You can count on Allen Meltzer to offer sound and sensible advice on economics, and his article, "
The Fed Compounds Its Mistakes," in today's WSJ is one more reason why. It would be very hard for any economist worth his salt to disagree with anything Meltzer says here, so why in the world is the Fed so hell-bent on proceeding with QE2? Excerpts follow, but read the whole thing:
The Federal Reserve seems determined to make mistakes. First it started rumors that it would resume Treasury bond purchases, with the amount as high as $1 trillion.
Then the press reported rumors about plans to raise the inflation target to 4% or higher, from 2%. This is a major change from the Fed's quick rejection of a higher target when the International Monetary Fund suggested it a few months ago.
Increasing inflation to reduce unemployment initiated the Great Inflation of the 1960s and 1970s. Milton Friedman pointed out in 1968 why any gain in employment would be temporary: It would last only so long as people underestimated the rate of inflation. Friedman's analysis is now a standard teaching of economics. Surely Fed economists understand this.
Adding another trillion dollars to the bank reserves by buying bonds will not relax a constraint that is holding back spending. There is no shortage of liquidity in the economy.
The most important restriction on investment today is not tight monetary policy, but uncertainty about administration policy. Businesses cannot know what their taxes, health-care, energy and regulatory costs will be, so they cannot know what return to expect on any new investment.
The only lasting solution for housing is to let prices fall to a new equilibrium. Painful, yes, but necessary. Temporary palliatives such as lower interest rates delay that adjustment.
Once the economy does begin to heat up, the Fed will urgently need to reduce excess bank reserves lest they stoke inflation. The Fed has talked about policies it can use to do so, such as raising the interest rates it pays to banks to hold their reserves. It has not offered a coherent, credible program to do so since it does not say, and probably does not know, how high the market interest rate would have to be.
Yes, a sustained deflation would be a big problem, but it is unlikely in today's circumstances. Countries with a depreciating exchange rate, an unsustainable budget deficit, and more than $1 trillion of excess monetary reserves are more likely to inflate. That's our problem today, and it's another reason the Fed should give up this nonsense about more stimulus and offer a credible long-term program to prevent the next inflation.
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23 comments:
Well! I feel like I have been hit by a freight train.
Hey, there are multiple points of view on QE.
Ben Bernanke strikes me as the very picture of sobriety and circumspection. If Bernanke goes to QE, he has good grounds to do do.
Meltzer seems to playing a very partisan card of late.
Benji, those of us for retiring QE2 urge you to visit Long Beach when it is berthed next to the Queen Mary. You can admire it at rest and not have to get thrown around by its wake. I wish I was still living at the motel room my parents had on Long Beach Blvd. so I could see those ships every day at rest.
I believe the market is expecting the Fed to do 'something' at the November meetings (after the elections). Some kind of action has already been discounted by the markets. However, I am coming around to the idea that it still is not a 'done deal' although the bazooka is loaded. There are going to be some political fireworks in about three weeks and the markets may do something unexpected as a result so maybe Uncle Ben and his collegues wait and gather some additional data before acting. Also, should the Republicans win enough Senate seats to change control, they may want to consider potential changes to fiscal policy before they shoot. There is a lot for the Fed to think about here and as Scott says, having the bazooka loaded and the market convinced they will fire has already had an effect. If they can string it out, the markets may relieve them of the problem of whether to pull the trigger.
What has been missing is clarity on many taxes and regulations, and plain old confidence (fear?). If the elections alleviate some of this, maybe QE2 won't be necessary.
Just (one of) my cheap opinion (s).
John-
Buddy-
Yeah, The Queen Mary is a sight, and Long Beach a fun town...
I will tell all of you this: I would feel better if Allen Meltzer, Obama, John McCain, Bernanke and all the rest had ever run a real business in their lives, risking their own capital.
Meltzer has never been outside the Ivory Tower, save when he served on the President's CEA, which is not far removed. He can piously pettifog about inflation all he wants to, but he has never a faced a week when the mortgage is due, payroll has to be met, and when the phone rings it is a bill collector, not new business.
I just talked to a guy who runs a space in the Denver Merchandise Mart (wholesale furnishings mart).
Business is off 60 percent.
I have more than 20 years in the cabinet and furniture-making business, selling to retailers, or commercial estbalishments. It is ugly out there, and it is still ugly out there. My (industrial)neighborhood has many similar small businesses, and nobody looks happy. Fewer employee cars in parking lots etc. I see it.
Unlike these sniveling sissies I hear who are going to work less due to taxes and regs, I have never turned down a job in my life. I can't even imagine turning down a job. I am advertising more, not less (in part as I have a new line aimed at sports bars).
Jay Crickey Almighty, the CPI is reading 1.1 percent for the last 12 months, and Boskin says that is probably one percent too high-indeed with the Internet and global markets for products and services, I would guess that right now we are in deflation.
Oh, but let's have another sermonette about inflation.
Thank you Allen Meltzer. I am glad you are concerned about inflation in the Boskin-adjusted zero percent range.
Benj,
I am VERY sympathetic to the plight of small businesses struggling in this lousy economy. That includes you. There are also millions of Americans who want to work but lack the opportunity.
I am in the camp that believes the reason for the weak economy is poor government policies. I know many small businessmen/women who are scared and hunkered down because they simply don't believe in this country's leadership. If there is a massive enough legislative turnover I am convinced it will make a difference in business confidence, and in time, employment and every other economic metric. I realize there are many (perhaps you) that do not agree. But one of the purposes of QE2 is to instill confidence in the markets. Scott has documented the strong evidence that their promise/threat to use their tools has mattered even without their being used. I maintain the election can have a similar effect. Businesses and individuals need clarity of rules and confidence in the future in order to make longer term investments and increase consumption. Since those in power have clearly (at least to me) not delivered it, some kind of change is necessary to instill that confidence. It can be a super agressive Fed or it can be a positive Congress that 'gets it' on the issues that matter most to business and investment. Or it could be both, should it be deemed necessary by the powers that be.
As Alan Greenspan has said, 'the Fed is a creature of Congress'. It is only logical that the 'creature' wait and have a look at who and what their new masters are.
Businesses cannot know what their taxes, health-care, energy and regulatory costs will be, so they cannot know what return to expect on any new investment.
Absolute bunkum.
John-
You are a voice of reason in a large sea of madness.
Thanks for letting me blow off some steam, and to Mr Calafia too.
I am back to normal now, or as close as I get....
BTW, give Marmico credit where credit is due; his link shows business investment rising nicely.
It sank in recession, and is growing sharply now.
This makes sense---business is uncertain by nature. Sales are the biggest worry.
Business people in most countries put up with worse--corruption (Latin America, Africa), taxes and regs (Europe), governmental sloth and inertia (India), Communist Party control of key enterprises (China).
If the sales are there, business in America is a good place to be.
Right now, sales are dead.
Business investment is indeed rising on the margin, but capex has a long ways to go before it reaches new highs in real terms relative to where it was 10 years ago. The reluctance to invest undoubtedly has played an important role in the slowness of this recovery.
Here's wishing I had as much confidence in a Republican outcome as you fellers. Should the Rs take both houses of congress, they won't hold 60 Senate seats and won't be able to override a veto. Obama is enough of an socialist ideologue to use it often if necessary. I don't think it's going to be easy undoing any of the bad policies of the past two years, but new damage can be controlled.
As to the Republicans, the last time they held a majority they were arrogantly corrupt. Have they really learned the lesson? We'll know only when we see them removing earmarks. Right now, I do not have confidence in either party.
I liked George W. Bush but I am extremely upset at him for not using his veto pen in his first term. He let spending go wild.
I'm not holding Iraq against him, but I wish it had not happened.
Bernanke has MZM 13wk moving average growing at about 8.5% and that's good. The yr/yr 4wkma is a little above zero and needs to move higher. Mr. Greenspan drove monetary policy all over the road and it looks like Chairman Bernanke is trying to reign it in.
I don't think we need QE. The household survey shows we're creating 205,000 jobs a month. Consumer purchasing power is growing. Total cash earnings in the private sector are growing at an annual rate of 4.4% and consumers are paying down debt. Productivity growth is strong. Capacity utilization is at 75% and the long-term average is around
80%. Business investment in capital equipment should accelerate going forward. Homebuilders will have to accelerate the rate of new home construction by about 150% over the next 3 years in order not to fall behind in supply. The auto industry is gaining in strength.
There's no evidence yet of inflation. What we need now is to let consumers keep more of what they earn, and business and the economy could boom.
The reluctance to invest undoubtedly has played an important role in the slowness of this recovery
More bunkum. When there are less vacant homes for sale or rent across the street in the subdivision affectionately known as Fraudclosure Acres, home builders will build. When the vacancy rate declines more in the commercial real estate buildings across the street affectionately known as Seethrough Towers, developers will build.
Only when those conditions are satisfied, will there be sustained investment growth in residential and nonresidential structures thereby making a material contribution to the growth rate in total private fixed investment.
Real investment in equipment and software will reach its prior peak in Q42010, 3 years after the onset of the worst post-WW11 recession. You are prone to spin v-shaped data, Grannis. I'm surprised that you aren't trumpeting this extremely bullish data point. Ooops, it contradicts your talking points play book bunkum of regime uncertainty.
Oh BTW, the absolute bunkum chart was real not nominal.
Actually, marmico's data supports Scott's point. Businesses have increased investment in things that increase the productivity of their existing employees because it is fairly clear that the tax treatment of those things will not change materially. Also, businesses deferred pruchases so long that unless they adopt newer technologies, they will fall behind their competition.
Businesses are not investing in new employees because their costs remain uncertain. That uncertainty will not be cured by a Republican Congress. Businesses are not investing in structures because new communications technologies are making commercial real estate less and less valuable. In fact, real investment in non-residential structures is at its lowest level in history. The increase in real equipment and software investment is not enough to offset the decline in real structural investment.
I agree with you that QE isn't doing much good. I have written an article on why quantitative easing would not work, with similar views.
Z the Analayst:
I enjoyed your highly intelligent piece.
But you seem to be saying the USA will have a slow deflationary bust, and a rising dollar--a replay of Japan. Long term bear markets in property and equities.
But you say QE2 is not an answer.
Heavens to Murgatroy, if a secular deflationary bear market of decades in duration is facing us, shouldn't the Fed gun the presses come hell or high water?
Milton Friedman clearly advised QE in deflationary environments where interest rates hit zero.
Release of Fed minutes:
The bazooka is clearly loaded.
The Fed says inflation going lower, for 2011 and 2012.
BTW, we are at zero now, according to Boskin.
The Fed also reported unit labor costs have been deflating, actually going down.
I just can't imagine worrying bout inflation now.
From the 9/21 meeting...
"Overall inflation was projected to remain subdued, with the staff's forecasts for headline and core inflation little changed from the previous projection. The current and projected wide margins of economic slack were expected to contribute to a small slowing in core inflation in 2011, which was anticipated to be tempered by stable inflation expectations. Inflation was projected to change little in 2012, as considerable economic slack was expected to remain even as economic activity was anticipated to strengthen."
"The most important restriction on investment today is not tight monetary policy, but uncertainty about administration policy. Businesses cannot know what their taxes, health-care, energy and regulatory costs will be, so they cannot know what return to expect on any new investment."
This is the biggest myth. The most important restriction on investment is lack of demand. There is lack of demand because of high household debt, damaged credit, and lack of job security.
Demand is also curtailed by uncertainty in commodity prices. Remember during the last administration when gasoline went up to $4.50 a gallon. At that point a lot people threw in the towel with respect to house payments.
Anybody notice how comparitively stable gas and other commodity prices have been since Obama started?
Scott-
You should come up with a acronym for businesses and their concern for Taxes, Health-Care, Energy and Regulatory costs. I like TERH, as in these policies are "TERH"ing down the american dream.
From the wires---
"The federal government borrowed $32 billion from investors for three years at the lowest rate on record.
The three-year notes auctioned by the Treasury Tuesday paid a 0.57 percent yield. But the low rate sapped demand. Buyers placed bids for 2.95 times the $32 billion offered, slightly less than the average over the last year."
A couple of q's based on the above:
If I read this right, the T-bills were oversubcribed by about three times--why not offer even lower rates? Is there a reason we taxpayers borrow money at a higher rate than necessary to raise the money?
Seems like capital galore out there.
John-
Like your last post---but you seem to vacillate between leftie and rightie. That's okay, I do too, depending on the issue. Just wonderin'
Benjamin:
This blog thread has two Johns, one port-side, the other starboard.
From stem to stern, I find both Johns to be interesting reads....
As I you, sir.
Portside John,
As you point out, demand is curtailed by uncertainty in commodity prices. Also, uncertainty in job security, home prices, etc. This uncertainty feeds lack of confidence which, to me, has much to do with the economic malaise we endure. It seems it is all related.
I enjoy your comments. Thank you.
Starboard John
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