I understand the problems with boosting employment and paying off subsequent government debt.  I also understand how a few years of moderate inflation (say 6%) would help with both.  My problem is expecting that a Fed chairman will have the skill and timing to shift accomodation into neutral before inflation gets out of hand and all that is accomplished is "kicking the can down the road" until another crisis commences.

The Fed knows better than to use tools that it has no business using http://www.jrdeputyaccountant.com/2010/09/dallas-feds-fisher-fed-isnt-here-to-fix.html

Meanwhile, how can you expect America to "be patient"? This is not going to resolve itself overnight or even in the next several years. We're notorious for being horribly impatient you know.

Don't forget that Mr. Rogoff noted that "far too much discussion has centered on what governments can do to stimulate demand through budget deficits and monetary policy."

The big picture is underlying the real economy are real people trying to run really small businesses. These are the true backbone of the economic system.. Not GS or GM or even GE. For everything GE does would still be done if GE were 50 smaller businesses and probably for less cost.

Most businesses start as micro businesses. One or two people with an idea. Since I was young, the burdens placed upon micro start ups has grown dramatically. In fact it has grown so big it is smothering most micro businesses and many small ones too. All in the names of protecting us from ourselves or with some new ideal or fee to support some bureaucratic cause.

Big business has always found ways to get around or bend the rules. Even big small businesses can find ways to circumvent the rules but micro businesses much of the time get trapped in the endless catch 22 of licensing, accounting rules, zoning laws, etc.

The TBTF got caught up in gambling and lost but that was after they bought their way to the gambling table. The government bailed them out with money that will ultimately have to come from the micro and small business community in higher fees, taxes and cost due to the new gaming of commodities.

IMO why the Tea Party exists today is not because of the regulations and taxes on those at the top but because there has been a continued piling on of rules, license fees and regulations, taxes and other costs at the bottom end of the economy to the point where micro and really small businesses are strangling. This is a totally unfair and out of balance system. And is failing.

An economic system is only as strong as its base and the base has always been the micro to small businesses. Until many of the burdens are removed, America's place in the world will continue to decline along with the standard of living and the middle class. Cheap money does little good at this point because much of that cheap money is siphoned off by local and state government, it does no good to just make more of it available..

This does not mean we should remove more regulations from the TBTF or almost TBTF. We don't need to let the free market take care of pollution or abuse or food safety. The free market won't stop the TBTF from monopolizing and strangling the system. We need the top to be controlled but we need the bottom to be turned free to be entrepreneurs and craftsmen. Until this happens, the US is a failed system looking for excuses.

After a few decades of all the rewards of productivity increases going to capitalists and little or none to middle class working people, consumers are broke and working off their debts, thereby killing demand, while the piles of capitalist money are overwhelming the paucity of capital investment opportunities. The only thing that will get us back to square one is to tax the capital away from the capitalists and completely remove the income tax on people making less than the median wage. (about $50,000) These middle class people spend their income and create most of the demand. So, this will reinvigorate the demand for goods and services and rebalance the available capital with the need for capital to finance real growth. This balance must be maintained if we want to avoid asset bubbles in the future.

Putting this past decade in historical perspective makes the employment situation look particularly alarming.  From 1960 through 2000 total nonfarm payroll increased 1% for each 1.5% increase in constant dollar GDP.  In the past decade it took an  11% increase in GDP to generate the same 1% increase in NFP.  Two periods were particularly weak for job creation.  From 2000 to 2004 GDP rose 8%, but NFP decreased 0.3%.  then in the past two years ('08 and '09) NFP shrunk 5% while GDP dropped 2.6%.  Based on the recent historical relationship, a 2.6% drop in GDP should have resulted in only a 1.7% drop in NFP.  Is the historic relationship being skewed by greater automation and increased concentration of income at the highest levels?  Meanwhile GDP growth has been anemic.  From 1960 to 2000 GDP growth per decade ranged from 30% to 42%.  This decade GDP is growing only about 20%.  There will need to be major structural changes and new government policies to get 16.7% U-6 down to historic levels, especially given that the labor force is expected to grow about 10% this decade.

A few years ago, I created and developed a system like the Internet in the real market process. As I was developing my invention I realized we had a serious structural problem in our economy. The longer we took to correct this problem, the more I felt the economy would stall. The longer the situation was left as it was, the worse employment conditions would become for lower- and middle-income people. On both counts, I proved correct. Unfortunately, I could not arrive at a clear explanation of the causes of these economic problems because I lacked sufficient econometric data, for no such data existed. I am a business man, not a professionally trained economist. So I hoped, and expected, that economic experts would find the answers and suggest a solution to our economic woes. Furthermore, I hoped that their solution would be along similar lines of the system I developed, and that it would match their analysis.

But to my surprise nobody was able to see clearly that our economy was rapidly falling into a dangerous situation. Now it appears to be too late. I have tried to warn the country that our economy was in peril these past several years. But, sadly, my message did not reach the right people or they simply refused to listen. Things are now unraveling just as I predicted.

Many economic experts have tried hard to find the answers, but to no avail. I believe the system I invented has the answers that could have averted this economic collapse. It could still save us from further catastrophe.

I would like to pose this question to you directly: If somebody insists that he has discovered the real cause of the current economic crisis – and, moreover, developed a clear solution, what would you do? Are you still going to refuse to listen?

I hope you take a few moments to see the following post - Saving the world economy: Overcoming an Economic Sisyphean Task – Or, the True Path Back to Economic Prosperity http://goo.gl/b/rgcU

A New Perspective on the Global Economic Crisis VI: Why Indeed Isn't America Working?

I. Introduction

During the last six months, I had been abstaining from publishing on the current economics conditions. However, the appearance of some important articles from professional economists recently has made it necessary for me to comment now. Firstly, the outgoing Chairman of the Council of Economics Advisors, Professor Christina Romer has given a thoughtful farewell speech on her efforts during the past 20 months to contain the economic crisis. This speech is important both for the reason that Professor Romer brings her cutting-edge skills as a professional economist to analyze the problems afflicting the American economy, as well as, that it provides an insider-view of the policy decisions made by President Obama's economics team.

Although Professor Romer's speech provides an excellent analysis on the problems afflicting the American economy, there is one major issue that the Obama economics team seems to have missed completely. And that is, gross underestimation of budgetary shortfalls. This oversight seems to be one of the main reasons why the liberal political agenda that President Obama had envisioned upon taking office has gone so awry. As I have explained in my earlier articles, full-fledged Keynesian policies were only suited for colonial times. Even so, the decline in the voting public's approval of these policies, in the last 20 months, was so rapid that it is really confounding. We analyze Professor Romer's farewell speech in Section II to postulate that the main reason for such a rapid decline in voter approval was the inability of mathematical models to incorporate full-fledged Keynesian policies within a short period of four years (2006-10).

Secondly, Professor Kenneth Rogoff has made some important comments in his latest article, "Why America Isn't Working" on Project Syndicate. He makes a strong case that there isn't a lot more that fiscal spending policies could do to deal with the economic crisis, in view of mounting national debt. However, he goes on to say that the Fed could do substantially more. He proposes that the Fed's target for medium-term inflation be raised. Professor Rogoff had made this same proposal originally in December 2008 (He had proposed keeping the Fed's inflation target at 6% for two years in December 2008, but recently he has commented in the media that he would like that the medium-term inflation target be raised to 4%).

At the time Professor Rogoff first made his proposal, I had expressed great appreciation for his judiciousness in selecting this policy. However, with the further benefit of twenty months' worth of hindsight on the global economic crisis, I have to say now that the policy of raising the Fed's medium-term target for inflation would be quite counter-productive. Furthermore, the situation is  worrisome since, based on the Fed Chairman's recent presentation at the Jackson Hole, Wyoming conference, one might expect that Professor Rogoff's proposal could actually become the Fed's policy. I explain why this proposal should not be implemented in Section III.

Thirdly, Professor Joseph Stiglitz has written a timely article on the mortgage crisis named "Fixing America's Broken Housing Market" on Project Syndicate. The issues involved in the mortgage crisis are understood much better now than they were before President Obama took office. For over thirty months now, the government and the Fed have been propping up the housing market in various ways under the banner of Keynesian policies. However, the widespread prediction of massive losses for the Democrats in this November's Congressional elections is strongly signalling the return of conservative policies within the next few months. One can be reasonably sure that cost-cutting and deficit reduction are going to take the center-stage because the problem of exploding national debt is considered very important by the electorate, as the polls indicate.

On the other hand, without the continued large scale spending of the government and the Fed on the housing market, there would essentially be no housing market, as Professor Stiglitz observes. Every indication is that housing is going to be a big flash-point of contention between opposing political forces within a few months after the coming Congressional elections. It is for this reason that Professor Stiglitz's article is timely and wise. I do not have much further to say on the housing market however. I had commented on it at length in my article "A New Perspective on the Global Economic Crisis" where I had proposed a price-adjustment mechanism between the security-owners and property-owners.


II. A matter of another 500 billion dollars a year

The federal budget deficits/surpluses during President George W. Bush's 8 year term were as follows: FY2001 - $128.2 billion surplus, FY2002 - $157.8 billion deficit, FY2003 - $377.6 billion deficit, FY2004 - $412.7 billion deficit, FY2005 - $318.3 billion deficit, FY2006 - $248.2 billion deficit, FY2007 - $160.7 billion deficit, FY2008 - $458.6 billion deficit (Note that the FY2001 budget was proposed to the Congress in 2000 by President Clinton and the FY2009 budget was proposed by President Bush in 2008). In view of the these budget figures, at the time that President Obama won the November 2008 election, it seemed reasonable to expect a budget deficit (excluding stimulus expenditure) of $400 billion to $500 billion for FY2009.

Since there was widespread awareness in the political system that the severity of the recession that had hit the American economy was unprecedented in the post-Second-World-War period, there was strong political support for a large stimulus bill. So the enactment of the stimulus bill (then projected to be at $787-billion spread over a two year period) would have allowed for an additional expenditure of about $400 billion for FY2009, over and beyond the expected deficit of $400 billion to $500 billion mentioned above. So, this would have meant that the particular severity of the ongoing economic crisis would have resulted in an all-time high budget deficit that was between $800 billion and $900 billion for FY2009.

However, the actual budget deficit for FY2009 was just over 1.4 trillion dollars. In hindsight, this overshooting of more than  500 billion dollars a year, projected to continue for several years starting from FY2009, was one major surprise that the political system could not handle. Strangely, there is no discussion at all about this budgetary shortfall in Professor Christina Romer's farewell speech. However, it is in budgetary shortfalls that we see a fundamental divergence between the functioning of the political system and that of the economic system. The 2006 Congressional election and the 2008 Presidential election testified to the ability of the political system to return vastly changed preferences of the voting public than in the earlier six years, 2000-06.

In contrast, the economic system did not have the necessary mathematical tools to shift its functioning from conservativism to liberalism in such a short time. It could not effectively raise awareness about the rapid changes in government spending and tax receipts. The government publishes monthly budgetary figures every month. Moreover, an additional shortfall in tax receipts in view of the severity of the recession was to be expected. So, by the summer of 2009, it should have been obvious that the budget deficit for FY2009 was going to be of gigantic proportions.

In fact, it was in the summer of 2009 that the Obama policy advisors were faced with a watershed decision whether to continue to concentrate all their efforts on the economic recovery, or to focus on their remaining priorities like health care, renewable energy and financial regulation. Even as the Obama economics team was called upon to make this crucial decision, the team simply did not have the necessary mathematical tools for guiding them through this decision. Under the dominating influence of the Chicago School of Economics, all the major developments in economics in the last half-century had been made with the twin assumptions of minimizing the state's power, and making all economic decisions on a quantitative basis.

As Professor Romer has mentioned repeatedly in her farewell speech, the path that the American economy has been taking during the current economic crisis is territory that is completely unchartered for professional economists. The precision and speed that are necessary pre-requisites for making effective decisions about an advanced economy could only be delivered with the mathematical models that economists had come to use in the last few decades. Unfortunately, these models did not allow for the immediate adoption of full-fledged Keynesian economics, an area of research that had been out of favor for more than forty years. Besides, concepts from Keynesian theory -- like animal spirits, demand management, pump-priming, consumer confidence -- are inherently difficult to quantify, especially so in this new age of globalization.

As a result, the Obama economics team simply resorted to plain old sloganeering against austerity measures. Furthermore, the team regularly conjured up scenarios of the recurrence of the Great Depression, for which it received widespread support from the community of professional economists. The team maintained strongly that this was no time to worry about deficits and debt. The conviction with which the economics team advocated Keynesian policies was buttressed by the Fed's own drastic policy shift towards Keynesianism in the last couple of years. Consequently, the politicians was re-assured that the economic crisis was being brought under control, since the correct policy framework had been found.

So, the political system moved onto the problems on health care, environment and financial regulation. This is not to say that the politicians are without blame. As it so happened, the Obama administration along with the liberals in Congress rammed through a massive health care legislation in a period of nine months starting from the late summer of 2009. A series of townhall meetings to discuss the health care agenda only lent credence to the suspicion that agreements made before-hand between vested interests were being shoved down the throats of the unsuspecting voting-public.

By the end of 2009, however, the Obama administration had realized that its policy agenda had been seriously stalled. In the intervening six months, the voting-public had been made aware of exploding public debt through the precise mathematical tools that the monetarists had developed over the last half-a-century. So, the Obama administration began to soft-pedal on environmental issues. And it squandered its historic opportunity to make progress on environmental issues during the Copenhagen meeting. These events are recorded in detail by Professor Jeffrey Sachs in his two articles written at that time -- "Obama in Chains" and "Obama Undermines the UN Climate Change Process" -- on Project Syndicate.  

Now, it may be argued that the politicians did have some expertise on health care, because this topic had been regularly debated by them for the past 40 years or so. However, each voter has adequate experience about health care only from her own individual perspective. The health care facilities for individuals from different strata of society are vastly different. So the health care legislations that the Obama administration was proposing needed a lot of public debate so that individual voters could become familiar with the choices being made. So, the quick-fire approach to health care legislation that the liberal majority adopted ended up getting the disapproval of the voters.

While the Obama administration and the Congressional Democrats had the excuse that they were quite familiar with the issues of health care even if the voters weren't, they could not claim any such thing with financial regulation. No expertise whatsoever was available in the political system on the economic and financial issues afflicting the American economy. Yet, liberal politicians saw an opportunity to channel popular anger, against the bailout of finance firms, in their favor. For over two years now, the various financial regulatory organizations -- the FDIC, the Treasury, the Fed, the SEC, along with the Congress, the Presidency and state-level regulatory agencies -- have been wrangling among themselves for the powers to regulate the finance industry.

Thus faced with waning public disapproval on account of the economic recovery, health care and environmental issues, the politicians decided to quickly enact financial regulation. They fancied that legislating new financial regulation would be the ticket to the resurrection of their own political fortunes. They drafted nearly 2,400 pages of financial regulation within a few months. Most legislators had not even read all these 2,400 pages but they had voted on them, to make drastic changes in the finance industry. However, the voting-public is too smart and it has sealed its complete disapproval of liberal politicians, as the polls clearly indicate. The events described in this section were the main causes for the surrealistically rapid decline in the public approval for liberal policies within a short period of 20 months (Jan 2009 -- Aug 2010).


III. Fed's medium-term inflation target

The first main argument in favor of Professor Rogoff's proposal is that in the last two decades, professional economists have gained significant confidence on soft-landing an economy that has been over-stimulated through Keynesian policies. On the one hand, the natural rate theory on inflation and employment from the 1970s analyzes the consequences of monetary and fiscal policies that are overly stimulative. On the other hand, the experience of Japan's sluggish economic performance for the last two decades has been an experimental ground for stimulative policies, and Japan's experience paints a picture of too little stimulation.

Professor Paul Krugman has been commenting repeatedly these days that he foresaw much of the troubles in the American economy. For example, in http://krugman.blogs.nytimes.com/2010/09/11/one-model-to-rule-them-all/, he says "I was, in a way, ready for this particular mess: a decade earlier, trying to make sense of Japan's woes, I had thought through the economics of a liquidity trap ... ... That basic framework led me to conclude that the Obama stimulus was much too small; that the huge increase in the monetary base wouldn't be inflationary; that interest rates would stay low as long as the economy remained depressed, despite huge government borrowing."  

The second main argument in Professor Rogoff's favor is that the Fed has a really effective infrastructure to monitor the economy closely. If the economy was to pick up robust growth at any time, the Fed's stimulation efforts are calibrated to wind down smoothly, so that the run-away inflation of the 70s can be avoided. The Fed's Beige Book and the six-weekly reports from its 12 regional branches provide up-to-date information about various economic indicators. Moreover, the Fed's empirical data-gathering efforts are supplemented by  the analysis of many professional experts from academia and the private sector. It is with the help of this monitoring infrastructure that the Fed Chairman and the Treasury were able to rapidly inject trillions of dollars into the economy as soon as the financial crisis hit in 2008 (as if dropping wads of dollars from a helicopter).

Furthermore, the Fed was able to quickly move the trillions of dollars on its balance sheet between different parts of the economy according to where it thought relief was most needed. At the beginning of the financial crisis, the Fed directed its resources towards direct lending to the financial sector (term auction credit, commercial paper purchase) and currency swap agreements with foreign central banks. As time went on, these programs were shut down without much trouble and the money was re-directed to purchasing mortgage securities and treasury securities. These purchases helped to bring down the long term interest rates, which in turn, has helped homeowners to meet their monthly mortgage payments and keep their homes from foreclosure.

So the Fed does have formidable tools to micro-manage the economy. Then what is the problem with Professor Rogoff's proposal for announcing that the Fed's medium-term (4 to 12 years) target for inflation is 4% or above? To analyze Professor Rogoff's proposal we need to observe that this proposal fits hand-in-glove with Professor Krugman's program of 'massive fiscal spending and loose monetary policy in order to stimulate the economy, as long as inflation and long-term interest rates stay low'. There are several problems with this approach.

Firstly, let us consider the opportunity cost. As we noted in the previous section, the liberals have been stubbornly adhering to their refusal to rein in budgetary shortfalls under the excuse that a recession is no time for worrying about debt and deficits. Whatever the merit of this argument, one cost it does have is that it foregoes the chance for the government to retire older debt (which were issued at high interest rates) by issuing new debt (at interest rates that are very low at present). Instead, all the new debt is going towards increased spending. In this situation, raising the Fed's medium-term inflation target to 4% is only going to signal to the market that there is no plan whatsoever to reduce debt servicing costs.

Secondly, even the Fed does not have complete control on the way its funds can be put to work on the economy. For example, for several months in 2009, the reserves that the banks had with the Fed had reached upwards of $800 billion. Most of this money was meant to be leant out to the business sector to stimulate growth, but the sluggishness in the economy precluded any prospects of credit expansion. This was the classic case of the 'liquidity trap' and the Fed was simply 'pushing on a string'. We saw in the previous section how overshooting of targets to the tune of hundreds of billions of dollars could have serious political consequences. The same phenomenon is in work here.

Thirdly, even if Professor Krugman claims that he has found new ways to deal with the liquidity trap (see quote above), deflation is not something that the economics profession has any serious expertise to deal with. The natural rate theory gives some foundation for dealing with increasing inflation. Japan's example gives a lower bound for stimulative policies. Other than these two extreme situations, there is no particularly insightful modern treatment of the phenomenon of deflation. The response to the economic crisis from professional economists demonstrates clearly that to deal with deflation, modern economics relies totally on Keynesian theory which is more than 70 years old now.

Fourthly, let us assume, for argument's sake, that price stability can be achieved, in the medium term (4 to 12 years), using the Fed's approach of calibrating the expansion of its monetary policy by just the right amount to ward off deflation. Even so, in a break from the tradition of so many decades past, this price stability would no longer be guaranteed to result in robust growth. This is because the classical models of growth which relied on steady gains in productivity brought about by technological progress, and ready availability of abundant natural resources were all reasonable assumptions 70 years ago. But now these assumptions are no longer valid, and there is no reliable theoretical developments in growth theory that can predict how a modern economy is supposed to grow in the 21st century.

Fifthly, this prevailing ambiguity about the long-term drivers of economic growth has resulted in the relative decline of business investment as a spending priority. The stimulative efforts, that the liberals in office have been directing at the economy, have been focused mostly on consumer demand. Professor Robert Reich makes frequent appearance in the media to emphasis that the most severe problem in the American economy is the drop in consumer demand. In fact, there has been a high-profile debate among economists recently as to whether the causes of the sustained high levels of unemployment that the economy would be facing for several years are structural or cyclical. The Keynesians are arguing now that the main cause is cyclical downturn in consumer demand. Just two years ago, the Keynesians led by Professor Krugman were declaring that they were going to use domestic savings to re-engineer the structure of the American economy. In particular they were going to resuscitate the entire manufacturing sector through a renewed industrial policy.

Sixthly, the pre-occupation with massive efforts at stimulating consumer demand (as long as prices and interest rates remain low), has resulted in the liberals taking isolationist and protectionist views on the American economy. They believe that the recovery of the American economy can be engineered purely through the government's re-investment of domestic savings. Especially in view of the coming political elections, the liberals have been ratcheting up their rhetoric on international trade. These views are definitely counter-productive for fighting deflationary pressures. Instead, by engaging the rapidly growing economies of Asia and Latin America in a constructive manner, America can ensure robust economic growth for itself. As a result, foreign policy and globalization are two major phenomena that could bring much larger benefits for the future of the American economy than having the Fed use all its tools in the pursuit of a medium-term inflation-target of 4%.

The reality is the whole Western economy was based on Ponzi Scheme,of course Bernie Made-Off beacme the poster child.

WE are teaching the World to live beyond our means,through that we have created environmental disasters everywhere.

Someone asked Ghandhi what he thinks of western civilization his answer was it will be a good idea.

Our game is over. We are bunch of IVY LEAGUE elites with nothing inside. We all make lots of noise but Vehicles are empty. We are at the end game here.

Agree on the fiscal side but doubtful about the potency of monetary policy. The impotency of monetary policy has been highlighted by Milton Friedman in his 1971 paper. Please check out.

Quah, Chee Heong