Friday, October 28, 2011




The Problem
(or Fed Fail)

Notice the "L" shaped recovery, there's no catch-up growth or "V" recovery.

Austrians and lefties who have embraced their siren song on debt argue that the potential GDP line is angled too steeply upward in the chart above. It's true that the housing boom had debt-fueled consumption, but why can't that continue with full employment if it's managed well? Maybe the blue trend line should be angled slightly more downwards but it doesn't mean that the Austrians are right. The argument is over the degree of the angle. To me the angle of the red line is a result of accomadating Fed policy interacting with headwinds from declines in state and local government spending and from headwinds associated with households deleveraging and deleveraging in the mortgage market. It is running parallel with the blue line because Bernanke is more concerned with preventing deflation or runaway inflation than with firming up the job market. In my opinion, Evans and Rosengren are right that runaway inflation isn't a danger. The danger is that the Fed continues to lose credibility over failing to fulfill its dual mandate.

For me I just instinctually (instinctively?) disagree with the conservative, folk wisdom that all debt is bad. One just needs to be prudent.

As DeLong suggests here we should have used that debt-fueled demand on more productive investments than on consumption or tax cuts.

(graph via Bernstein)

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