Depression avoided. Another recession to follow? That seems to be a concern for some academics in the US, including Princeton economist Alan Blinder.
Writing in the Sunday New York Times, Blinder says a combination of expansionary monetary and fiscal policies prevented 2009 from turning into 1930.
Mission accomplished it isn’t. Premature withdrawal of the stimulus could turn 2010 into 1936, when a series of missteps—the US Federal Reserve raised reserve requirements while FDR (Franklin D. Roosevelt) balanced the federal budget—sent the recovering economy down for Part II, according to Blinder.
To avoid a replay of the policy disasters of 1936-1937, both the Fed and our elected officials must stay the course, he writes.
While the current recession is the worst in the last 50 years, the issues facing policymakers are the same: How do they know when enough is enough?
Policymakers aren’t exactly sequestered. They have lots of information, both quantitative (economic data) and qualitative (surveys of businesses and consumers), at their fingertips to help them decide when the time is right to wean the patient from life support. They have econometric models, whose flaws are generally exposed after the fact. And they have (hopefully) the experience, wisdom, good judgement and fortitude to do what may be politically unpopular in the short run but vital in the long run for the health of the economy.
Let’s start with monetary policy and see what the seven men and women in Washington and 12 across the country could use as a guide.
Business cycle economists are forever testing indicators to see what leads, what’s concurrent with and what lags the economy’s ebb and flow. (I’ve never understood the value of the laggards.) The Conference Board maintains an index of Leading Economic Indicators (LEI), which peaked in March 2006, moved sideways for more than a year and came within 0.1 point of the peak in July 2007 before heading down.
The LEI is widely ignored in the best of times and dismissed when it doesn’t agree with the forecast. The 10 components, most of which are known by the time the index is released, get the same treatment.
The April LEI, due Thursday, is expected to show a 0.8% increase, according to the average forecast of 56 economists surveyed by Bloomberg. That would be the first increase since June, with stock prices, the spread between the federal funds rate and 10-year treasury note yield, and consumer expectations contributing to the expected increase.
One month does not make a trend. Nor does it reverse the gloomy message reflected in the six-month annualized change in the LEI and the six-month diffusion index, measures preferred by Conference Board economists to the monthly change. Then there’s the possibility historical revisions will change the leaders’ outlook: January’s 0.4% initial increase became a 0.2% decline with subsequent revisions.
For the moment, the financial, or intangible, indicators—the interest rate spread, the stock market and real M2, which probably didn’t show an April increase but has soared since September—are showing hopeful signs. And they typically lead more concrete measures, such as jobless claims, building permits and orders for capital goods.
Raw materials prices are sending a similar message. The CRB Spot Raw Industrial Price Index, which excludes oil, bottomed in December and went nowhere for three months before heading higher.
There’s a reason they’re called sensitive materials prices: They respond to slight changes in demand. Manufacturers can step up their purchases of copper and steel scrap faster than raw materials’ suppliers can increase output. Prices rise as a result.
Intangibles and price signals aren’t enough for the Fed, which is why monetary policy tends to overstay its welcome. Blinder can rest easy on that score.
When it comes to the possibility of fiscal restraint, the only possible reason to worry is the Obama administration’s expressed desire to tax the rich and unexpressed need to tax everyone else to pay for the proposed spending.
Congress enacted a $787 billion (Rs37.53 trillion) fiscal stimulus bill in February (only 11% has been spent so far) and a $3.55 trillion budget last month. The projected deficit for the current fiscal year is $1.84 trillion and $1.26 trillion for fiscal 2010. And that’s before the dream of universal healthcare is realized. The idea that Congress can revamp one-sixth of the US economy before the August recess is either folly or hubris. Either way, it’s frightening.
President Barack Obama has said current deficits are unsustainable, but that will be for foreigners to decide and us to find out. At some point, they will demand higher returns on their dollars or return their dollars. That would be a sure sign the government waited too long to tighten fiscal policy.
If that coincides with monetary policy that has overstayed its welcome, fanning inflation expectations and actual inflation down the road, it might not be long before Blinder starts worrying about a replay of the 1970s, not the 1930s.
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