By Clive Crook
Published: August 29 2010 19:29
The US recovery is stalling. As a matter of economics the balance of risks strongly favours further fiscal and monetary stimulus. Politics appears to rule out the first, and a divided Federal Reserve is hesitating over the second. America’s leaders are letting the country down.
The recovery is in danger of petering out altogether. Recent numbers have been dismal. Second-quarter growth was marked down to 1.6 per cent on Friday. Earlier, signs of a new crunch in the housing market gave the stock market another pummelling. Already low expectations were disappointed nonetheless: sales of existing single-family homes in July fell by nearly 30 per cent, to their lowest for 15 years. Sales of new homes were at their lowest since the series began to be reported in 1963.
Unlike most other advanced economies, the US could undertake further fiscal stimulus at acceptably low risk. Global appetite for its debt is undiminished. The risk, such as it is, could be all but eliminated if Congress could commit itself to stimulus now, restraint later – an easy thing, you might suppose, but evidently beyond its grasp. The administration could and should be pushing for just such a package, but it is not.
The political problem is that US voters, ever wary of big government, have wrongly decided that the first stimulus was an expensive failure. The administration is partly to blame. It oversold the likely effects of the first package and, worse, made it part of a broader agenda of expanded federal power. The message that the stimulus should be “timely, temporary and targeted” – a reassurance that many voters needed – got lost.
One cannot know how many jobs the stimulus saved, but it is absurd to see high unemployment as proof that it was ineffective. More likely this shows how powerful the recession’s downward pull has been, and still is. Most economists think the stimulus helped a lot. Yet, as in other areas, President Barack Obama’s defence of his policy has been strangely diffident.
For sure, politics is leaning hard against further action, at least this side of November’s midterm elections. But what if the administration promoted a second stimulus based on low taxes – temporarily extending all the Bush tax cuts, due to expire at the end of the year, plus (say) more generous payroll-tax relief tied to new jobs? Could Republicans object to that? Such a proposal might give output and employment a less powerful push than another surge of public spending – that is debatable – but it would be better than nothing, which is where things are stuck at present.
Meanwhile, there is monetary policy. At the end of last week, speaking at the Jackson Hole conference, Ben Bernanke, Fed chief, acknowledged the faltering recovery, and reminded his audience that the central bank has untapped capacity for stimulus. The benchmark interest rate is effectively zero, but that leaves quantitative easing and other unconventional measures. So far as QE goes, the Fed has already pumped trillions of dollars into the economy by buying debt. If it chose, it could pump in trillions more.
Mr Bernanke and his colleagues are understandably nervous about extending the radical measures they have already taken. Divided on the point, they have taken a modest further step by preventing the maturing of debt they hold from tightening monetary conditions, as it otherwise would have. They are right to worry about their exit strategy; they are also right to be nervous about being in uncharted terrain. But the balance of risks has moved. They need to go further.
George Magnus of UBS argued on this page last week that deflation poses a greater risk for the US than inflation. That seems right: inflation expectations, as revealed by rates on index-linked US debt, are very low. Mr Magnus was surely correct to say this points to the need for further monetary easing – but wrong, I think, to say that “unreconstructed monetarists will not be persuaded”. His point was that monetarists would see the policy rate at zero and banks holding enormous reserves at the Fed and conclude that money was already too loose.
As the monetary economist Scott Sumner has pointed out, Milton Friedman – name me a less reconstructed monetarist – talked of “the fallacy of identifying tight money with high interest rates and easy money with low interest rates”. When long-term nominal interest rates are very low, and inflation expectations are therefore also very low, money is tight in the sense that matters. When money is loose, inflation expectations rise, and so do long-term interest rates. Unreconstructed monetarists ought therefore to agree with Mr Magnus’s main point: under current circumstances, better to print money and be damned.
Admittedly, once that strategic issue is settled, difficult tactical questions arise. For instance, which assets should the Fed buy? As Alan Blinder, a former vice-chairman of the Fed, has noted, the recent policy of replacing maturing mortgage-backed securities on the Fed’s balance sheet with government debt has a secondary effect of reducing downward pressure on risk spreads, which is a pity. From that point of view, it would be better if a new phase of QE concentrated on private securities – but then the question would be, exactly which?
Details such as these need thinking through. But the main thing is simple enough: further monetary stimulus is needed, and soon.
Copyright The Financial Times Limited 2010.
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