Thursday, June 23, 2011

Can Ben Bernanke really be this stupid?

Ben Bernanke is surprised that the economy is not recovering faster:

Fed Chairman Ben Bernanke told reporters Wednesday that the central bank had been caught off guard by recent signs of deterioration in the economy. And he said the troubles could continue into next year.

"We don't have a precise read on why this slower pace of growth is persisting," Bernanke said. He said the weak housing market and problems in the banking system might be "more persistent than we thought."

Well, I'm not surprised. It's completely obvious to me why the economy has not recovered: we have done absolutely nothing to fix it. The housing crisis was not an unexpected aberration, it was the completely predictable result of the systematic dismantling of the tax and regulatory regime that was in place in this country since the end of WWII, and replacing it with a tax and regulatory regime that more closely resembles what we had after WWI. In 1925 top marginal tax rates were lowered from 46% to 25% and banks were deregulated. Five years later the Great Depression started. By 1945 top marginal rates were back up to 90% and a strong banking regulatory regime was put in place that resulted in thirty years of unprecedented financial stability and prosperity. Starting in 1982 we began to dismantle that regulatory regime and lowered top marginal tax rates back down to 30% or so. The predictable result was increasing financial instability and economic inequality. Since 2008 we have done absolutely nothing to change the strategic situation so it shouldn't come as a surprise to anyone that we continue to see the same results.

I'm going to go on record here with the following prediction: within the next five years we will see an economic crisis that will make 2008 look like a cake walk by comparison. We came very close to a global meltdown back in '08, and the only thing that saved us from complete calamity was using up what little margin was left in the system to restore liquidity. The next time things start to come apart at the seams that margin will be gone. I have no idea when or how this crisis will come about. I just know that unless we make some painful choices it is a question of when, not if, this will happen. And right now I see no indication that those painful choices will be made. The fact that Ben Bernanke apparently has his head shoved so far up his butt that he can't see what is blatantly obvious to an amateur like me does nothing to bolster my optimism.

[UPDATE] Looks like my prediction may be coming true faster than I thought.


Don Geddis said...

You say that your theory of what caused the financial crisis is "blatantly obvious to an amateur like" you, and wonder why Bernanke can't figure it out.

The obvious possibility, of course, is that your theory is simply wrong, and, as expected, Bernanke is smarter (or at least more knowledgeable) than you.

For example, without going into any of the details, Scott Sumner (The Money Illusion) has spent a few years pushing the compelling theory that the real problem was a drop in aggregate demand (yes, originally sparked by the subprime stuff, but which had no need to spread to the rest of the economy), which was not correctly countered by the Fed. Bernanke didn't helicopter in enough money, early enough.

If Sumner is right (and he has a lot of data on his side), then Bernanke indeed made a mistake; but it's nothing at all like the mistake you're suggesting, and your proposed fixes wouldn't have helped anything.

I think there are more likely explanations of what is going on, than "Bernanke is stupid".

Don Geddis said...

Or, let me try a different way: you're probably right, that financial deregulation leads to increasing financial instability. But that could be a perfectly fine tradeoff for an economy to make, to achieve greater average growth.

The "real problem" is that the financial instability led to an economy-wide (even global!) recession.

Compare the dot-com crash in 2000, to the financial meltdown in 2007. Both were devastating for their local industries, but the first was contained, and the overall economy hardly noticed. Not so with the second.

Most likely you think that banking has a more intimate connection with the overall economy than dot-coms do. But Sumner has a compelling argument that the financial spark did not require an economy-wide wildfire. Bernanke ran the fire trucks, and he didn't keep the damage contained.

That's a very different story than the one you're suggesting, and a story with a radically different fix.

Dennis Gorelik said...

Could you please remind us what is top marginal rate in Hong-Kong and how deep is economic crisis there?

Let me go on the record here too:
In the five years (2016) our economy would be nothing like economic crisis of 2008. It would be at the highest prosperity level ever.
It would resemble 1999 with inevitable bubble burst in the following years, but that burst would be no worse than bubble burst of 2000-2001.

And yes, I expect that top marginal rates would not go up or at least would no go up much.

Ron said...

Time will tell which of us is right, but one thing is certain: history will not vindicate Bernanke, because he is not taking a position. He's standing there with his dick in his hand saying that he doesn't know what is going on. I may be wrong, but at least I have a defensible and testable theory. He doesn't. And that's bad because it's his fucking job.

Ron said...

Also, just for the record, I will be thrilled if it turns out that I'm wrong and Dennis and Don are right.

Don Geddis said...

I agree that Bernanke is screwing up. I happen to think it's for a different reason than you do, but he's the one with all the controls for the economy. When he says that he was "caught off guard" and doesn't know why the slow growth is "more persistent than we thought", that's a self-admitted failure.

"I don't know what is happening" is not an acceptable response, from the chair of the Federal Reserve.

Dennis Gorelik said...

I don't see any problem with Bernanke claiming to be caught off guard.
If he claimed to be confident about economy that would not be any better.

Bernanke's job is to keep US Economy relatively stable and so far he's doing ok. There is no big dip since 2008.

Overall long-term progress of the economy is not under Bernanke's control anyway.
Long term economy strength is defined by two factors:
1) Technological progress.
2) Government spending relative to GDP.

#2 is controlled by Congress and President.

#1 is not really controlled by anybody in particular.

Don Geddis said...

Dennis, you're probably right about the long-term possibility of the economy, but certainly not about the short-term actual economy.

The US had 4-6% unemployment from 1996-2008. And 9-10% unemployment from 2009-now. Those missing 5% of the working population could have been doing something productive for the last couple of years, and the US would currently be wealthier if they had been. But instead they were idle.

That unemployment rate is close to directly controllable by the Fed. Most of the Fed's possible actions, involve a tradeoff between inflation and unemployment.

10% unemployment for two years means the Fed has failed at its job, and the US economy has underperformed its potential.

Ron said...

> If he claimed to be confident about economy that would not be any better.

There is a big difference between being confident in the economy and being confident in one's ability to understand the economy. From the Fed chairman I expect the latter, not the former.

> That unemployment rate is close to directly controllable by the Fed.

That theory was debunked in the 70s. Maybe you're too young to remember ;-)

Don Geddis said...

Stagflation was notable at the time, because it was such an unusual economic situation. Rarely seen before or since (and certainly not the case today), and complex to account for in macroeconomic theories.

All that said, my original point stands: most Fed actions either lower unemployment by raising inflation, or vis versa. The Fed has a tradeoff to make. That's independent of what the particular absolute levels of unemployment or inflation happen to be.

Volcker cured '70s stagflation by raising interest rates, which successfully lowered the inflation rate, but at a cost of significant additional unemployment. (The unemployment later returned to the natural rate on its own.)

In today's world, we have very high unemployment, but very low inflation. There's no question that the Fed is making a terrible mistake, and we would all be better off if inflation were slightly higher, along with unemployment being much lower. And making that tradeoff is exactly what the Fed does (or should be doing).

coby said...

I will go on the record agreeing with Ron on this one, though I don't think picking a particular year is a safe prediction. We are headed for another crash and it is in no small part due to the complete lack of a proper remedy for the first one. Glass-Steagal should be restored, derivatives and CDSs regulated, existing regulations toughened and properly enforced.

US economic history unambiguously supports the case for higher marginal tax rates being beneficial to stable and meaningful economic growth. (Note: I do not consider growth in GDP a meaningful economic indicator when employment is very low and poverty is increasing and income gaps are widening. This is what tax breaks for the very wealthy do).

Bernanke does deserve some cursing for playing dumb and not even trying, however (channeling Krugman here) the Fed's powers are very limited when interest rates already near 0%. The only possible remedies are politically impossible in the broken American political system, renewed disaster is inevitable.

Don Geddis said...

Coby: You (and Ron?) seem to view regulation as a dial, where the US is now on 3 out of 10, and you want to move the dial up to 7. But it doesn't work like that. You need actual, specific, regulations, not just more of them. What is the specific behavior that is problematic, that you want to prohibit? These questions are not at all easy to answer. (Well, Glass-Steagall is specific, but I mean the other ones.)

And BTW: Krugman is wrong (as he himself has admitted at rare times in his blog) to imply that the Fed is impotent at 0%. He's done a disservice to you and others by harping on the "liquidity trap". It is simply false that the Fed has no possible actions other than setting the interest rate. It is false that those other actions are ineffective at 0%. The Fed has chosen not to be more active in the last few years, but it is not because their powers are limited.

Ron said...

> You need actual, specific, regulations

> Glass-Steagall is specific

I'm starting to worry about you, Don.

There are no magic bullets here. Inflation is one way out of this mess, but that is effectively a tax on those whose assets are primarily in currency i.e. savers and those at the bottom of the economic ladder. I don't think that's the best solution, but that is not really the point. The real point is that we have three options: we can decide to impose a burden on those most able to bear it (the rich, by raising their taxes) or we can decide to place a burden on those least able to bear it (the poor and elderly, by printing money and inducing inflation) or we can do nothing and wait until the system comes apart at the seams. Those are the only options. Bernanke is essentially choosing option 3. That's bad enough, but it's made worse by the fact that he is choosing this option not because he's thought about it and thinks it's the best option, but because he self-admittedly doesn't understand what is going on! And he's getting paid for this! Shit, I'll happily run the economy into the ground for half of what we're paying Bernanke to do it.

Don Geddis said...

Ron, you seem to be confusing a whole bunch of different issues here.

First of all, I agree with you about Bernanke.

A second issue is how we as a society choose to pay for government services that we want, and what share of that burden falls on the wealthy vs. the poor. But that's not what we're talking about here.

A third, related, topic is how we deal with the national debt, and whether we can "inflate our way out of it". Again, not the topic we're discussing.

The topic here is the recent financial meltdown, and the two years of extreme recession and 10% unemployment and 0% GDP growth. That's the problem. Not the deficit, not the debt. I'm not worried about the elderly on fixed income who will suffer a bit with mild inflation. I'm worried about the healthy 25-year-old who can't find a job, and who has not been productive at all for the last two years.

As for inflation, the Great Moderation of stable GDP growth from 1980-2000 (or even to 2007) had a successfully targeted inflation rate of 2-3%. The last two years, the inflation rate has been about 0%. Your comments might be useful, if someone was proposing to raise inflation to 15%, which (as you say) is an unfair transfer of wealth from fixed-income and bond holders, to others in society.

But you radically underestimate the damage to the economy from inflation that is too low (or worse: deflation, as in 2009).

An inflation rate of 0% is not good, and is basically the reason we've had 10% unemployment and the economy woefully underperforming its potential for the last few years.

I'm not asking for 15% inflation. I'm asking for the usual 2-3% inflation of the last three decades.

Don Geddis said...

My favorite econ blogger, Scott Sumner, has posted a short and thoughtful analysis of what both progressives and conservatives missed about the recent recession.

I note in Ron's original post, he writes: The housing crisis was not an unexpected aberration, it was the completely predictable result of the systematic dismantling of the tax and regulatory regime that was in place.

Which is essentially a theory of the the causes of the recent recession.

Contrast this to Sumner's analysis: Progressives tend to blame the instability of unregulated capitalism, prone to bubbles and crashes. Conservatives blame moral hazard created by government insurance and/or policies that tried to get more low income people into housing. But both seem to see the sub-prime crash as the proximate cause of the crisis of late 2008. I think they are both wrong. [...] I’m depressed by almost all discussions of the current crisis, as they all start with the premise that “it goes without saying” that the Great Recession was triggered by financial crisis. No, the Great Recession caused the financial crisis.