The End of Monetary Policy
by Charles Lemos, Mon Dec 15, 2008 at 09:45:51 PM EST
I apologize in advance since this post isn't as tight as I'd like it but I've been dwelling on three things this evening, the President-elect's news conference on Monday in Chicago, the expected fed funds rate cut on Tuesday and some comments by Paul Krugman in Germany's Der Spiegel. So with this introduction . . .
Another reduction to the Federal Reserve's funds rate, the interest banks charge each other on overnight loans, is all but certain to be announced tomorrow. The Fed's funds rate is already near historical lows at 1.0% but most economists expect the Federal Reserve to cut the rate in half to 0.5%. Some economists are even pushing for a more aggressive three-quarters of a point reduction. Their argument is that such a cut might cushion some of the economic fallout and prevent a tailspin. Well, I think that's already too late. I think I am sanguine when I say we'll be lucky to lose only 750,000 jobs next year.
My sense is that a fed rate cut is spit in the ocean. Not that I am against the rate cut, it should be cut, but rather that the cut in and of itself isn't likely to spur the American economy much less the global economy. The bitter truth is that we have reached the end of monetary policy as an instrument. To spur the economy, we really waiting on President Obama's fiscal stimulus. Only a Keynesian style investment program is likely to soften the edges of the economic downturn.
Here's the problem as noted in MSNBC:
However deeply the Fed decides to cut rates, the prime rate -- now at 4 percent -- for many consumer and small-business loans would drop by a corresponding amount. The prime lending rate is used to peg rates on home equity loans, certain credit cards and other consumer loans. Cheaper rates could give pinched borrowers a dose of relief.
The goal of lower borrowing costs is to entice people and businesses to spend more, which would revive the flat-lined economy. So far, though, the Fed's aggressive rate reductions have failed to lift the country out of a recession that started last December.
Clobbered by the financial crisis, worried banks have hoarded their cash and been extremely reluctant to lend money to customers. Fearful consumers, watching jobs vanish and their investments tank, have sharply cut back their spending, including big-ticket purchases like homes and cars that typically involve financing.
Banks are hoarding cash, businesses have postponed making investments (including hiring) and consumers have cut their discretionary spending. In short, the crisis is now a problem of confidence. There isn't any. Hence the need for an optimistic and confident Obama. And Obama's fiscal package, his infrastructure proposals, his energy proposals highlighted today with his presentation of his energy and environment team speak well to this. I watched with fascination the press conference today from Chicago. While there was a measure of stern and sobering reality, the President-elect threw in heaps of we'll get through this. I swooned and learned to start loving Obama. A sobering reality confronts him and yet he smiled and spoke with measured determination that we have a way out. It, of course, helps that I agree with what he had to say from the role of science in the economy to the urgent necessity of having a decade to do what should have been done 30 years ago.
I'm a peak oiler and though I don't have an energy background, I know enough to realize that the era of cheap energy is coming to an abrupt end and that the free market will ride oil to the last drop to human detriment. To solve the energy and climate crisis will require a level of cooperation not only within the country but across the globe. Obama today in Chicago said everything that I have been to waiting to hear from a President. And not to shortchange Joe Biden because what I really enjoyed about his comments today was his partisanship. In terms of attack dogs, there are few better than Joe Biden and it's important that the American people realized that when it comes to energy and climate the GOP is almost wholly responsible for ignoring a reality that was frankly self-evident a decade or more ago.
In other economic news, Paul Krugman offered an interview to Germany's Der Spiegel. It's well worth a read though it mostly centers on Germany's woes and the lack of clarity and prudence from the German Chancellor Angela Merkel in confronting the economic crisis. This portion of the interview struck me as pertinent and analogous to our own situation.
SPIEGEL: Unlike Americans, Germans tend to spend less and save more. Is there a danger any kind of tax benefits might just end up in saving accounts?
Krugman: Yes, there is. That's why the focus of a program should be on government spending as much as possible. But the perfect is the enemy of the good -- we are in a severe plunge, and must do as much as possible quickly.
SPIEGEL: Are there no alternatives?
Krugman: In normal times monetary policy, combined with automatic stabilizers, is sufficient. I'm opposed to discretionary fiscal policy in normal times.
SPIEGEL: And what is different right now?
Krugman: Monetary policy has lost traction! When interest rates are either at the zero lower bound or quickly approaching that point, fiscal stimulus becomes essential.
The problem is global. The solutions likely will require closer coordination of policy across borders. Every day that passes without action is an opportunity lost that will make the climb out only that much greater. When it comes to financial contagions, time is critical yet we have to endure 34 days of more ineptitude. I don't blame Chairman Bernanke nor the Federal Reserve. They are policy makers whose instruments have failed because the economic crisis is far beyond the scope of interest rate cuts. We have reached the end of monetary policy. It's time for a Keynesian approach. As Dr. Krugman notes a fiscal stimulus becomes essential in times of a severe plunge. I hate to say this so bluntly but the world is really waiting on Obama.