NPR's attempt at 'gottch' journalsim. NPR's Frank James challenges the media to confront Rick Perry over his denunciation of Ben Bernake's 'Money Printing'. "So, again, here's the question for Perry. How would you have fought the deflation threat?"
Asnwer: I wouldn't have....at least not as recklessly as the Feds are doing.
There's a (very large) school of economists who believe the Fed's easy money supply policy was, and is, the right response to falling GDP...the deflation Mr. James is so terrified of. In general, I agree with this theory, but there are two reasons we should have used it more sparingly this time around. First, any attempts to mitigate falling GDP inherently assume the retraction was bad and the old GDP number (or higher) should be the target. Second, it is extremely difficult to predict the inflationary repercussions of exploding the money supply as quickly as we did and to the extent that we did.
1. How do you know if the old GDP was legitimate or what the 'right' GDP should be?
Economist call this the 'Potential GDP'...what GDP would be in 'normal' times when everything is going good, when we have full resource utilization and inflation is at zero. While it seems reasonable, the ability to get anything close to an accurate measurement is pretty much a crap shoot. Think about it, you're trying to calculate the value of all the goods and services that will be produced across the US in a 12 month period....assuming full employment, full production at all manufacturing facilities and all service providers running at 100%. There's a saying in surgery, "If there's more than one way to perform an operation, there is no best way to perform that operation." The same can be said of economic modeling, if there is more than one way to estimate a data point, there is no best way. In the case of potential GDP, there are 5 widely accepted methods. If you're really into it, or can't fall asleep, here's a summary of the different models from the CBO. All 5 of these models fall into one of two categories; statistical or theoretical. The problem with statistical modeling is that it can't take into account known, relatively subjective dynamics like the impact of NAFTA, oil embargoes, significant leaps in technology and changing demographics. The problem with theoretical modeling is that is DOES take into account these variables. Yet another reason economics is called the dismal science. Statistical models tend to be pretty accurate in the long run. But like Keynes famously quipped, "In the long run we're all dead." More importantly, in the near term, and recent past, they're subject to the unpredictable influences of a statistical phenomenon known as 'end-of-sample' errors. In other words they're not very accurate for the very time period we are most interested in.
So the bottom line is we're making trillion dollar wagers using economic models that don't work very well.
My personal belief is that the GDP from 1996 or so through 2007 was an inflated, ill begotten, unwarranted standard of living...but more on that later.
2. One issue you'll never hear the President or his advisors address with any specificity is how they calculated the potential inflationary forces of their fiscal and monetary policies, what their exit strategy is to get away from them and what the mechanisms are to tell them it's time to pull back. Any mention of inflation is brushed off as being untimely and absurd as evidenced by the tone of the NPR article. As we've been told numerous times, we're in unchartered waters with the massive explosion in fiscal and monetary policy. And while some of each was called for, nobody is able to offer empirical evidence that these policies have worked and that they won't make the future more bleak than it already is.
The Presidents' trademark line is "I inherited this problem." Unfortunately if he guesses wrong on his monetary policy, we will inherit Jimmy Carter's economy.
My comments on the NPR blog;
How would he have fought the deflation threat?
Answer: I wouldn't have. Deflation was justified based on the fundamentals of the economy. Consecutive bubbles in tech, consumer lending, and housing, coupled with low cost international labor, resulted in an artificially high aggregate demand starting in the mid 90's and running through mid 2007. We look at this past GDP as the benchmark instead of accepting it as a mirage. The demand mirage was built by illegitimate income and excess consumption....in other words we didn't earn the standard of living we borrowed.
The current anti-deflation crusade is led by the Apostle Paul (Krugman), preaching the quest of the mythical metric known as the Potential GDP. P-GDP is a guesstimate on what the GDP of a country should be with full resource utilization and no inflation (more or less). There are a number of ways to divine this number, none of them superior to another - though the IMF methodology favored by Dr. K does have the benefit of subjective inputs allowing for 'revisions' on the fly...code for we're really not sure.
Regardless of the machinations used, the anti-deflationary doomers are simply wrong, the US economy needed to be deflated.
Now let's focus on rebuilding.
rwillis (oldguy12), thank you for that insightful, respectful post. Below I attached a link from a 2008 blog post by Paul Krugman about the dangers we faced in entering a liquidty trap. While I agree with your post, I am confused about your assertion that monetary/fiscal policy can not defeat the trap. I'm guessing that by inspirational leadership you mean having a leader that resorts confidence? I don't see someone like Rick Perry (who received a D in economics, less we forget) doing that. Thoughts?
http://krugman.blogs.nytimes.com/2008/03/17/how-close-are-we-to-a-liquidity-trap/
S T (STuck)...
All capitalist economic models rely on a rationale consumer who desires to increase their std of living and, as such, is responsive to price fluctuations. If the price of a desirable item increases, they buy less, if it falls they buy more. And these assumptions hold true in the aggregate under 'normal' economic cycles. Implicit in the models is the lack of impact emotions, such as confidence, have on aggregate behavior. Economist know it's an issue, but for the most part they don't like subjective data as it's hard to quantify and easy to manipulate.
P. Krugman believes massive government spending is needed to off-set the lost demand. While it will move the needle of nominal GDP, stimulus doesn't address the core issue of a lack of confidence. Consumers understand at some point you have to shut off the stimulus...then what? What along the way will make consumers confident in the future when they know the stimulus has to end? Consumers who lived through past recessions had confidence that the economy would bounce back since it always did. This recession is different...too many consumers don't have confidence DC knows what to do, so they're not responding to either fiscal nor monetary policy (cont.)...
S T (STuck) cont...
Like fiscal policy, monetary policy is impotent at overcoming the confidence trap. In fact, expanding the money supply any further is probably going to make things even worse as far as consumer confidence is concerned. We're already seeing the cost of groceries increasing and food prices have an incredible inverse, real time, impact on confidence. Shoppers change their purchasing behavior as they're shopping for groceries. Every dollar spent maintaining food demand is one less dollar available to increase demand in another area.
Consumers are essentially suffering a type of PTSD from all the crashes, bursting bubbles, financial scandals, bail outs, criminal activity, stimulus plans, unemployment rates, foreclosures and so on. They're holed up.
This uncertainty at the consumer level is one of the two factors that killed demand at all levels...even the 'rich' have curtailed spending. An indirect measure of consumer confidence is the velocity or circulation of money. Basically how fast does a dollar move from one person to another. Google M2 velocity and and then consumer confidence and you'll see the relationship.
What's the single most memorable line from FDR?
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