Forget austerity, housing and the economy need more stimulus
Proponents of austerity predicted a number of dire consequences for fiscal stimulus, but so far, none of them have come to pass.
Have you ever been completely certain about something only later to find out you were completely wrong? Most people won’t admit it, and many people fail to acknowledge the truth even to themselves. I like to believe I have been more right than wrong over the last nine years of writing about these issues, but I have made some significant blunders.
So far pretty much every prediction I’ve made about interest rates has been wrong. I was nearly right last year when I said interest rates would not rise in 2015, but in the late December meeting Janet Yellen proved me wrong again. I was right about the housing bust, but I was wrong about the housing bottom. I was six months late in accepting the March 2012 bottom was the real deal.
Over the last several years, I’ve sided with those who favor less central bank tampering the economy and our money. Since I am personally fiscally conservative, I extrapolate my believes on how governments and central banks should act. The idea of a central bank printing money and stealing the stored wealth in my savings is repugnant, and although I was never a gold bug, I believe in the idea of sound currency. These personal biases caused me to oppose those who wanted to stimulate our way back to economic health.
After what transpired over the last several years, I’ve come to believe I was wrong. Quantitative easing did not make the US dollar into toilet paper. In fact, the relative strength of the US dollar is one of the problems hindering growth right now. Quantitative easing did not lead to rampant inflation. Deflation is still a huge problem globally, and price inflation has been far less than 2% for many years now.
The problems of asset mispricing and the poor allocation of capital have come to pass. Despite our poor economic growth over the last decade, we’ve managed to inflated several asset bubbles that will like deflate with high volatility over the next several years. I don’t believe this will have the negative impact on the economy that most fear, but I could be wrong about that too.
Icarus and endless quantitative easing
Icarus is a character from Greek mythology. He wanted to escape the island of Crete, so his father fashioned him wings made of wax and feathers and instructed him not to fly too close to the sun or the wax would melt and he would crash. Icarus did not heed his father’s warning, and when he flew too high, the wax melted, the feathers fell off, and he crashed back down to earth.
Quantitative easing is much like the flight of Icarus. When the economy got really bad, it was arguably the only way out of our predicament. If they print just the right amount, we can fly to safety. However, if they print too much, if they fly too close to the sun, the melting rays of inflation will cause investors to stop buying bonds, the federal reserve would lose control of long-term rates, and we could have a complete meltdown of the mortgage and housing markets.
The central bankers are simply crazy, not evil. …
If the central bankers have gone crazy with this whole negative interest rate theory, then the public is simply out of their minds. The euro rallied because Draghi cut rates further, extended the stimulus another year, increased the amount by another 33%, and then declared rates would stay there for years to come. And these insane traders cheer. Unbelievable! They are celebrating the public admission of Draghi that all his efforts to date have failed, so let’s do even more of the same. And they love this nonsense?
While the hyperbole is certainly entertaining, let’s think about this for a moment rationally. Most Central Banks around the world have lowered interest rates and printed money with little results to show for the policy. So the question is “were these policies completely misguided, or did they fail to go far enough?”
Generally, the sign of a failed government policy is that its proponents claim it didn’t go far enough. All wars since world war two have been limited engagements. In all these conflicts that were not decisive (and even some that were), proponents claimed we didn’t go far enough to win and ensure future peace, and opponents claimed the whole idea was a failure. Which side is right?
Negative interest rates have become simply a tax on saving money and the stupid traders and media writers love it. The Fed tries to raise rates and they say – NO! This is a stunning combination of admission and stupidity …
All they see is that lower interest rates “should” stimulate but ignore the fact that they never do. They are too stupid to grasp the fact that raising taxes cannot be offset by lower interest rates. People judge everything by the bottom-line and not some crazy theory that’s just stupid. A simple correlation study by a high school student in math class would prove this theory does not correlate to the expected outcome. And we cheer this insanity confirming our own overall stupidity and one is left wondering who is crazier?
I suppose it is just that central bankers are crazy and the public, as well as the media, are just out of their minds.
Did the theory correlate to the expected outcome? I don’t think either side of the debate can claim victory by that criteria.
Proponents of stimulus and quantitative easing claim that their policies would lead to economic growth and prosperity. While the economy hasn’t been as strong as previous expansions, we have experienced economic growth.
Opponents of stimulus and quantitative easing claimed those policies would lead to currency debasement, runaway inflation, and a plethora of associated economic problems. While the ZIRP policy inflated asset bubbles and likely misallocated capital, it had none of the other more serious deleterious effects its opponents were certain would occur.
On balance, I have to go with the proponents of stimulus and quantitative easing. In retrospect, I don’t think we went far enough to boost the economy.
01/08/2016, Brad DeLong
Economist Joe Stiglitz warned back in 2010 that the world risked sliding into a “Great Malaise.” This week, he followed up on that grim prediction, saying, “We didn’t do what was needed, and we have ended up precisely where I feared we would.”
The problems we face now, Stiglitz points out, include “a deficiency of aggregate demand, brought on by a combination of growing inequality and a mindless wave of fiscal austerity.“
I was a proponent of austerity. I didn’t believe printing money and artificially stimulating demand would do much of anything. Further, I believed inflation was always right around the corner and the reckless policies of the federal reserve were sure to trash the dollar and rob the stored wealth of everyone holding cash. In retrospect, it was clear that I was completely wrong.
None of the problems I feared ever materialized. It’s apparent to me now that we could have printed a lot more money, papered over many more problems with none of the ill effects I envisioned.
He says the only cure is an increase in aggregate demand, far-reaching redistribution of income and deep reform of our financial system. The obstacles to this cure, he writes, “are not rooted in economics, but in politics and ideology.”
Indeed. Joe Stiglitz is right.
Politicians from the right and conservative economists all incorrectly predicted rampant inflation and a collapsing dollar. Investors loaded up on gold for an inflationary spiral that never occurred, and many gold bugs lost a significant portion of their wealth in the bear market since 2011. If anything, it looks today like we didn’t go far enough with stimulus.
Back before 2008, I used to teach my students that during a disturbance in the business cycle, we’d be 40 percent of the way back to normal in a year. The long-run trend of economic growth, I would say, was barely affected by short-run business cycle disturbances. There would always be short-run bubbles and panics and inflations and recessions. They would press production and employment away from its long-run trend — perhaps by as much as 5 percent. But they would be transitory.After the shock hit, the economy would rapidly head back to normal. The equilibrium-restoring logic and magic of supply and demand would push the economy to close two-fifths of the gap to normal each year. After four years, only a seventh of the peak disturbance would remain.
In the aftermath of 2008, Stiglitz was indeed one of those warning that I and economists like me were wrong. Without extraordinary, sustained and aggressive policies to rebalance the economy, he said, we would never get back to what before 2008 we had thought was normal.
I was wrong. He was right. …
What we need now is 1) debt relief to unwind the overhang and 2) much tighter financial regulation to prevent the growth of new fragilities. And if those prove inconsistent with full recovery, then we need massive government spending on infrastructure and other investments financed by money printing until full employment is reattained.
Worries about inflation prompted the federal reserve to raise interest rates in December of 2015. So far the fears of inflation appear unfounded, and the economy shows signs of weakness due to the soaring dollar caused by rising interest rates. If we do have a recession this year or next, don’t be surprised if we have renewed calls for more stimulus, and this time, the opponents won’t have much credibility in their arguments against it.
Like Brad DeLong, I’ve come to believe I was wrong for many years about the problem of inflation and printing too much money. I was a proponent of needless austerity. Based on everything we witnessed over the last decade, it’s hard to continue to embrace a policy of austerity that’s failed to produce meaningful economic growth. Until we see a problem with inflation, I’m in favor of bringing on more stimulus. We aren’t there yet.