Bummer in the summer (updated)

In today’s press conference Bernanke acknowledges the obvious: the economy is worse than we thought and likely to stay that way into 2012.  The Fed lowered its official economic growth forecasts and raised its unemployment rate forecasts for 2011-2012. After almost two years of slow but steady recovery and myriad positive straws that one could grasp, the last couple of months have brought mostly lousy news, notably the latest jobs report, which showed a gain of just 54,000 jobs last month, only about a quarter or a sixth as many as we’d need to get unemployment down to normal levels in five years or so.

It’s notable that the imminent end of the Fed’s quantitative easing, all $600 billion of which will be over by the end of the month, brings few calls for another round — everyone seems to agree that we’re in a liquidity trap, in which further monetary stimulus fails to stimulate, because interest rates are already practically 0%, banks are not eager to lend, and companies are not eager to invest in new capital.*

Our best hope, it seems to me, is an almost nihilistic one: the economy somehow recovers on its own, through black-box mechanisms that we still don’t really understand. Business confidence returns, hiring finally picks up, and the economy roars forth. This may be a vain hope, but the “animal spirits” of investors (and consumers) that Keynes wrote about in The General Theory are not really visible, despite the several monthly surveys of business sentiment that are out there.

Our next best hope is another fiscal stimulus. It won’t be like the first one, which is about to run out and was too small anyway, not with a Republican majority in the House that believes spending = death and doesn’t even want to avert a financial crisis by raising the debt ceiling unless the Democrats agree to massive long-term spending cuts. But I could see the two parties agreeing on a big set of tax cuts, which is the usual form that a fiscal stimulus takes anyway (e.g., 1964, 1981, 2001).  That has a couple of disadvantages: (1) the “multiplier” effect of a tax cut on GDP is typically empirically estimated to be smaller than that of a spending increase of equal size, because not all of a tax cut gets spent; (2) tax cuts are hard to reverse, as everyone hates seeing their taxes go up, so they could make the long-term debt problem much worse. Still, it’s probably the only politically viable option for a fiscal stimulus.

* The last part of that statement (companies are not eager to invest in new capital) is less true than I had thought. As the Wall Street Journal article linked to below notes, a survey of banks indicated that small businesses were demanding more loans, at least in the first quarter of the year.

UPDATE: This Associated Press article from the next day’s newspapers adds some helpful detail. The headline from the Syracuse Post-Standard’s version of that article says it all: “Slow Economy a Puzzle: Fed chief flummoxed, says troubles could last a while.” My quick take:

(1) The economy has long been in a liquidity trap (Krugman’s definition, i.e., a slump in which monetary policy is no longer effective).

(2) Bernanke has long suspected this himself, but as Fed Chairman he feels obligated to try to stimulate the economy through monetary policy, via unusual, unprecedented channels “that just might work” like QE2.

(3) QE2 has failed to measurably stimulate the economy, because the economy was in a liquidity trap.

(4) Liquidity trap or not, it’s not easy for the Fed to just throw in the towel, so a QE3 might well happen. But I doubt the Street will get all that excited about it, considering what a dud QE2 seems to have been.

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5 Responses to “Bummer in the summer (updated)”

  1. Mark Eanes Says:

    We need a Robin Hood approach that starts with a huge fiscal stimulus that when the banks fail to lend it there is a strong arm mechanism to force their hand. Perhaps this stimulus must be of the magnitude that significantly devalues the dollar that leaves us domestic spending as the only option. That should kick start things.

    Along with that, I think an equally huge government jobs creation program needs to happen. Employment really is the gift that keeps on giving (or spending). This would tide us over for a few years.

    Meanwhile, and none of the above will work for long without it, we need policies that redistribute the wealth. Higher taxes and or closing of loopholes for the rich must happen.

    Please pick out the flaws with my pie-in-the-sky idealism so I can counter with more of the same. I was always more of a micro guy anyway.

  2. Ranjit Says:

    I agree that a huge WPA-type government jobs program would be the way to go and have advocated something like that in past posts. The only flaw there is the political one — even with big Democratic majorities in 2009, the stimulus package that emerged was much smaller and depended only subsidies to private companies and tax cuts, rather than direct government job creation. With a Republican-controlled House, any program whereby the government directly employs any new people (except in the armed forces) is a non-starter politically.

    Not sure about your first paragraph. Strong-arming the banks to make more loans seems problematic, as bad loans are no small part of what got us into this mess. Besides, borrowers, as much as banks, seem to be holding back. If the normal number of good credit risks showed up wanting loans, I’m pretty sure they’d get them.

    A devaluation of the dollar could well be a good thing, if it improves net exports like the textbooks say it should.

    PS I hate to say it, but I agree with Michele Bachmann on something: Obama’s a one-term president, at least if the economy doesn’t magically get a whole lot better by mid-2012.

  3. Mark E Says:

    As for the likelihood of a WPA-type jobs program, I don’t suspect it has much of a chance, I just agree that it is the way to go. I was referring in the first paragraph to what seems to be a correlation with very low interest rates and a lack of loaning toward even lower risk endeavours. It may soon be time to drop money out of the sky from helicopters directly from the printing press.

  4. Mark E Says:

    Here’s a good article on loaning to small businesses that includes multiple viewpoints


    • Ranjit Says:


      Wow, that is one informative — and depressing — article. I suppose we should be encouraged that small business’s *demand* for loans has increased. But you are undoubtedly correct that banks have been holding back on making those loans. To repeat some numbers from the article:

      * In the past six months, only 17% of loan-seeking small businesses obtained bank financing.
      * In March 2011, the amount of loans outstanding to small businesses was down 9% y/y. A separate study found that the decline was 3% among small/medium sized banks and 14% among large banks.

      Bankers told the surveyors that their decline in lending is largely due to new federal regulations, such as pressure to not make so many bad loans as they did during the subprime bubble (doesn’t sound like an actual regulation) and increased capital requirements (am I missing something? Loaning reserves out does not change the bank’s capital; it merely changes the composition of the bank’s assets). I’ve got a feeling the bankers are looking to pass the buck, so to speak — especially after just reading James Kwak’s excellent Baseline Scenario post about real and bogus reasons why firms aren’t hiring:

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