June 2010 Archives

Finally, the idea that the world's rich countries need to cut spending and raise taxes has a lot of truth to it. The United States, Europe and Japan have all made promises they cannot afford. Eventually, something needs to change.

In an ideal world, countries would pair more short-term spending and tax cuts with long-term spending cuts and tax increases. But not a single big country has figured out, politically, how to do that.

So true.  I, too, would be cautious about allowing the economy to slip.  But is it that we need more stimulus, or is it that the original stimulus wasn't done right?  If the latter, that's a problem if we really do need something more, as there's little hope that they'd get it right the next time.

Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months. 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 moderate for a time.

Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee's flexibility to begin raising rates modestly.

Mark Thoma thinks that fiscal and monetary policy should be used more aggressively, citing this David Leonhardt column in the NY Times.  Leonhardt's column is worth quoting at length as it pretty succinctly describes the feeling that has been building in my mind and I'm sure in others over the first half of this year.

Ben Bernanke believes that he and his Federal Reserve colleagues have the ability to lift economic growth at their meeting this week. The Fed, he has said, "retains considerable power to expand aggregate demand and economic activity, even when its accustomed policy rate is at zero," as it is today.

Mr. Bernanke also believes that the economy is growing "not fast enough," as he recently put it. He has predicted that unemployment will remain high for years and that "a lot of people are going to be under financial stress."

Yet he has been unwilling to use his power to lift growth and reduce joblessness from near a 27-year high. Instead, Fed officials are expected to announce on Wednesday that they have left their policy unchanged, even if they acknowledge that the economy has recently weakened.

How can this be? How can Mr. Bernanke simultaneously think that growth is too slow and that it shouldn't be sped up? There is an answer -- whether or not you find it persuasive.

Above all, top Fed officials are worried that financial markets are fragile. They are not so much worried about inflation, the traditional source of Fed angst, as they are about upsetting the markets' confidence in Washington. Yes, investors remain happy to lend the United States money at rock-bottom interest rates, despite our budget deficit and all of the emergency Fed programs that will eventually need to be unwound. But no one knows how long that confidence will last.

In effect, Mr. Bernanke and his colleagues have decided to accept an all-but-certain downside -- high unemployment, for years to come -- rather than risk an even worse situation -- a market panic, a spike in long-term interest rates and yet higher unemployment. As the last few years have shown, market sentiment can change unexpectedly and sharply.

If you fear that the recovery is about to stall, today's news on new home sales probably increased your worries.  And in the midst this, an FOMC member, Hoenig (Kansas City), dissented from the consensus opinion, believing "that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee's flexibility to begin raising rates modestly."

Hoenig and Bernanke have similar concerns about stability.  Hoenig is of the opinion that keeping rates low will lead to risks to that stability.  Bernanke seems to be hoping that they can maintain the low rates, but seems to be drawing the line at providing any further support like, say, buying long-term bonds and pushing those rates down as well.

But what if GDP stalls in the 2nd half of 2010?  Do you pull the trigger and use unconventional monetary policy?  What is worse, another year of 10% unemployment or instability in the financial markets?  If you wait too long to decide, will you get both?

The person in the big chair has to make that decision, and for now he's content to sit on low short-term rates, even if that makes it hard to reverse course later.  And he's keeping his powder (what little remains of it, at least) dry.

As it seems to me that price pressures seem to be even more muted right now than 6 months ago, I would want to be ready to do something unconventional in case Congress has a fit of anti-deficit hysteria at the same time GDP stalls and unemployment edges back up.  We do not have to repeat past mistakes.

The 2nd half could go either way, but I'm a little more pessimistic today than a month ago.

On a related note, Bill Conerly thinks that the Fed has actually been doing a little quantitative tightening, but thinks they should continue easing.  Connerly sees tightening in the slight reductions lately in bank credit, slower growth of M2, and decline of MZM.  Maybe these are just short-term aberrations, but they are worth noting.  Eventually these quantities should return to a more normal trend reflecting a neutral stance, but now is not the time for that yet.  If we see this continue for a couple more months, I would be concerned about this apparent stealth tightening.  Stay tuned.

You would think that there were few barriers to switching cellphones. But the carriers try to make it harder to switch by locking customers into two-year contracts with high early-termination fees. And each handset maker also inspires loyalty by continually making improvements in its phones, as Apple announced last week for its iPhone. Some people may complain incessantly about their iPhone and AT&T's service for it, but not that many are switching. And that's just the way the companies have intended it.

...

In a classic bit of economic sleuthing, Minjung Park, an assistant professor of economics at the University of Minnesota, looked at the impact of the Federal Communications Commission's mandate that customers could keep their phone numbers when they switched carriers, starting in late 2003 in large markets and mid-2004 in smaller ones. (The phone companies had fought the decision because nonportability had been a very effective way to hold onto customers.)

She examined more than 100,000 calling plans and found that the prices of wireless plans dropped by as much as 6.8 percent in the seven months after the rule change. After adjusting for the overall trend in wireless prices, she calculated that the savings totaled $845 million during that period.

The article goes on to point out that economic theory would also predict that once they have you locked-in to the a particular phone technology (e.g. iPhone) they will raise the price on you.

Yep.