The great economic experiment of 2013: Ben Bernanke vs. austerity … We rarely get to see a major, nationwide economic experiment at work, but so far 2013 has been one of those experiments … – Washington Post
Dominant Social Theme: The Federal Reserve and the US government have to work hand-in-hand to resolve this mess.
Free-Market Analysis: Here's an interesting article in the Washington Post explaining how US fiscal austerity needs to be offset by Federal Reserve pump priming.
We would argue, not to put too fine a point on it, that it is a confused mess. The logic is lacking and the facts are in doubt. Unfortunately, it seems to make perfect sense to the author, who works for the Roosevelt Institute. As its name might suggest, the Roosevelt Institute is entirely comfortable with governmental activism on the economic front – even the nonsensical kind.
So here is a question: If activist economic management works so well, why is the world doing so poorly?
When one takes a look around at the devastated economies of Europe, Japan and the US, one would have to question whether monetary and fiscal activism really does provide the kind of miracles that are claimed for it.
The kind of solution being proposed in this article is not just confusing; it is also naïve.
First of all, the author doesn't really define what "austerity" is. And actually, austerity, as it has been initiated, is not merely government cost-cutting. It also often includes MORE taxes and more regulation; its privatization is often of the monopoly kind that makes the privatized conglomerate no more efficient than under government control.
Having simply (apparently) asserted that austerity is cost-cutting, the author moves on to proposing that the Fed needs to print lots of money to make up for the government's austere "fiscal policy."
How exactly money printing of paper-debt instruments makes up for government cost cutting on the economic front is never made clear. Nor is it made clear why government cost cutting – would that it were actually happening – needs to be offset to begin with.
We could go on. But see for yourself. Here's more from the article:
… The biggest threats to a full recovery are both early fiscal and monetary contraction. The Evans Rule is the right rule to communicate to the markets the Federal Reserve's stance, which is properly a balance between price stability and full employment. The Federal Reserve was, in fact, sitting on its hands, and it is no longer doing that.
Second, there is still more the Federal Reserve could do to try and balance out austerity in 2013, but those moves would require a big change from current policy. Minor tweaking is unlikely to help. Joseph Gagnon of the Peterson Institute for International Economics suggests that, instead of committing to mortgage purchases, the Fed could target the mortgage rate for a time. Other economists, such as Brad DeLong, suggest that an explicit higher inflation target would be important. Still others, ranging from Christina Romer to market monetarists, think the Fed should explicitly target a nominal GDP.
Given that the Fed appears to be having trouble getting these new policies to move inflation expectations or interest rates, a dramatic change may be harder than originally thought. And if even subtle statements by the FOMC can break expectations of policy, as many are worried about, monetary policy at the zero lower bound will be far too fragile to carry us to recovery. However, the status quo of a low inflation target teamed with "break out unconventional policy in case of emergency" doesn't appear robust enough to handle future recessions.
But the most important lesson to draw is that fiscal policy is incredibly important at this moment. In normal times, the broader effect of government spending, or the fiscal multiplier, is low because the central bank can offset it. But these are not normal times. It's not clear why the Federal Reserve's actions haven't balanced out fiscal austerity. But since they haven't, we should be even more confident that, as the IMF put it, "fiscal multipliers are currently high in many advanced economies."
These multipliers work in both directions. As spending benefits the whole economy more in these times, austerity is also much more vicious than it would normally be. Using fiscal policy also avoids the expectations problems that plague monetary policy. When President Obama signs a law promising spending, the public believes the government will spend. That's not so with the Federal Reserve, where a random statement from a Federal Reserve governor can cause markets to doubt the Fed's long-term commitment.
Meanwhile, the idea that there exists a debt "danger zone" that should cause us to embrace austerity has recently collapsed due to questionable data and methodology. The question is, will we now move to stimulus to complement the Fed's efforts to get to full employment, or will we continue to sabotage the recovery?
So let's try to sum up. As the US government is cutting costs, the Federal Reserve ought to print more money to offset government contraction.
But presumably this money – much of it – flows THROUGH the government, so the article is basically proposing that while the government is cutting costs it also ought to be embarking on various forms of pump priming.
How can the government do both? Either the government is cutting costs or it is not. And even if we accept this illogical perspective, we still have to grapple with the issue of the efficiency of government spending in the first place. The author seems sure it will realize the proper results. Has he been sleeping in a cave these past decades?
We would suggest this argument places a good deal too much faith in government power and policies. The real solution to the current economic crisis lies in the free market's Third Way. Get government officials and monopoly money printing bankers out of the business of managing the economy.
Let the market itself – as much as possible – provide the solutions via Adam Smith's Invisible Hand of Competition. What this article is proposing, if we understand it adequately, will only compound the problem.
Why is it that would-be policymakers so often avoid the real-life solutions provided by the competitive marketplace? It's very strange. It's almost as if they want more chaos and currency devaluation. And why would that be …