anuary 31 6:26 AM

The Fed’s Exit Strategy – Allan Meltzer had an op-ed in the Wall Street Journal the other day in which he argued that the Fed’s exit strategy will fail. Meltzer and I likely disagree on when the exit strategy needs to begin, however, we are in agreement that the strategy will not work. The banking system is currently flooded with excess reserves — over $1 trillion. Historically, that figure has been around $1 billion or less. Thus far this has not led to inflation because of the declines in velocity and the money multiplier (for more on this see here and here). It is only a matter of time before confidence re-emerges and banks start lending these excess reserves. When this happens, monetary policy will have to respond by draining these reserves from system. It is possible to do so in one of two ways. The first way is to sell bonds through open market operations. The second way is the raise the interest rate that the Fed currently pays on reserves. While I have no doubt that the latter is possible, it is a much trickier assignment and only tackles the problem indirectly. If the problem is with reserves, the Fed should tackle the problem directly.

Stan Collender: GOP Doesn’t Do Fiscal Responsibility – The following all happened just this week:Item 1.  The Conrad-Gregg commission, which needed 60 votes in the Senate, was defeated 53-46.  The amendment creating the commission would have been adopted 60-39 if all of the GOP senators who co-sponsored the amendment voted for it.  Item 2. All Senate Republicans voted against re-establishing the pay-as-you go rules, which would have required that, with certain exceptions, any new mandatory spending or revenue legislation not increase the deficit.  Item 3.  With the Conrad-Gregg commission killed, congressional Republicans have been heavily critical of the commission the Obama administration may create by presidential order to consider ways to reduce the deficit.  Item 4.  Republican Chairman Michael Steele is saying so often that Republicans are against cuts in Medicare that it’s starting to sound like a mantra.  Add to that their stated opposition to revenue increases (see #1 above), military spending reductions, homeland security reductions, and the extremely low possibility that, if Medicare is too hot to handle, they’ll go anywhere near Social Security, and the deficit reduction math becomes totally impossible.

Peter R. Orszag: Facing the Fiscal Facts: (CBO)A Wall Street Journal op-ed today by the prior Administration’s CEA Chair, Edward Lazear, observes that the ratio of federal spending-to-GDP has risen by 14 percent since 2008—and that the transition from 2008 to 2009 saw the greatest annual increase in spending in the last 30 years. Ed is right about the numbers—but let’s look at the facts. On January 7, 2009, the Congressional Budget Office issued its Economic and Budget Outlook for Fiscal Years 2009-2019.  In that document, CBO projected that government spending would rise from 20.9 percent of GDP in fiscal year 2008 to 24.9 percent of GDP in fiscal year 2009.  (Just for the record, that CBO projection was issued 2 weeks before the current Administration took office.) This week, CBO issued its updated Economic and Budget Outlook for Fiscal Years 2010-2020.  That document shows that government spending in fiscal year 2009 turned out to be 24.7 percent…. It is thus correct that federal spending rose by roughly 4 percentage points of GDP between 2008 and 2009 — and it is also the case that the increase in spending has helped to stabilize the economy — but it is wrong to attribute that increase primarily to Administration actions since it took office.  The increase was already on the books when we arrived.

#HealthCareFAIL: How The Dems Botched Their Signature Legislation – Talk about fits and starts. A year ago Democrats committed to passing comprehensive health care legislation; six months ago, it became clear that their project wouldn’t go smoothly; one month ago it was full speed ahead; and a week and a half ago it all fell apart.Health care reform is now on life support. To mix metaphors, it’s on life support and the back burner at the same time. How the Democrats’ signature agenda item went from a foregone conclusion to a prospect in peril is a tale of missteps and bad luck. No single player or event brought us to where we are today. But if any of the below episodes had gone…more smoothly, this might’ve been a done deal.

Chrystia Freeland: What Toronto can teach New York and London – FT – Canada is the only G7 country to survive the financial crisis without a state bail-out for its financial sector. Two of the world’s 15 most highly valued financial institutions – a list dominated by China – are Canadian and a recent World Economic Forum report rated the Canadian banking system the world’s soundest. Even Barack Obama, on the eve of a visit last year to Ottawa, the Canadian ­capital, admitted: “In the midst of the enormous economic crisis, I think Canada has shown itself to be a pretty good manager of the financial system and the economy in ways that we haven’t always been.”

A Funny Thing Happened on the Way (Back) to the Fed – Although Bernanke remains as chair, the political impact of the confirmation tussle looms large. First, brewing dissatisfaction with the Fed’s performance extends far beyond the confirmation vote. The House has voted to allow audits of monetary policy, while proposals in the Senate would strip the Fed of its supervisory powers, rein in its emergency lending powers, and confine it to the task of setting (interest) rates (which, of course, some could argue is the most important element of central banking). Bernanke’s wafer thin confirmation margin reveals legislators’ wariness—if not downright distrust—of the Federal Reserve.  Second, the road to confirmation has imposed a steep tax on the Fed’s independence. Bernanke’s explicit lobbying for senators’ support, as well as claims from the Democratic leader that his support was “conditional,” belies the myth of Fed independence. That of course raises the possibility that political pressure could interfere with the Fed’s conduct of monetary policy— thus stoking the risk of inflation.

China Is Leading the Race to Make Renewable Energy – NYTimes – China vaulted past competitors in Denmark, Germany, Spain and the United States last year to become the world’s largest maker of wind turbines, and is poised to expand even further this year. China has also leapfrogged the West in the last two years to emerge as the world’s largest manufacturer of solar panels. And the country is pushing equally hard to build nuclear reactors and the most efficient types of coal power plants.These efforts to dominate renewable energy technologies raise the prospect that the West may someday trade its dependence on oil from the Mideast for a reliance on solar panels, wind turbines and other gear manufactured in China.

 The State of the Union Is Comatose – Many Americans were more eagerly anticipating Steve Jobs’s address in San Francisco on Wednesday morning than the president’s that night because they have far more confidence in Apple than Washington to produce concrete change. One year into Obama’s term we still don’t know whether he has what it takes to get American governance functioning again. But we do know that no speech can do the job. The president must act. Only body blows to the legislative branch can move the country forward. The historian Alan Brinkley has observed that we will soon enter the fourth decade in which Congress — and therefore government as a whole — has failed to deal with any major national problem, from infrastructure to education. The gridlock isn’t only a function of polarized politics and special interests. There’s also been a gaping leadership deficit.

From Davos, predicting the next economic crisis – A panel of experts gathered in Davos, Switzerland, to debate where the next global crisis will come from. Their grim forecast: Some of the very measures that governments have taken — or might take — to fend off financial turmoil are only setting the stage for more trouble. Harvard economist Kenneth Rogoff kicked off the Wednesday discussion with a simple, depressing argument: The banking collapse is morphing into a long-term crisis of government debt. Instead of financial panic, we now face an "illusion of normalcy," with governments stepping in to guarantee everything. They’ve succeeded in fending off another Great Depression but at the cost of skyrocketing debt. And if history is any guide, he said, financial crises are often followed precisely by a wave of sovereign debt crises a few years later.

How to Reform Our Financial System, by Paul Volcker – In approaching that challenge, we need to recognize that the basic operations of commercial banks are integral to a well-functioning private financial system. It is those institutions, after all, that manage and protect the basic payments systems upon which we all depend. More broadly, they provide the essential intermediating function of matching the need for safe and readily available depositories for liquid funds with the need for reliable sources of credit for businesses, individuals and governments. Combining those essential functions unavoidably entails risk, sometimes substantial risk.

Did Obama Change the Conversation? –  I think it’s too soon to be talking about deficit reduction given the state of the economy, and particularly the state of labor markets, but there’s no reason to let the people who do want to talk about it dominate the conversation. We do need a plan to bring the deficit down in the long-run, but right now we need more, not less deficit spending, and there are job creation proposals currently under consideration by Congress that rely upon the ability to increase the deficit in the short-run (e.g. see here for Dean Baker’s negative reaction to one recent proposal from the administration).  If we could talk about the long-run deficit problem without making it less likely that we will enact further job creation measures now, there would be no problem with the deficit discussions. But that’s not the case.

Resolving fake homeownership  Mike Konkzal has a new post on the homeowner crisis. In it, he describes the current phenomenon of homeowners being offered mortgages, which they can’t afford once rates are reset after a teaser period, then being left with an uncertain future as banks defer on foreclosure after they‘ve gone delinquent. He gives this a term, “Fake homeownership”, which is probably a very apt term for what the arrangement essentially amounts to. He has given vivid illustrations of what is actually going on in the ground, and like many, is reasonably perplexed at how banks could have let people come this far into trouble. Not being in the US, many of the things he says are new to me, but having once been in a bank, I will put my comments and clarifications on key passages of his post, to try to put more light on some of the reasons why they are what they are, so that Mike (who’s doing an admirable work of trying to get to a deeper understanding) can give us more nuanced recommendations.

Questions For Joseph Stiglitz – Interview – NYTimes

Spurned by Big Banks, Small Firms Find Cash Where They Can – NYTimes – Recently, the Treasury Department began tracking lending by the 22 largest bank recipients of federal bailout money, and it found a sizable decrease in small-business lending. Banks, of course, are now more reluctant to hand over money to small and midsize companies partly because the practice is riskier than it was just a few years ago, when consumers were spending freely. Banks are writing off record numbers of bad loans and have tightened their underwriting standards to limit their losses. “After Chase said no, I went to Citibank. I went to Capitol One. I wasn’t going to sit around waiting,” says Mr. Levy, explaining that he needed to borrow $1 million last year for $1.5 million in purchase orders for new products, including frames with Wi-Fi access. “All of them said the same thing: ‘the underwriters, the underwriters.’ They just tightened and, boom, they just shut it off.”  WHEN small businesses face funding squeezes, Mr. Eitelberg and others like him offer an enticing, if expensive, pitch for desperate entrepreneurs.

Five myths about America’s credit card debt – They’re yuppie food stamps. They give new meaning to the question "paper or plastic?" And they’re in everyone’s wallet. Americans have nearly 700 million all-purpose bank credit cards, plus nearly 500 million retail store cards — and they have transformed how we live and consume. Today, Americans are more dependent on credit than savings, a radical departure from the last major economic crisis, in the 1930s. Congress’s effort to change that, the Credit Card Accountability, Responsibility and Disclosure (CARD) Act signed by President Obama last spring, will go into effect in a few weeks. But it won’t fix everything. Or maybe not much of anything. Here are the myths that muddle our understanding of how we’ve racked up so much credit card debt.

Cossack Rahm Works For The Czar – Ezra Klein finds Rahm Emanuel’s apparent willingness to let health reform slide into the indefinite future very depressing. So do I. And it’s not just health reform that will die under this approach — it’s the road to a caretaker presidency. It’s all very well to say “we’re going to focus on job creation”. But what does that mean? At this point, no major economic programs have any chance of getting passed. Think of it this way: a year ago the question was whether the stimulus would be $700 billion or $1.2 trillion, now we’re talking about $30 billion jobs tax credits. Maybe financial reform will happen, or at least set up a “teachable moment” battle with the GOP. But by letting health reform slide, the administration is abandoning one really big policy initiative that is just inches from happening. Let this go, and there’s likely to be no achievements worth remembering.

"Hearts and Minds" – Robert Shiller says pessimism is leading to a pessimistic outlook for economic recovery: Stuck in Neutral? Reset the Mood, by Robert Shiller, NY Times;  I don’t know if "problems in the hearts and minds of workers and investors" — workers in particular — is the "heart" of the slow recovery problem. I always find Shiller’s psychology-based explanations less than fully convincing, but listen anyway because he has a pretty good track record at predicting emerging bubbles. But I will say this. Aggressive, effective job creation policy by the government — putting people to work — would go a long way toward repairing any problems in the hearts and minds of workers.  As for investors, their hearts and minds would be best repaired through strong regulatory measures that prevent the type of behavior that got us into this mess

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