Tuesday 12 Oct 2021 | 22:56 | SYDNEY
Tuesday 12 Oct 2021 | 22:56 | SYDNEY

US needs a path out of here


Stephen Grenville

29 August 2011 12:15

Those who were expecting a powerful policy initiative from Fed Chairman Ben Bernanke at the Jackson Hole Conference on Friday were bound to be disappointed. Monetary policy has done just about all it can do. There is always room for fine–tuning, but the gaping policy shortfall is in fiscal policy, not monetary policy.

It's clear what should be done. While fiscal policy shouldn't be tightened with unemployment still so high, what is urgently needed is a credible detailed commitment to get the budget on a sustainable track. This is clearly in the hands of the politicians. Considering the very real danger of emulating Japan's lost decades, this is a major political failure.

Bernanke included a muted version of this criticism in his Jackson Hole talk. He no doubt feels constrained by the unsympathetic, even patently hostile, Republicans like Ron Paul and Rick Perry, but it may be time for him to use his position to put the responsibility squarely on the politicians who control fiscal policy. Former Fed Chairman Paul Volker would have been bolder.

It is in the nature of politics that the nation's interest will often be subordinated to self–interest. One group of politicians is happy to see the economy perform badly in order to damage Obama's re–election prospects. Another group sees this as a historic opportunity to put America onto the path of small government.

Against these destructive forces, the hope is that there are enough politicians who recognise that persistent 9% unemployment leaves long–term scars on the economy. They might also acknowledge that the Tea Party's small–government agenda doesn't take America back to the resilient self–sufficiency of the Founding Fathers, but to a level of government services totally inappropriate for a modern advanced country.

Whatever excuses the politicians have for inaction, there is no excuse for the failure of economists to put forward, loud and clear, the case for an active policy response to the stalling recovery. Why are economists' voices so muted?

Some called the recovery wrongly, and are reluctant to admit they made a mistake. For example, in June the Bank for International Settlements assessed the recovery to be firmly on track, and urged countries to tighten both monetary and fiscal policy. Bad call, even with the data available at the time. Other economists have not yet noticed the poor fit between the real world, and their view of how it works, which assumes that the self–equilibrating forces in the economy are very strong and efficient markets will allocate resources optimally.

Others are de–facto advocates of inaction, because they see the current recession as being different from the usual downturn. Historically, most recessions have been caused by tight policy responding to inflation. This time, the central problem was private–sector over-borrowing. There is a legacy of over-leveraged balance sheets which have to be whittled away into a sustainable shape. This takes time, and it is argued that policy can't do much to speed up the adjustment.

But is this the central issue in America? Certainly, the recession started with sub–prime over–borrowing. In the decades since financial deregulation, households have geared up, taking their debt to around 150% of income. But is this oft–quoted figure all that alarming?

A more relevant comparison is the asset/liability ratio. This has also grown since financial deregulation (this type of balance sheet expansion was, after all, the principal motivation for deregulation). But household assets have also increased and are now four times larger than liabilities. Restating this, the household debt/equity ratio is 1:3, which any company would regard as astonishingly conservative.

Speaking of companies, their balance sheets are in fine shape and their profits excellent. It's just that none of them wants to invest. What about the bank balance sheets? Of course they have bad debts to write off. Bank of America is still paying for its foolish take–over of Countrywide's mortgage portfolio just as the crisis unfolded. But with low funding costs, banks' margins are fat and their balance sheets are quickly recovering.

What about the government balance sheet? It is quickly slipping the wrong way, and will soon be in unsustainable territory. But this is largely the result of the recession. Whereas time might help household balance sheets, a long recession will make the government's position much worse.

The economics is simple. Rather than urge Bernanke to undertake QE3 (which will have little effect), mainstream economists should be calling for Congress to come up with a credible plan for a sustainable fiscal position, to be implemented when the economy recovers. As well, to hasten this recovery, economists should identify specific stimulus actions (some directed at speeding resolution of the mortgage mess, some aimed at encouraging employment).

The 2009 stimulus, hamstrung by a fractious Congress, was so timid as to be inadequate. Successful stimulus programs (eg Australia and China) are characteristically too big, and the measure of their success is that afterwards they are criticised as being unnecessary.

All this, you might say, is America's debate and foreigners should mind their own business. But this, combined with Europe's inability to sort out the minor problem of Greece, has taken the world economy into dangerous territory, for which we are all paying the price.

Photo by Flickr user Andrew Michaels.