Tag Archives: Keynesian Policy

Interest Rates under Volcker, Greenspan and Bernanke

Here is a chart from WSJ Graphics which shows the level of interest rates in the US from 1980 to today. With the stagflation of the 1970’s Paul Volcker was faced with some very tough decisions. Below is an extract from an interview with him on the PBS Commanding Heights documentary.

It came to be considered part of Keynesian doctrine that a little bit of inflation is a good thing. And of course what happens then, you get a little bit of inflation, then you need a little more, because it peps up the economy. People get used to it, and it loses its effectiveness. Like an antibiotic, you need a new one; you need a new one. Well, I certainly thought that inflation was a dragon that was eating at our innards, so the need was to slay that dragon.

If you had told me in August of 1979 that interest rates, the prime rate would get to 21.5 percent, I probably would have crawled into a hole. I would have crawled into a hole and cried, I suppose. But then we lived through it.

US Interest rates 1979-2014

US infrastructure could create those jobs

US InfrastructureSome alarming figures have been banded about with regard to America’s infrastructure. It is estimated that over 700,000 bridges are rated as structurally deficient. In 2009 Americans lost approximately $78 billion to traffic delays – inefficient use of time and petrol costs. Also crashes which to a large extent have been caused by road conditions, cost a further $230 billion.

According to the American Society of Civil Engineers the US needs to spend $2.2 trillion bring their infrastructure up to standard. The Congressional Budget Office estimated in 2011 that for every dollar the federal government spent on infrastructure the multiplier effect was up to 2.5. Other indicators state that every $1 billion spent on infrastructure creates 18,000 jobs, almost 30% more than if the same amount were used to cut personal income taxes. – The Economist

Positive Externalities from infrastructure.

Investment in infrastructure has a lot of positive externalities – faster traveling time for consumers and companies, spending less time on maintenance. Research has shown that the completion of a road led to an increase in economic activity between 3 and 8 times bigger than it initial outlay with eight years after its completion. But what must be considered is that now is the best time to invest in infrastructure as it is very cheap – much cheaper than it will be when the economy is going through a boom period.

Chinese growth = blow up bridge and rebuild it.

Another very useful clip from Paul Solman of PBS News. China has for quite a few years now gone down the route of government planning to keep economic activity buoyant. Assumptions have been made that in 10 years time there will be 200 cities in China with over 1 million people and 8 being over 10 million. However a recent blog post showed that there are ghost towns in certain areas of China with empty housing estates.

An example of artificially creating growth, as well as building ghost cities, is have a 7 year old bridge (built to last for 40 years) blown up and rebuilt. This generates jobs for construction industry including contractors for different aspects of the bridge. This likens to Keynesian policy where J.M.Keynes said that you should dig holes and fill them in to keep people employed. The Soviet Union found that central planning is good at mobilising resources, but is not good at sustaining innovation, or incentives that promote long-term growth. What China needs is more domestic consumption and move away from a reliance on government investment projects and export revenue. As ever Paul Solman explains things well.

“We should repair our highways” says The Economic Naturalist

Robert Frank author of “The Economic Naturalist” and “The Darwin Economy” recently wrote a piece in The New York Times advocating tradiitonal Keynesian stimulus policy. With the US election on the horizon both Obama and Romney will be focusing on how to kick-start the economy. Obama has been a keen believer in infrastructure investment as a way to get American back into work whilst Romney has recognised the clear link between spending and employment.

In 2009 it was estimated that US roads, bridges and other infrastructure were in disrepair by the order of $2 trillion. There are many with the skills to do these jobs that are currently unemployed. Furthermore the longer you leave the repairs the more expensive it becomes. Some have said that this just puts the government into further debt but Frank argues that:

The same logic applies to overdue infrastructure investments. Yes, paying for them requires more government debt. And while austerity advocates fret that such projects will impoverish our grandchildren, they concede that the investments can’t be postponed indefinitely, and that they’ll become much more expensive the longer we wait.

It seems that there is great opportunity to stimulate growth in the economy.

Professor Bernanke v Chairman Bernanke

In a recent edition of The New York Times magazine Paul Krugman wrote an article discussing the role of Ben Bernanke as an academic versus that of being the Fed Chairman.

When the financial crisis happened in 2008 it seemed that there could be no better person to be Fed Chairman. Having studied the Great Depression and written various academic papers on this and the crisis in Japan in 1990’s economists felt that Bernanke was the man for the job. Although the Fed has done a lot to rescue the financial system there is still major concerns about the labour market and the rising long-term rate of unemployment. Remember that the Fed has a dual mandate of Price Stability and Maximum Employment. In order to stimulate growth in the economy, especially when inflation is low, central banks lower interest rates but when the Fed Funds Rate reached 0 – 0.25% on the 16th December 2008 they basically ran out of ammunition as rates couldn’t go any lower. Here you tend to get stuck in what we call a “liquidity trap” in that monetary policy is no longer effective. When Japan was going through very slow growth in the 1990‘s, in which it experienced deflation, Professor Bernanke stated that Japanese policy makers should be a lot more active in trying to stimulate growth and inflation. With interest rates already at 0% he suggested that monetary authorities were not proactive enough to experiment with other policies even though they might have been radical. This all harks back to the days of FDR (Franklin D Roosevelt) in which he created work schemes, infrastructure projects etc, in order to boost employment. I have summarised Paul Krugman’s article below in a table format which shows Bernanke policies for the US economy as a Professor v Chairman.

So why hasn’t he taken on the role of the Academic Bernanke? Krugman suggests that:

this is the effect of bullies and the Fed Borg*, a combination of political intimidation and the desire to make life easy for the Fed as an institution. Whatever the mix of these motives the result is clear: faced with an economy still in desperate need of help, the Fed is unwilling to provide that help. And that, unfortunately, make the Fed part of the broader problem.

*Krugman is a keen “Star Trek” fan and compares the Federal Reserve to a Borg — a race of beings that act based on the wishes of a hive mind, and present major threats to the Starfleet and the Federation.

Keynes 1926 pamphlet could have been written today.

Diane Coyle runs a blog called “The Enlightened Economist” which is very good for reviews of recently published economics books. One of her recent posts talked of the republished 1926 pamphlet by John Maynard Keynes – ‘The End of Laissez Faire’. Though Keynes states that an economy should be free of government intervention he suggests that government can play a constructive role in protecting individuals from the worst harms of capitalism’s cycles, especially concerns about levels of unemployment. Diane Coyle produces a quote (see below) from the book which is ironically similar to what is the anti-capitalist sentiment today. She also suggests that we need to go beyond the state versus market debate and recongize that the two type of systems need to work together to alleviate problems such unemployment, externalities, uncertainty, well-being etc.

“Many of the greatest economic evils of our time are the fruits of risk, uncertainty, and ignorance. It is because particular individuals, fortunate in situation or in abilities, are able to take advantage of uncertainty and ignorance, and also because for the same reason big business is often a lottery, that great inequalities of wealth come about; and these same factors are also the cause of the unemployment of labour, or the disappointment of reasonable business expectations, and of the impairment of efficiency and production. Yet the cure lies outside the operations of individuals; it may even be to the interest of individuals to aggravate the disease.”

He then goes on to say

“I believe that the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution, and partly in the collection and dissemination on a great scale of data relating to the business situation, including the full publicity, by law if necessary, of all business facts which it is useful to know. These measures would involve society in exercising directive intelligence through some appropriate organ of action over many of the inner intricacies of private business, yet it would leave private initiative and enterprise unhindered. Even if these measures prove insufficient, nevertheless, they will furnish us with better knowledge than we have now for taking the next step.”

Stand-Up Economist

Thanks to colleague Warren Baas for this a great clip from Standup Economist Yoram Bauman at the 2010 American Economic Association conference. Some great recipes for economists looking at Keynesian and Monetarist methods. Also jokes about the financial crisis, “What to expect when you’re expecting the Nobel Prize”, and some of the Nobel prize jokes from his Cartoon book Introduction to Economics.

Debt according to Krugman

Paul Krugman wrote an interesting piece on his blog (New York Times) about how those in Washington DC have no idea what they are talking about when in comes to debt. Although the US economy was technically going through a recovery last year, the levels of unemployment have been worringly high – 9%. However there is concern in Congress about the rising budget deficit and the need to reign in government spending.

Krugman explains that Washington isn’t just confused about the short run; it’s also confused about the long run. Those concerned about deficits portray a future where we have to pay back what we have borrowed – it is not like taking out a mortgage and struggling to paying it back. Krugman looks at government debt in two ways:

1. Although households have to pay back debt governments don’t – all they need to do is ensure that debt grows more slowly than their tax base. As the US economy grew (and the tax revenue for the government) the debt from WW II became immaterial and was never repaid – see graph below.

2. What is unique with regard to US debt is that it is not like an individual who owes debt to a bank. Essentially the US debt is money that is owed to the US themselves. Foreigners do hold a significant amount of government debt in teasury bonds but every dollar’s worth of foreign claims on the US is matched by 89 cents’ worth of US claims on foreigners. Furthermore because foreigners tend to put their assets into safe US investments, the US actually earns more from its assets abroad than it pays to foreign investors.

Nations with responsible governments willing to impose modestly higher tax rates when the situation warrants it have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe. The UK has had debt exceeding 100% of GDP for 81 of the last 170 years. Keynes suggested of the need to spend your way out of recession when the UK was deeper in debt than any other adanced nation today, with the exception of Japan. Krugman states that the US doesn’t have a government that is responsible ie. willing to impose higher taxes. Debt matters BUT more government spending is needed to reduce unemployment.

The Tolerance of Inequality

John Plender from the FT recently looked at the tolerance of inequality in the capitalist system today. Stewart Lansley, an author of “The Cost of Inequality” says that the modern economy appears to have only two routes:

1. the super-rich who are racing ahead on the autobahn at unlimited speeds
2. everyone else who has stalled in the slow lane in a 50km zone

Before 2007 those in he slow lane enjoyed enjoyed rising living standards maninly due to their ability to borrow more money using their property as collateral. Since the crisis they have struggled to service unmatched levels of debt whilst finance has come to play a new role as “a cash cow for a global super-rich elite”. However according to Plender this is nothing new – the industrial revolution saw large differences in income distribution as did the 1920’s and 30’s. This was when John Maynard Keynes wrote about a more humane form of capitalism and was notably scathing of what he called “individualist capitalism and the money motive.”

Although the despair of earlier recessions are not prevalent today ie. soup kitchens, 25% unemployment, and extreme poverty, the conerns seem to focus on the unfairness of the system. Top of the agenda is the banking system which in the 1930’s was concerned with deposit-taking and lending but today has become incredibly complex system which they themselves do not always understand and whose social utility is not apparent to the lay person – including the head of the UK Financial Services Authority who stated that the business of banking has become far too large. Historically this is not new. Keynes remarked

“To convert the business man into the profiteer is to strike a blow at capitalism, because it destroys the psychological equilibrium which permits the perpetuance of unequal rewards. The businessman is only tolerable so long as his gains can be held to bear some relation to what, roughly and in some sense, his activities have contributed to society”

Solution – Reduce the Power of the Lobbyist
The economic system of late has also rewarded those that have taken risks and failed ie. bailouts from the government. Surely this is against what the definition of capitalism is. So where to from here? Mancur Olson a institutional economist has argued that nations decline because of the lobbying power of distributional coalitions, or special-interest groups, whose growing influence fosters economic efficiency and inequality. In the 1970’s it was trade unions and business cartels whilst today it is finance professionals on Wall Street and in London. Jeffrey Sachs in his recent book entitled “The Price of Civilisation – Economics and Ethics after the Fall” noted the total lobbying outlays by sector during 1998-2011. The table shows those sectors that receive the most funding are in the deepest strife for reasons tied to regulatory failures. Each of these sectors – finance, health care, transport, agribusiness etc – have landed cushy federal contracts, subsidies, tax breaks, and slack regulation and inattention. Not surprisingly finance, real esate, healthare, and pharmaceutical companies rank amongst the lowest in public approval in Gallup polls.

“These industries epitomize the destructive policies produced by the corporatocracy, and the public knows it.” Jeffrey Sachs

Below is a presentation by Jeffrey Sachs at LSE in December last year. Well worth a look but it is long.

Do Central Banks need to reinvent policy?

To some the role of central banks was of prime importance in the financial crisis and the substantial increases in the incomes of those employed in the financial sector.

Since the days of stagflation in the US and UK in the 1970’s inflation has been the number one target for central bankers. US President Jimmy Carter’s attempts to follow Keynes’s formula and spend his way out of trouble were going nowhere and the newly appointed Paul Volcker (US Fed Governor in the 1970’s) saw inflation as the worst of all economic evils. Below is an extract of an interview from the PBS series “Commanding Heights”

“It came to be considered part of Keynesian doctrine that a little bit of inflation is a good thing. And of course what happens then, you get a little bit of inflation, then you need a little more, because it peps up the economy. People get used to it, and it loses its effectiveness. Like an antibiotic, you need a new one; you need a new one. Well, I certainly thought that inflation was a dragon that was eating at our innards, so the need was to slay that dragon.”

The policy of the time was Keynesian – inject more money into the system in order to get the economy moving again. This was also the case in the UK in the early 1970’s but Jim Callaghan’s (Labour PM in the UK ousted by Thatcher in 1979) speech in 1976 had reluctantly recognised that this policy had run its course and a monetarist doctrine was about to become prevalent. Below is an extract from the speech.

“We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment. That is the history of the last twenty years”

With this paranoia about inflation central bankers began to implement a monetary policy targeting inflation in the medium term. In NZ the Reserve Bank Act 1989 established “price stability” as the main objective of the RBNZ. “Price stability” is defined in the PTA (Policy Target Agreement) as keeping inflation between 1 to 3% (originally 0-2%) – measured by the percentage change in CPI. Around the world central banks were adopting a more independent approach to policy implementation and with targeting inflation a new prevailing attitude seemed to be like an osmosis and suggesting that low prices = macro-economic stability as well. Also, raising interest rates is an unpopular political move and governments could now blame the central bank for this contractionary measure.

However, the rise of asset prices were largely ignored by central banks and although inflation remained relatively stable, this was in part due to the disinflation of the emerging markets that were now becoming more a part of the global market. Therefore with low inflation, central banks could afford to lower interest rates and ultimately stimulate a lot of borrowing which increased asset prices. The Rethinking Central Banking report (written by a group of economists, financiers and policy makers) recommend an “international monetary policy committee” which can look at the bigger picture in the global economy.

According to Jeremy Warner in the Daily Telegraph:

The bottom line is that central banks need to be much more open about precisely what their objectives are, mindful of the international implications of what they do, and clear about what circumstances would trigger particular courses of action.