You can bet that I am not going to be found in a camp opposing restraint on the part of the federal government when it comes to taming this recession. The authorities have one big, mean tiger by the tail and could well get mauled before this is over. I am, however, now and probably in the future going to speak out loudly about the need to get rid of the dead weight that the economy is dragging around.
First, let’s look at a couple thoughts that I picked up on the Web today. They have to do with the Fed’s decision to cut interest rates to effectively zip.
Market Watch has a nice short post that puts the Fed’s expected actions from now on in plain English:
In essence, the Fed intends to be “the invisible hand” in all financial markets, according to Joel Naroff, president of Naroff Economic Advisors.“Wherever market failures exist, the Fed will be the market maker,” Naroff said. The Fed has already become the market maker for corporate paper and mortgages and mortgage-backed securities.It has plans to become a market maker in loans to households and small businesses.And a senior Fed official said that other credit markets could be helped.
That is, even if the Fed cannot reduce nominal interest rates, it can reduce real interest rates by committing to modest amount of inflation.Some would view this as a radical change in monetary policy. In some ways it would be. Given how weak the economy is, however, a bit of radicalism may be called for. I am more comfortable having the Fed commit itself to modest inflation than having the federal government commit itself to a trillion dollars of new spending.
The abandonment of “price stability” would be the modern equivalent of Roosevelt’s abandoning the gold standard. Of all the things that Roosevelt did to get the economy out of the Depression, jettisoning the gold standard was the most successful. Today, monetary policy is not fettered by gold but by fear of inflation. Perhaps it is time is get over that fear, at least for a while. As Jim Tobin said in an earlier era, there are worst things than inflation, and we have them.
Japan’s economy grow anemically over that decade, but as the nearby chart shows, its national debt exploded. Only in this decade, with a monetary reflation and Prime Minister Junichiro Koizumi’s decision to privatize state assets and force banks to acknowledge their bad debts, did the economy recover. Yet recent governments have rolled back Mr. Koizumi’s reforms and returned to their spending habits. But Japan does have better roads.
Now we’re told that a similar spending program — a new New Deal — will revive the U.S. economy. How do you say “good luck” in Japanese?
The thrust of the Journal’s article was that though Japan spent like drunken sailors during their recession there was little to show for it in terms of recovery primarily because they attempted to keep zombie banks and industrial companies alive.
Though disparate, all of these commentaries taken together paint a fairly good picture of what’s ahead. The Fed is embarking on a journey with no landmarks to guide it, save for a lot of economic theory. It’s certain to if not make mistakes, make policy decisions that will have unexpected negative feedback and will have to be both nimble and independent in order to get its part of the job done. In abandoning its concern about inflation for the moment, it appears to be making the proper move. And, all of these actions may provide little fruit if we don’t also attack some of the fundamental weaknesses in the economy. Banks have to be cleaned up-that hasn’t happened yet-or closed in one way or another and weak industrial companies have to fade from the scene. Mankiw expressed his discomfort with a massive stimulus program and the WSJ ably points out the pitfalls of doing it wrong. No matter the intentions, there is plenty of room to muck things up badly through either monetary or fiscal policy.
The Fed took its first step down the new road today. The Obama administration will very shortly start its own journey. We will soon see what both are made of and let’s hope it is of some substance. If not, we might experience Japan’s fate many times over.
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