Anatomy of the Global Economy
The Retreat of Macroeconomic Policy
J. Bradford DeLong
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BERKELEY – One disturbing thing about studying economic history is how things that happen in the present change the past – or at least our understanding of the past. For decades, I have confidently taught my students about the rise of governments that take on responsibility for the state of the economy. But the political reaction to the Great Recession has changed the way we should think about this issue.
Governments before World War I – and even more so before WWII – did not embrace the mission of minimizing unemployment during economic downturns. There were three reasons, all of which vanished by the end of WWII.
First, there was a hard-money lobby: a substantial number of rich, socially influential, and politically powerful people whose investments were overwhelmingly in bonds. They had little personally at stake in high capacity utilization and low unemployment, but a great deal at stake in stable prices. They wanted hard money above everything.
Second, the working classes that were hardest-hit by high unemployment generally did not have the vote. Where they did, they and their representatives had no good way to think about how they could benefit from stimulative government policies to moderate economic downturns, and no way to reach the levers of power in any event.
Third, knowledge about the economy was in its adolescence. Knowledge of how different government policies could affect the overall level of spending was closely held. With the exception of the United States’ free-silver movement, it was not the subject of general political and public intellectual discussion.
All three of these factors vanished between the world wars. At least, that is what I said when I lectured on economic history back in 2007. Today, we have next to no hard-money lobby, almost all investors have substantially diversified portfolios, and nearly everybody suffers mightily when unemployment is high and capacity utilization and spending are low.
Economists today know a great deal more – albeit not as much as we would like – about how monetary, banking, and fiscal policies affect the flow of nominal spending, and their findings are the topic of a great deal of open and deep political and public intellectual discussion. And the working classes all have the vote.
Thus, I would confidently lecture only three short years ago that the days when governments could stand back and let the business cycle wreak havoc were over in the rich world. No such government today, I said, could or would tolerate any prolonged period in which the unemployment rate was kissing 10% and inflation was quiescent without doing something major about it.
I was wrong. That is precisely what is happening.
How did we get here? How can the US have a large political movement – the Tea Party – pushing for the hardest of hard-money policies when there is no hard-money lobby with its wealth on the line? How is it that the unemployed, and those who fear they might be the next wave of unemployed, do not register to vote? Why are politicians not terrified of their displeasure?
Economic questions abound, too. Why are the principles of nominal income determination, which I thought largely settled since 1829, now being questioned? Why is the idea, common to John Maynard Keynes, Milton Friedman, Knut Wicksell, Irving Fisher, and Walter Bagehot alike, that governments must intervene strategically in financial markets to stabilize economy-wide spending now a contested one?
It is now clear that the right-wing opponents to the Obama administration’s policies are not objecting to the use of fiscal measures to stabilize nominal spending. They are, instead, objecting to the very idea that government should try to serve a stabilizing macroeconomic role.
Today, the flow of economy-wide spending is low. Thus, US Federal Reserve Chairman Ben Bernanke is moving to have the Fed boost that flow by changing the mix of privately held assets as it buys government bonds that pay interest in exchange for cash that does not.
That is entirely standard. The only slight difference is that the Fed is buying seven-year Treasury notes rather than three-month Treasury bills. It has no choice: the seven-year notes are the shortest-duration Treasury bonds that now pay interest. The Fed cannot reduce short-term interest rates below zero, so it is attempting via this policy of “quantitative easing” to reduce longer-term interest rates.
Yet America’s right wing objects to this, for reasons that largely remain mysterious: what, at the level of economic theory, is the objection to quantitative easing? Blather about Federal Reserve currency manipulation and excessive risk-taking is not worthy of an answer.
Still, here we are. The working classes can vote, economists understand and publicly discuss nominal income determination, and no influential group stands to benefit from a deeper and more prolonged depression. But the monetarist-Keynesian post-WWII near-consensus, which played such a huge part in making the 60 years from 1945-2005 the most successful period for the global economy ever, may unravel nonetheless.
J. Bradford DeLong, a former US Assistant Secretary of the Treasury, is Professor of Economics at the University of California at Berkeley and a Research Associate at the National Bureau for Economic Research.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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naufalsanaullah 12:24 26 Nov 10
There is a vitally significant variable that was held stable during that 1945-2005 period that now is very much up for debate as part of a true paradigm shift, and that is where a logical refutation of long-term asset purchase programs from the Fed arise. That variable is the perceived risk-free reserve nature of the US's fixed-income and currency, and now, with back-end curve spreads (like 10s30s) steepening quickly and highly correlated with precious metals and USA sov CDS, the market is clearly discounting long-term inflation/debasement risk (the credit risk of US government debt, given the Fed's fiat power causing purchasing power erosion rather than capital destruction) and now that QE 2 has been all but discounted and the Fed's synthetic bond demand has been front-ran, the Treasury bond market, after more than three decades of bull market, has topped and yields will rise from here.
Did we need QE to combat deflation risk? Yes. The way the Fed employed it? No. It should have been a total of $600b, with a zero or negative interest rate on excess reserves. The created liquidity is mostly sequestered within excess reserves at the Fed, and the Fed (in a July 2009 white paper) has even admitted that there are real "liquidity trap" effects resulting from a risk-free 25bps via IOER. If the BoE can generate inflation in the UK via QE, with worse economic fundamentals, worse debt ratios, and a worse banking system at the heart of the crisis, then there is no reason the Fed's attempts should be failing due to lack of demand from borrowers.
The US did the same thing during the Great Depression by hiking reserve rate requirements, to keep banks in sounder capital environments, which had the unintended consequence of catalyzing the second wave of banking stress in the US.
Why is the Fed sequestering this liquidity? So it can maintain political capital/leverage to continue with easing as much as it takes, and with muni's next on the list, probably as soon as Q2 2011, an extension of QE 2 or perhaps a third iteration of QE will be on its way, for the Fed to monetize muni's and socialize their risk as well.
But the bond vigilantes are now out and about, chasing sovereigns. There will be no crash in the UST market or hyperinflation in USD, but there will be a sharp bear market in Treasury bonds, and that will prove Bernanke's policies to be the misguided underhanded gifts to Wall Street that they were.
LeroyDumonde 03:58 26 Nov 10
Yes Dr. DeLong, we are in fact in a Dark Ages. But on the upside imagine what the next enlightenment will be like. I just hope we'll be around to see it (I'm fairly certain we will - I bet someone 20 years ago we'd have a black president, and, oh boy, he owes me a ton of money with the compound interest...). Cheers!
kjmclark 08:01 26 Nov 10
Roosevelt very publicly attacked the bankers. Bernanke, Paulson, and Geithner, and Presidents Bush and Obama, have protected the bankers.
One important lesson we should have learned from behavioral economics at this point is that people are willing to damage their own interests in the name of justice.
The right is skillfully using the injustice of supporting the wealthy bankers who caused this mess, in order to attack both the left and everything to do with government. However, this kind of fire has a bad habit of escaping control and burning everyone.
WaltFrench 08:36 27 Nov 10
Maybe we're facing the demise of the post-WWII respect for the little guy. It was pretty obvious that the war was fought on his (and her) backs, and at the end of the war Congress passed a full employment policy. 20+ years later, Humphrey-Hawkins (apparently, you're better informed on this than I) *weakened* it in order to also call for price stability.
But even then, instead of Brinkerton mowing down organizers, labor was in ascendancy. Policies that provided for their support still relied, however (I hypothesize) on the good will built by the greatest generation.
All gone now. They're just consumers and Unit Labor Costs. I noted first under Reagan that he talked about American consumers, not "citizens" and we continue to treat blue collar types as despicable lumpens.
profmsf 05:06 02 Dec 10
Your article illustrates the gap in the understanding of basic economic principles between people with some formal training and everyone else. The burden of bridging that gap lies with those of us who take such knowledge for granted. It is unreasonable to expect a reasoned discussion among elected officials when the voters who elect them have no idea what we are talking about. I see no short-term solutions to his problem (that we currently share with climate science) so I believe we must prepare for a long slog with a lot of setbacks along the way.
ElderTruthTeller 12:48 11 Dec 10
Well, nowadays, everybody is an UBER KEYNESIAN: that is Spend til you Drop! And no one seems to have this down better than FED CHAIRMAN, BEN BERNANKE (or is that BURN the ANTE)? At the rate, Bernanke is PRINTING money, he alone will give us a PAPERLESS Society!
Your assessment is spot on, however. The KEYNESIAN MODEL is broke. Whatz better? A FREE MARKET. Altho, not the MISES theoreticum (nor LAISSEZ-FAIRE). Rather just good old fashioned bargaining between the PRINCIPALS. The Market can indeed Seek its own Levels without being handled by a bunch of Ivory Tower professors touting the obsolete philosophy of DEAD economists.
--Elder TruthTeller--
RalphMus 08:26 19 Dec 10
Elder Truth Teller sounds like one of those pseudo pro free market Republicans who wants trillions of dollars of free money handed to the banksters on Wall Street (in defiance of basic free market principles). Am I right there, Elder TruthTeller?
Or would you have preferred genuine a genuine free market in which every bank collapsed at the height of the credit crunch, which would have resulted in something far worse than 1929?
hotdog 12:34 26 Dec 10
Part of the problem - noted by JKG in the 70s (regardless of how you view his economics, much of his social commentary was prescient) is that from the view of a min wage High School worker, PhDs at Yalvard ain't that different from 8 figure bonus guys at Goldman, so the apparent contradiction of workers supporting the tea party is not that much of a contradiction - the guys who claim to be helping them - say the Krugmans of the world - are both distant and, in actuality, not that helpful: as many on this website must know, the cost of college texts is a significant burden for many; Krugman, a wealthy man, charges students 150 bucks for his basic econ text; where I sit, he is part of the problem, not part of the solution.
Beyond this is the shameful, shameful failure of hte "left" to organize in any meaningful fashion. Take the payrol tax holiday in the recent tax compromise; I assume all on this website understand the long term risk to social security: the GOP has already said that in a year they will say not renewing the holiday is a tax increase.
Did Krugman and dean baker and stiglitz and R reich and all the others get together and try and have a single clear message that would have enough oomph to get thru the media haze ? no;. they all act as if the most important thing is how many people read their blogs....
A lot of high school educated workers know that they ain't gonna make a lot of money; all they have is their pride, which comes out as leave me alone and let me do what I want, with no stinkin' regulations
carlson73 07:30 26 Jan 11
No disrespect intended, but folks with your academic training will have to reestablish your credibility to people who have been subject to the impact of the leadership provided by Dr. Bernanke, Dr. Summers, Mr. Geithner, Dr. Greenspan and other similarly brilliant people who also just happened to be dead wrong on a number of critical issues for the last 15 years. The policies of this group and others, maybe including you, blithely recommended a combination of cheap money and deregulation that allowed the bubbles that happened in 2000, and again in 2008. Twice in one decade.
Sure the bankers were greedy and self-dealing, that has always been true; sure Congressmen and Senators pass laws, even stupid laws, that they think will get them re-elected, not a shocking revelation. But you guys have Ph.D.s in a science, you are experts, we trusted you guys to do the right thing. Except you really are not experts in real world economics, you are experts in a world full of math models, not one full of bankers, sharks, and hedge funds.
You are not credible to people who pay their bills every month, go to work every day, and think a highly educated person (a Doctor!) who says they can tell you the right thing to do, should actually know what they are talking about, and should be held accountable for serious mistakes. Yes a Fed induced Bubble leading to 10% unemploument is a serious mistake. In the world of all the people not smart enough to understand your brilliant analysis, Dr. Bernanke, Dr. Summers, Mr. Geithner, and their fellow screw ups would not have a senior job in this line of work again. Seriously, think about it, you guys really screwed up, show a little humility, before telling everyone we just aren't smart enough to understand. We understand, we just don't believe you.
This level of outrage would be reasonable from a person who has been subject to the collateral damage caused by of the actions of your peers, but from you, a member of the F Troop of economics, it is ludicrous hypocrisy.
watchout5 05:10 25 Nov 10
http://www.npr.org/blogs/money/2010/10/07/130408926/quantitative-easing-explained
This is more my opinion on it, while you support quantitative easing, you're in the same boat when it comes to having no idea if it works. "While the economy is still this bad, the Fed really might only have two options: Do this as a desperation move, or do nothing."
I loved your point though, it's true that we've lost something we used to have, empathy maybe? Or at the very least, the understanding that a good job is the front line defense in someone who will need much less government assistance in their lifetime. If we don't create any good jobs, and the majority of our jobs become fly by night minimum wage dead end jobs, we'll never recover.