The Washington Post editorial board is firmly non-committal on the question of whether the Fed should take more steps to boost the economy. On the pro side we have the fact that the economy is well-below full employment and growing slowly. Furthermore, the Post acknowledges that there is no threat of inflation. Given the Fed’s twin mandates for full employment and price stability, it seems like we have a clear answer here.
But no, that would be too easy. The Post tells us:
The Fed may also need to save ammunition to help deal with a financial collapse in Europe.
That sounds profound and important. Let’s see, the Fed must save ammunition in case something really bad happens in Europe. But wait, isn’t the Fed’s ammunition the reserves it can issue? And, isn’t the only real limit on the amount of reserves it can issue the concern about inflation? In other words, if it throws too much money out there and we don’t have the ability to produce the goods and services to meet the demand, then we would get inflation.
However, the Europe disaster story is one where we are seeing a further hit to demand as Europe’s economy implodes. How does it help in that situation that the Fed restrained itself in boosting the economy today? In fact, any boost to the U.S. economy will help, at least modestly, to boost European economies, thereby making an implosion less likely. Therefore concerns about an imploding Europe should provide yet another argument for more stimulus from the Fed.
Finally the Post tells us:
Rather, slow growth may reflect structural factors, such as the huge household debt burden, which is declining but still equal to 83.6 percent of GDP. Then there’s the federal government’s out-of-whack tax and entitlement policies, and the uncertainty they generate.
By effectively transferring much private and government debt onto its own balance sheet, the Fed bought time for the U.S. economy to rebalance under relatively benign conditions. Companies and households have used the time so far to deleverage significantly. More monetary easing now might buy the economy even more time to heal. But soon it will be government’s turn to adjust; the Fed can prop up growth, not engineer a permanent escape from fiscal reality.
To try to make sense of this one, we need to turn to our old friend Mr. Arithmetic. He tells us that demand (Y) is equal to consumption (C), plus Investment (I), plus government (G), plus exports (X) minus Imports (X-M). In other words:
Our problem today is that demand is too low, as even the Post acknowledges. However it tells us the problems are structural: the huge household debt burden and uncertainty generated by “out-of-whack tax and entitlement policies.” Okay, this seems to imply that people are not spending enough because of their debt burden and their uncertainty, and perhaps businesses also are not investing enough.
We have a quick way to answer the first question; we look at the household saving rate. That is currently around 4.0 percent. This is well below the average in the pre-stock and housing bubble years, which was close to 8.0 percent. This means that people are spending a larger share of their income than they normally do, not a smaller share.
Why would the Post think that reducing the uncertainty created by tax and entitlement policies would cause consumption to go higher and saving to go lower? That seems especially unlikely when the Post’s remedy for entitlement programs involves cuts to Social Security and Medicare. Mr. Arithmetic says that lower future benefits should cause people to save more (i.e. spend less).
As far as the investment side of the story, it might be interesting if the Post had any evidence to support this interesting theory. In other words, do we have any reason to believe that firms would be investing more if we cut Social Security and Medicare and made its desired tax reforms? What would be the mechanism that would cause the additional investment and how much would we expect to see?It certainly couldn’t be lower interest rates.
As a practical matter, investment in equipment and software is already pretty much back to its pre-recession level measured as share of GDP. Given the large amounts of excess capacity in many sectors this is a very strong pace of investment. If surveys can be trusted, the National Federation of Independent Businesses tells us that their members see a lack of demand as the major factor restraining hiring and investment, not uncertainty about entitlement programs.
In short, the Post doesn’t seem to have any obvious source of demand to show Mr. Arithmetic that would replace whatever demand the Fed might be able to stimulate. Many economists would point to the last part of the equation, X-M, as the way to boost the economy. This could be helped by additional quantitative easing from the Fed, since that would put downward pressure on the dollar.
In a system of floating exchange rates, the way in which countries with large trade deficits like the United States are supposed to see their deficits move toward balance is to have their currencies fall in value. The Fed could play a large role in this process. If the dollar fell enough to bring the trade deficit into balance, it could generate close to 5 million new jobs in manufacturing. That would be a solid boost to the economy and to middle class living standards.
For some reason the Washington Post never mentions net exports or the value of the dollar. It instead bizarrely tells us:
“But soon it will be government’s turn to adjust; the Fed can prop up growth, not engineer a permanent escape from fiscal reality.”
Hmmm, no one seems to be requiring an escape from fiscal reality, as witnessed by the 1.6 percent interest rate demanded by investors to hold long-term government bonds. We have a clear yardstick to know when “soon” is. It is when the economy is approaching full employment and by the Post’s own admission, we are nowhere close.
This sort of reasoning is why the Post is known as “Fox on 15th Street.”
Economist Dean Baker is co-founder of Center for Economic Policy and Research and writes regularly on CEPR’s Beat the Press blog, where this post first appeared.