Up and Down Wall Street
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WEDNESDAY, NOVEMBER 21, 2012
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No Easy Answers to Sluggish Growth
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By RANDALL W. FORSYTH
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Bernanke, others offer explanations but no magic bullet to bring down unemployment.
Does the U.S. economy suffer from a severe but curable condition? In that case, what is the best prescription to nurse it back to health? Or is the U.S. economy in a state of decline that has been disguised by the aggressive treatment it has received, which is beginning to show negative side-effects?
That crucial question is being addressed by a number of thinkers who have come to radically different conclusions.
Federal Reserve Chairman Ben Bernanke presents the official line that the economy suffers both from the after-effects of the credit crisis of 2007-08 and from the uncertainty surrounding the fiscal cliff that lies ahead at the turn of the year, and that the central bank is doing all it can to offset those forces. Still, the economy's potential growth may be less than previously thought.
Critics have contended the Fed's efforts may be doing more harm than good by stoking future inflation. And in a provocative new study, some academics contend that, in a reverse of what everybody learned in macroeconomics classes back in our undergraduate (and for some, graduate) studies, hiking interest rates maybe what's needed to boost growth.
Finally, one nonacademic, finance professional turned public intellectual thinks the economy's speed limit has been lowered by demographic instead of economic factors. So far, that has been offset by the extraordinary fiscal and monetary stimuli applied by governments since the bursting of the dot-com and then the housing bubble, but those limits are becoming harder to exceed.
Taking these arguments in order, Fed Chairman Bernanke contended in a speech Tuesday before the Economics Club of New York that the economy in general and the job growth in particular still feel the effects of the hangover from the credit crisis of 2007-08. That impact was seen in previous such episodes, as detailed by Carmen Reinhart and Kenneth Rogoff in their seminal book, This Time is Different: Eight Centuries of Financial Follies, which was footnoted in the text of Bernanke's speech.
Fed policy since the crisis has sought to learn from history and to counter to those forces. But there is only so much monetary policy can do, Bernanke conceded, owing to the retarding after-effects of the credit collapse.
Even at zero interest rates, borrowing is sluggish as debtors pay off debts and creditors are reluctant to lend. In addition, the looming fiscal cliff has restrained businesses from investing and hiring. Moreover, he emphasized, there is little the central bank can do to prevent the economy from contracting if Congress and the White House fail to come up with a package that prevents the sharp tax increases and spending cuts that are slated to go into effect. In all, the U.S. economy's potential growth rate may be lower than the 2.5% pace that has been assumed.
The Fed's policies to boost growth -- keeping its federal funds rate target near zero through mid-2015, buying $40 billion of agency mortgage-backed securities and extending the maturities of its Treasury securities portfolio -- have come under criticism. As discussed several times in this space, the Fed's security purchases have had the effect of boosting asset prices, which benefits the more affluent households, while raising the cost of commodities, notably food and energy, which lowers the real income of middle class and lower families.
That's been the contention of Lacy Hunt, chief economist of Hoisington Investment Management in Austin, Tex. At the same time, the banking system is swimming in $1 trillion of excess reserves, so the injection of more liquidity may help the now-cliché 1% while hurting the 99%. But there are signs the Fed's policies are showing diminishing returns ("Is the Fed Losing the Fight Against Deflation?" Nov. 13.)
Some academics go so far as to argue the opposite -- that the Fed could give the economy a boost by raising interest rates. In a provocative new working paper at the National Bureau of Economic Research, Stephanie Schmitt-Grohe and Martin Uribe of Columbia University turn everything everybody knows on its head.
Lowering interest rates and holding them near zero leads businesses and households to anticipate bad times and deflation, they contend. With prices expected to fall, stable wages translate to rising real (inflation-adjusted) labor costs. With wages difficult to cut, businesses are averse to hiring or pare payrolls instead. So, zero interest rates depress employment, the economists argue.
Schmitt-Grohe and Uribe support their hypothesis with the typical Greek-letter-laden equations. But reality does not intrude into their model. The Fed's zero-interest-rate and quantitative-easing policies have been associated with an increase, not a decrease, in anticipated inflation. This is empirically evident in the market for Treasury Inflation Protected Securities, or TIPS. The spread between nominal Treasury yields (which consist of real yields plus and inflation premium) and TIPS yields (which are real yields) provide a market-generated forecast of inflation rates. Buyers of 10-year TIPS realize a real yield of minus 0.87%, which compares with 1.65% on the benchmark 10-year Treasury.
That indicates investors anticipate the Consumer Price Index will rise 2.78% per annum over the next decade -- up sharply from a nadir of 0.91% in March 2009, when the Fed embarked on its so-called QE1, the first round of quantitative easing.
These empirical facts fly in the face of the Columbia academics' hypothesis. The TIPS market doesn't signal deflation; investors accept negative-real yields as the cost of insurance against future inflation.
Moreover, business people in the real world worry about rising costs and taxes, plus the cost of compliance with regulations, all of which inhibit them from hiring and investing. To suggest raising interest rates would induce capitalists to change their expectations shaped by the uncertainty over these costs of doing business is, to express it in the most polite terms, incomprehensible.
Finally, viewed from a long-run perspective, Jeremy Grantham, chief investment strategist of GMO, argues the U.S. faces growth of about 1.4% per annum, half the annual pace of 3% that America has come to regard as normal. Population growth is stagnating and productivity increases are likely to be just 1.3% per annum from here on. Meanwhile, the global economy faces rising costs for increasingly scarce resources, which will further constrain growth.
So far, Grantham argues, expansionary macroeconomic policies -- especially money printing -- have been able to push the U.S. economy despite these barriers to growth. But the jig is nearly up and these environmental and demographic constraints will put a lid on growth in coming decades.
It should be clear that there are no easy answers to the problem of weak growth and high unemployment (but some really bad ones.) Reinhart's and Rogoff's work shows it takes upwards of a decade or more for an economy to recover from the bursting of a credit bubble. It's been only five years since the peak of the past cycle, so you do the math.
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