the economic downturn, every bit as much as foreclosures and layoffs. When personal incomes stop growing, people become less broad-minded, and suspicion of foreigners and other ethnic groups grows. We have seen this time and again, in this country and in others.

...

Benjamin Friedman, an economist at Harvard whose 2005 book "The Moral Consequences of Economic Growth" argued that growth tends to foster liberal sentiments and open societies, whereas slowdowns undermine them, says this summer's events "are predictable consequences of this kind of sustained economic downturn."

"Manifestations like these have appeared in the U.S. at such times before," he told me, "most obviously in the 1880s and early 1890s," when a sustained period of economic stagnation coincided with the abandonment of the Reconstruction-era commitment to civil rights, the widespread adoption of anti-Chinese legislation and a nationwide wave of lynchings directed not only at blacks, but also Catholics and immigrants.

I watched the Sunday morning news show This Week with Christiane Amanpour and during the roundtable discussion, Financial Times managing editor Gillian Tett mentioned these issues as well. She was impressively concise and substantive as was George Packer.

Tett's book Fool's Gold* is one I've been meaning to read for a while now, as well as Friedman's Moral Consequences of Economic Growth which Yglesias mentions. Also on the list are Nouriel Roubini's Crisis Economics, Raghuram Rajan's Fault Lines and Carmen Reinhart and Kenneth Rogoff's This Time It's Different.

I still have a stack of books from this list*** I haven't got through. Recently, I finished Liaquat Ahamed's Lords of Finance and John Cassidy's How Markets Fail and am currently rereading Doug Henwood's prescient tomb Wall Street. In the recent debates surrounding FinReg there was discussion of breaking up the banks. Thanks to Henwood, I remain convinced that big is not wholly bad. From Wall Street, page 241:

Modern anticorporate antiglobalizers -- like people in and around the San Francisco-based International Forum on Globalization -- seem not to appreciate any of these virtues of capitalist socialization, and have no sense of how to organize social production on any reasonable scale. Big multinationals may be too large on social and political grounds, if not economic ones, but there's no way to sustain an industrial society without something like the corporate form.

Marx's view that corporate capitalism has made possible its own transcendence, by organizing production on a large and sustained scale and simultaneously rendering its owners socially vestigial, has gone somewhat out of fashion, to put it mildly, but is sorely worth recovering. In the light of his interpretation of the corporation as containing the seeds of a postcapitalist future, an analysis of that institutional form is in order -- in the interests not only of understanding but also of transforming.

Just in the last few years, the United States Government has nationalized the nation's largest insurance company, A.I.G., the two largest mortgage companies, Fannie Mae and Freddie Mac, two large auto companies, and backstopped the entire financial system. It's just that there's no inkling of a socialist movement pushing to remove its vestigial ownership and so we continue with trickle-down economics, i.e. socialism for the rich and harsh free markets for the rest.
-------------------------------
*

**



***this Alice in Chains video I linked - embedding disabled - at the old blog post best sums up the Great Clusterfuck era we're living through.

Government Policy to Heighten Inequality

Krugman blogs that Bernanke knows what's up having seen this show before in Japan. He directs us to Tim Duy who writes:

Word on the street is that Fed staff are increasingly frustrated with the lack of action from leadership. Why exactly is Bernanke showing such deference to the more hawkish elements such as Kansas City Federal Reserve President Thomas Hoenig, Dallas Federal Reserve President Richard Fischer, and Philadelphia Fed President Charles Plosser? If you seek more easing, you are not alone. Board staff are increasingly your allies.

It seems they might do a small adjustment to stop the passive reduction of mortgage-backed securities on their balance sheet but nothing else unless things are reaching crisis level.* What is the tipping point or trigger in their eyes I wonder? Actual deflation?
-----------------------
* The Fed was predicting 9.5% unemployment for this year and 8.7% for next near, in other words job growth will be glacial. (The IMF is predicting 9.5% for both years, and the White House's OMB is forecasting 9% for next year.) These European levels of unemployment minus Europe's social safety net is an assault on the working poor and middle class of America. The "threat of the sack" becomes much more potent and it's easier for managers to instill discipline. Obviously it becomes much more difficult for workers to fight for their fair share of the pie. It could get ugly unless growth really picks up. As far as I can tell they are waiting on the foreclosure mess and housing market to sort themselves out.

Global Trade bouncing back.

From the Economist:

At first, the recession did hit trade hard. Global GDP fell by 0.6% in 2009 while the volume of world exports dropped by 12.2%. But whereas the Depression saw trade decline for at least four years, this time the rebound has been quick, and sharp. By May this year, emerging-economy members of the G20 were importing and exporting around 10% more than their pre-crisis peaks (see chart). Rich-world trade has recovered from the trough too, though it has not yet made up all the ground lost since the credit crunch began.