March 25, 2004

Keep Interest Rates Low! (Economic Deviancy Department)

The Financial Times's Gerard Baker has a very nice piece making the important point that U.S. interest rates need to stay very low until the amount of slack in the labor market declines. He thinks (and I think) that those who believe the economy needs a whipping from higher interest rates right now are positively dangerous. I mean, is employment really growing too fast right now?

However, I'm not sure that I can personally endorse his call to apply the chains and cuffs on advocates of such positions:

Gerard Baker: Shackle these sado-monetarists: Sado-monetarism, a deviancy popular among certain central bankers and commentators in the 1980s, is out of the closet and back in respectable living rooms. Even as the US economy is failing to generate sufficient growth to employ its expanding workforce, as the core inflation rate has fallen by a third in the past year, as the stock market slides below where it started the year and as the global economy is held hostage once again to war, Middle East terror and surging oil prices, there is a chorus of calls for the Federal Reserve to raise interest rates to squeeze the world's largest economy harder.

The Economist, a sado-monetarist of long standing whose complex psychology has been further tangled in recent years by an unhealthy bubble fixation (stock bubbles, housing bubbles, bond bubbles, dollar bubbles, hubble-bubble, trouble-bubble), is leading the charge. An editorial two weeks ago said: "A rise in rates could help to avoid another dangerous bubble by warning investors and homebuyers that asset prices cannot rise for ever."

Hurt me!

The New York Times, a relatively new convert to self-flagellation, says the same thing. The paper condemned the federal open market committee's decadent decision last week to leave policy unchanged and called for an immediate increase in interest rates. "Rates are so low that the Fed has plenty of room to move before being accused of adopting a restrictive monetary policy. It needs to get started."

Punish me!

If these two mostly innocuous institutions were alone in pursuing their habit in the secrecy of their own editorial boardrooms, we would not need to worry. But there are signs they have some support. A number of financial market analysts are urging the Fed to raise rates. In Europe, while the economy stagnates, the European Central Bank's policymakers are still doggedly refusing to ease interest rates. Indeed, in parts of European and American monetary policy debate it is the accommodative stance of the US, the only one of the three main areas of the industrialised world to have seen sustained growth for the two years, that is under fire. The recovery is essentially an artificial one, the argument goes. It has been built on unsustainable increases in housing prices and debt, all stoked by an overly accommodating monetary policy.

Fortunately the sado-monetarists are not in charge at the US central bank. Of course, in providing the necessary liquidity to keep the US economy afloat in the past three years, the Fed has created some unwelcome side effects. But it is unlikely the alternative would have been better. Leaving rates unchanged over the past three years, or cutting them more gently, would probably have produced no growth at all; in those circumstances lower absolute debt levels would have been far more dangerous because the economy would not have been producing any income to service them. Very well, say the critics, perhaps policy has been right up till now, but surely it is time to change. It is true that the economy is recording stronger rates of growth than when the central bank lowered the Fed funds rate by 475 basis points between early 2001 and mid-2003. With productivity growth running at 3 per cent plus a year, the current long-run equilibrium real interest rate - the rate that is neither stimulative nor constricting - is probably about 3 to 4 per cent; at today's inflation rate that points to a nominal neutral rate of about 4 to 5 per cent.

The Fed funds rate is currently 300 to 400 basis points below that, imparting a powerful stimulus. If the economy is growing at roughly 4 per cent a year, why is the Fed not moving rates back towards normality? By any measure the degree of unused capacity is still very large. The unemployment rate may be officially at only 5.6 per cent, but this is only because large numbers of discouraged workers have left the labour force. A rough measure of the overall slack in the labour market is the proportion of the population in work - that still hovers around 62 per cent, 4.5 percentage points (or about 6m jobs) lower than at the peak of the boom in 2000. Industrial capacity utilisation is 76.6 per cent, down from more than 82 per cent at the peak three years ago. This slack is reflected in the overall growth of gross domestic product. In only three of the past 14 quarters has output growth exceeded the estimated potential rate of about 4 per cent.

Despite the merest murmur of an uptick last week, inflation remains at about 1 per cent, with a strong probability of further declines in the rest of the year. The surge in oil prices in the past six months is much more likely to have a deflationary effect through incomes than an inflationary effect through prices. And the geopolitical environment these days is hardly crying out for tighter policy. Evidently, rates will have to rise as the recovery becomes more firmly established. But the keening for a tightening of monetary policy now is misplaced. Until the slack in the US economy starts to be significantly reduced - especially, until employment begins to grow rapidly - it is hard to be confident in the strength of the recovery. Without strong gains in employment, the economy will not generate the sort of self-sustaining income growth needed to work off the household debt incurred in the past few years at "normal" interest rates.

Sado-monetarists should be restrained before they do us all needless harm.

Posted by DeLong at March 25, 2004 12:50 PM | TrackBack | | Other weblogs commenting on this post

From late December, when the federal program designed to help the long-term unemployed began phasing out, through the end of March, an estimated 1.1 million jobless workers will have exhausted their regular unemployment benefits without receiving additional aid. In no other comparable period on record have so many individuals exhausted their regular benefits and gone without additional aid.

Posted by: anne on March 25, 2004 01:13 PM


Are these "sado-monetarists" descendants of the "liquidationists" of the 1930s like Andrew Mellon who thought a cycle of bankruptcy and deflation was healthy for the economy ?

Posted by: bhaim on March 25, 2004 01:17 PM


In Florida Groves, Cheap Labor Means Machines

IMMOKALEE, Fla. — Chugging down a row of trees, the pair of canopy shakers in Paul Meador's orange grove here seem like a cross between a bulldozer and a hairbrush, their hungry steel bristles working through the tree crowns as if untangling colossal heads of hair.

In under 15 minutes, the machines shake loose 36,000 pounds of oranges from 100 trees, catch the fruit and drop it into a large storage car. "This would have taken four pickers all day long," Mr. Meador said.

Canopy shakers are still an unusual sight in Florida's orange groves. Most of the crop is harvested by hand, mainly by illegal Mexican immigrants. Nylon sacks slung across their backs, perched atop 16-foot ladders, they pluck oranges at a rate of 70 to 90 cents per 90-pound box, or less than $75 a day.

But as globalization creeps into the groves, it is threatening to displace the workers. Facing increased competition from Brazil and a glut of oranges on world markets, alarmed growers here have been turning to labor-saving technology as their best hope for survival.

"The Florida industry has to reduce costs to stay in business," said Everett Loukonen, agribusiness manager for the Barron Collier Company, which uses shakers to harvest about half of the 40.5 million pounds of oranges reaped annually from its 10,000 acres in southwestern Florida. "Mechanical harvesting is the only available way to do that today."

Global competition is pressing American farmers on many fronts. American raisins are facing competition from Chile and Turkey. For fresh tomatoes, the challenge comes from Mexico. China, whose Fuji apples have displaced Washington's Golden Delicious from most Asian markets — and whose apple juice has swamped the United States — is cutting into American farmers' markets for garlic, broccoli and a host of other crops....

Posted by: anne on March 25, 2004 01:23 PM


Since there is much consideration of development in India:

Deserted by Doctors, India's Poor Turn to Quacks

BHOMATAWARA, India — The sturdy little public clinic in this poor, sickly village was locked up one recent afternoon, but that is nothing remarkable. Rampant absenteeism among government doctors and nurses is an open secret across India and much of the developing world, and they virtually never get in trouble for not showing up.

"Sometimes the nurse is here, sometime she's not," said Nagji Lal Pandore, a skinny old man in a saffron turban. "Sometimes she has medicines, sometimes she doesn't. Why take a chance?"

So, like many people here, his family has turned to amateur private "doctors" who have regular hours and plentiful medications to sell.

His daughter-in-law Shanti Bai, 30, went to such a doctor for a fever six months ago. He gave her an injection. The next day, she was dead and her children motherless.

Villagers blamed the doctor and he fled, but the heartache remains. Mr. Pandore and his wife have broken the news to their 5-year-old grandson, but they are still telling their 3-year-old granddaughter that her mother is away on a trip. "She cries and cries and asks, `Where is my mother?' " he said.

India has a vast primary health care system to serve its billion people, with clinics for every 3,000 to 5,000. But the system is often just a skeleton. New studies have documented the startling, damaging dimensions of chronic absenteeism — and not just in India.

Researchers for the World Bank discovered through large national surveys that medical personnel were absent from their public posts 35 to 40 percent of the time in India, Bangladesh, Indonesia and Uganda, and about a quarter of the time in Peru.

Researchers from the Massachusetts Institute of Technology and Princeton, in a detailed survey of 100 villages here in Rajasthan, in north India, found a no-show rate of 44 percent. When combined with absences for meetings and other work-related reasons, these vital clinics were closed more than half the time.

As the United Nations leads a global effort to prevent millions of deaths from AIDS, tuberculosis, malaria and a range of childhood illnesses, the fissures in public health systems are emerging as a main obstacle.

There is an increasingly heated debate among experts about whether multibillion-dollar infusions of foreign aid or politically sensitive domestic reforms are more central to repairing public health systems.

What is starkly clear in India, home to more poor people than any other country, is that the health system is both starved for resources and desperately in need of reform....

Posted by: anne on March 25, 2004 01:26 PM


The Baker piece is very good and funny. Just one query. Take a look at yield curves in other countries right now:

short 0.12
long 2.18

short 4.34
long 4.57

short 2.02
long 4.68

short 2.19
long 4.90

One country -- the UK -- looks sado-monetarist. But with virtually no difference from other countries in long rates. So maybe, just maybe, they reduce some of the speculative aspects of low short rates but keep the economy ticking along.

Posted by: P O'Neill on March 25, 2004 01:28 PM



I think you are framing the issue too narrowly. The U.S. economy indeed has a lot of slack, and U.S. policy rates need to remain low while that is true. But it is not unreasonable to worry whether excessive concentrations of leverage might be building up in the current low interest rate environment. If so, the right monetary medicine today could, as a side-effect, generate financial instability tomorrow.

For a few years, a literature has been building on whether monetary policy should, at least sometimes, attempt to pop growing asset price bubbles. (I think: emphatically not.) But the broader issue is whether we ought to draw a sharp line between a central bank's responsibilities for price and output stability and its responsibilities as prudential regulator. Claudio Borio of the BIS argues that they should not be treated as sharpl distinct, and argues for the concept of "macro prudential policy." After all, asset price volatility, and the associated booms and busts in credit extension, have often been the largest source of macro volatility.

This still leaves the difficult question of what tools central banks would need to conduct macro prudential policy (interest rates are too blunt); and whether such policy would be feasible, given the political and information contraints facing central banks. But I think there is a genuine issue lurking behind apparently uninformed monetary sadism.

See Borio at

Posted by: Matt on March 25, 2004 01:30 PM


I don't think that inflation requires an increase in interest rates right now. There is very little inflation.

What might require an increase in interest rates is a falling dollar, and resulting spike in the price of oil as producers adjust to that.

FWIW, the dollar is around a 4 month high right now.

I think that this is in expectation of the Fed raising rates, though the moves of the currency market are tough to understand.

That being said, there IS a housing bubble.

If the current level of interest rates is low and will eventually rise, which I think is a consensus opinion, then when they do, the price of housing will adjust.

If you can afford a $300K house at 6%, you can only afford a $225K house at 9%, which is pretty close to the historical average.

When coupled with the home buying frenzy driven by these interest rates, which has folks getting lots of ARMS, I don't think that it is unreasonable to assume that we will see flat or declining housing prices when interest rates go up.

Posted by: Matthew Saroff on March 25, 2004 01:39 PM


Were there a program of fiscal stimulus in place, a program that was designed for job creation, we could well already be growing fast enough to allow for gradual interest rate increases.

Posted by: anne on March 25, 2004 01:45 PM


We have to save our ammunition for the last ditch defense of the dollar next year, or maybe next week. Of course one deos have to ask when the Chinese are going to revalue;-} The Japanese are going to do it next gold, sell dollars. Sounds like a good deal for those who do it first,but then it is always devil take the hindmost!

Posted by: Allen M on March 25, 2004 01:54 PM


Prefer Roach's opinion.

Posted by: Gnao on March 25, 2004 02:01 PM


Prefer Roach's opinion.

Posted by: Gnao on March 25, 2004 02:02 PM


`Oh, don't bother ME,' said the Duchess; `I never could abide figures!' And with that she began nursing her child again, singing a sort of lullaby to it as she did so, and giving it a violent shake at the end of every line:

`Speak roughly to your little boy,
And beat him when he sneezes:
He only does it to annoy,
Because he knows it teases.'

Posted by: lise on March 25, 2004 02:30 PM


Notes on India:

Software of Democracy

My favorite building in Bangalore, India's Silicon Valley, is a corporate complex called the "Golden Enclave." In some ways, the whole tech sector in Bangalore could be called India's "Golden Enclave" — disconnected from the country's bad governance, as companies create their own walled enclaves, with their own electricity, bus service, telecommunications and security, and disconnected from the countryside, where many Indians still live in abject poverty.


Progressive in India

To the Editor:

If Thomas L. Friedman wants to see firsthand a model of good governance in India, he should head out of Bangalore and visit the Indian state of Kerala. Its history has been one of radical governments and popular movements, a combination that has ensured its population a standard of health care and education that far surpasses the rest of India.

But, contrary to Mr. Friedman's precepts, this hasn't been done in conjunction with globalization. Instead, the state has brought this about by a combination of radical land reform and effective provision of basic services like education, medical facilities and public food distribution. The result is a level of social well-being among the people that is hard to find anywhere else in India.

Managing Editor, The Progressive
Madison, Wis., March 21, 2004

Posted by: anne on March 25, 2004 02:44 PM


First, I'm not an economist, but I do a lot of reading so I'm not totally in the dark.

Question: Will the headline for March 25, 2005 and March 25, 2006 say the same thing: "Keep Interest Rates Low" ?? I think there is something fundamentally wrong when Japan is at 0%, the US is at 1%, and Europe at 2%. At what point do rates move up, or does Bernanke need to warm up the 'copter? Furthermore, does anyone seriously expect them to raise rates with this much debt on the books?

Posted by: Over Here on March 25, 2004 02:53 PM


As for the housing bubble, would it not be possible to mandate a certain level of downpayment?

Posted by: big al on March 25, 2004 03:07 PM


What a pity that you don't have a parliamentary type of government where such a move could be done overnight by an Order in Council.

Posted by: big al on March 25, 2004 03:10 PM


We have taken care of car buying and house buying with these ridiculously low interest rates. But what about people who work their whole life and save some money (and I don't mean millions) to add to and assist with their retirement income. Tough luck. Please don't tell me to put my savings in stocks. It's criminal and lawless what goes on in that business. Like the mutual fund scandal, you know, the top dogs are allowed to trade after hours and just what are the fees? Also the debt load is nonsensical to say the least. The last few months has been the worst ever in the non payment or late payment of credit card debt. But of course the credit card rates go up to 24%. Nice rate if you can get it. It seems to me since the only reason that the economy is holding up at all is the consumer is spending like a fool with out the money to pay for it. Also it seems that Greenspan will do anything to re-elect Bush. Now the news is reporting that the rush is on to re-finance your mortage, again, again and again.

Posted by: Why Not on March 25, 2004 03:36 PM


I agree completely with our host that there is no reason to be militating for the Fed to increase interest rates.

My fear is that market forces are going to increase long rates in a substantial way (say at least 2%) sometime in the next 12 months or so. Whether the trigger is oil prices, a slight change in priorities of Chinese and Japanese banks, traders losing faith that foreigners flush with dollars from the trade deficit will keep recycling them all here, or something i'm not smart enough to figure out, i have a deeply gnawing fear in the pit of my stomach that it won't much matter what the Fed wants at that point....

Posted by: howard on March 25, 2004 03:43 PM


But of course the fed must raise rates. Gerard Baker expalins why: 1% rates are not sustainable and way below the 'responsible' rate forward looking monetary policy. The only question is when and how fast.

Let's not castrate those that think the time is sooner as opposed to later, because in essence they are saying the economy is building in strength and they just may be right.

In other words, it would be better to have employment growth start to hit its potential and prompt the Fed to put in place two consecutive 50 bp increases this summer, than to languish where we are now. Such moves would still put them 200 bp below nuetral. So what's the big deal?

Posted by: mmm on March 25, 2004 04:46 PM


While one agrees in broad outline with the notion that high interest rates have often been misused by plutocrats, there are flaws to Professor DeLong's reasoning.

First, interest rates affect not only the general domestic economy, but the dollar, as well. Yes, enough capital is flowing in that there's no issue on current accounts. But the fall of the dollar tends to depress the European and Japanese economies. A dollar crisis, which is possible, could be more damaging to the world economy than the slightly depressed rates of growth caused by high interest rates.

The second point is that low interest rates are good for growth only to the extent that the borrowed money is used productively. The biggest borrower now is George W. Bush and his pack of congressional wastrels. Raising interest rates now will end the spending spree now. Low rates will merely encourage more waste.

Finally, how much effect would raising interest rates to, say, 3% have on growth? My guess is minimal. Consumers are over-extended, business is paying down debt... it's not clear that raising rates would substantially change economic behavior.

No, let's not be masochists. But let's also not fail to note that this is not an ordinary time, when stimulating aggregate demand through untargeted spending is helpful.

Posted by: Charles on March 25, 2004 05:11 PM


I come from a family of doctors, so my tendency is to view the economy like a patient, and monetary policy sort of like a patient's heart rate.

With interest rates this low, I'd expect the economy to be acting like someone on some really powerful stimulant, like crack cocaine.

What is strange is that this isn't happening; it's almost like somehow there's a tolerance for this.

On one hand, I lean towards suspecting that the inability of the economy to tighten the slack suggests that there is something seriously f-ed up (you know, sort of like horror stories about people who drink alcohol and take diet pills at the same time - the uppers and downers cancel out and lead to metabolic chaos).

On the other hand, raising interest rates now (which would be monetary detox) could be a real disaster.

This is our economy on drugs. Any questions?

Posted by: Jim D on March 25, 2004 05:18 PM


The big problem is deflation. Dollars are still flowing out of the United States at amazing rates. The fall of the currency is being staved off only because the central banks of Asian countries are stockpiling dollars. But those stockpiled dollars are just sitting there, out of the money supply. They're not coming back in circulation. The only way to keep the money supply from collapsing is to keep pumping dollars into it.

And of course I shouldn't need to tell anybody here why a deflationary spiral, where prices fall, incomes fall, and people are no longer capable of meeting their debts, repeat, wash, rinse, would be a disaster. 1929. 'Nuff said.

Posted by: BadTux on March 25, 2004 05:21 PM


The truth hurts, and I am a sadist. Current interest rates are unsustainably low, and the devaluation of the currency points to this. Either the US has to raise interest rates substantially, or cut the bugdet deficit substantially, or face a currency meltdown.

Of these the least painful is cutting the budget deficit. Judging from today's blue elephant abortion of a budget, that isn't going to happen.

Of the remaining two, which is less painful?

Posted by: Stirling Newberry on March 25, 2004 05:33 PM


>Are these "sado-monetarists" descendants of the "liquidationists" of the 1930s like Andrew Mellon who thought a cycle of bankruptcy and deflation was healthy for the economy ?

No, we are just uncomfortable of the Federal Reserve printing the word "Dime" on the one dollar bill...

Posted by: Stirling Newberry on March 25, 2004 05:34 PM


So Stephen Roach by this thread is the Sado monetarist poster boy for advocating the 2% hike --skip the chains and cuffs, bring on the whip.

And Greenspan? What kind of a poster boy is he?
He's reassuring us that things are not all that bad as long as you remember to switch to ARMs if you're in a pinch. And folks now, are doing just that. One last lick at the ice cream cone? ( I think 'why not' is mistaken about the 'again,and again' bit.) This last pull of equity from the refinancing may be enough to cover the rising gasoline bills. (Maybe not, in which case there is the possibility of a gasoline tax cut.) Will it be enough to cover the increased costs of consumables that are derived from these inflating commodities?
I don't think so.
howard describes my stomach on this issue:
"...a deeply gnawing fear in the pit of my stomach that it won't much matter what the Fed wants at that point." To get my head on/in it ("that point"), I think 12 months is a tad long.
Surely if foreign banks stopped buying Treasuries that would be more catastrophic than a 2% prime hike.
Alan 'Bubbles' Greenspan, the Loose an Easy monetarist poster boy?

Posted by: calmo on March 25, 2004 05:49 PM


If US interest rates go up, what happens to service on the US debt and the budget deficit. Words such as meltdown, black hole, and stygian abyss occur.

Posted by: Eli Rabett on March 25, 2004 07:02 PM


Call me old-fashioned, but I cannot see how aggregate demand can pick up smartly without a dollop of inflation -- which means printing money, which will cause short term interest rates to (temporarily) dip even lower, after which the first signs of inflation will become evident on the horizon, causing the dollar to fall, which will simultaneously make American goods more attractive for export, and American workers more attractive to hire (initially in those rapidly expanding export industries). I know this is not an especially sophisticated way of viewing the problem; but for the life of me, I cannot see any other way out. Without lower real wages and a cheaper dollar our enormous trade deficit is not going away.

Posted by: Luke Lea on March 25, 2004 07:15 PM


Even as the US economy is failing to generate sufficient growth to employ its expanding workforce,..."

By historical standards, we should have plenty of jobs given the growth rate. It's not happening so why should we conclude that the old nostrums will be sucessful. We need to look somewhere else besides growth if we are trying to create jobs. We figured out how to have low inflation and high growth. Now we need to shift our focus to modest growth and jobs.

Posted by: tstreet on March 25, 2004 08:51 PM


"We figured out how to have low inflation and high growth." That would be high growth of mortgaged residential housing, high growth of consummer debt, high growth of companies resorting to debt issuance to meet pension and health benefits, and piles more. It puts a new light on the "gross" part of GNP which is what tstreet is referring to above, no?
I only wish that I could get into the Command Mode so that I too could feel the control. Like this:
"Now we need to shift our focus to modest growth and jobs."
Like shooting ducks in a barrel. I almost admire the confidence.

Posted by: calmo on March 25, 2004 09:20 PM


For Charles it seems that higher interest rates is an insurance policy against a dollar crisis. And I think Stephen Roach, in advocating the 2% hike, is coming from the same place. It is the worldly and worried view.
But the next point, the Bush-wastrels needing to be slowed down by using the interest rate hike, seems highly unlikely. Not just that these guys have only a short term ( and as posters here never tire of pointing out, non-thrifty) outlook but there are other spenders out there borrowing money and not using it productively either. That would be us. The trade deficit, no?
The last point, the effect of 3% prime would be in your view, minimal. I look at mortgage rates and come to a different conclusion. There is currently a tiny 2% spread between a 30 yr fixed term and a 1 yr ARM. Incredibly, folks are switching to the ARMs. It can only mean they are stretched ( or that they see AG as God ) and that any interest hike would sink them.
But maybe they should sink. For the sake of the over-loaded ship?

Posted by: calmo on March 25, 2004 10:00 PM


The Economist is all wet.

The Fed can't begin to control ALL of this: price stability, the unemployment rate, the equity bubble, the bond market bubble, the housing bubble, (YOUR FAVORITE TARGET HERE), etc.

The Fed is doing fine on the target that is its charter, price stability. As for unemployment, we have to address labor market institutions to fix that. As for all the other stuff, we're going to have overshooting SOMEWHERE--take your chances; it's a free country.

Posted by: Jim Harris on March 26, 2004 05:26 AM


Running out the door yesterday, I thought I heard a news item on NPR to the effect that defaults on credit card debt had exceeded 5% of all accounts, an all time high. Anyone else remember hearing this?
I understand the desire to wait for unemployment to fall before raising rates. The jobs don’t seem to be coming though. In fact, one of Brad’s posts a few days past argued that employers were doing anything and everything to avoid hiring (permanent, in-sourced) workers.
If defaults on consumer debt continue to rise under these circumstances, do we risk approaching a point where it is no longer politically feasible to raise the rate?

Where can I get data on the current rate of default for residential mortgages?

Posted by: jack o'donnell on March 26, 2004 06:01 AM


Jin Harris is correct that the Fed can not do everything that people are asking of it.

However, the Feds primary role is not to fight inflation -- inflation is not cited once in the legislation establishing the Fed. The Feds primary role is to keep the system as stable as it can -- and working towards low inflation helps achieve that -- and preventing financial panics from spreading.

My position on fed policy has been the same for some time, if the economy is strong rates will go up. But the evidence that the economy is that strong is still not that convincing.

The posibility that the US is in a post-boom period of extended stagnation like Japan went through in the 1990s is still very real.

Everyone is pushing their view about rates based on their view of the economy. But I would argue that the economic outlook is still too uncertain for the Fed to do anything.

Posted by: spencer on March 26, 2004 07:25 AM


Bush's economic policies have re-awakened the dragon.

Normally I would be all in favor of job growth through monetary policy. The problem is that when monetary policy is used to generate job growth beyond its sustainable level, we get energy inflation. Gradually the pricing power saps out of the rest of the economy, and energy is where the action is. This is what has happened, as an examination of the internals of both PPI and CPI show.

Now, if there were a National Economic Council - similar to the NSC - stocked with people like Brad DeLong, Bob Rubin, Joseph Stiglitz and so on - with an OMB that was creating budgets based on honest numbers, run by someone like Byron Dorgan - I would say that we could keep rates low, because we could fix this problem from the fiscal side.

But that isn't the group of people we have. Sooner or later, the bond holders are going to demand a series of sharp stepped increases in the Fed Funds rate - just as the Fleming-Mundel model expects. The timing of which will be determined by the mobility of capital. Since much of the budget deficit in the US is health care and military related - this buys a certain amount of time.

But not much, and as soon as the consumer sector actually recovers, the Fed will have to throttle the engine back.

See "Vicious Circle"

Posted by: Stirling Newberry on March 26, 2004 07:30 AM


Stirling Newberry asks, "Of these [raising interest rates vs. cutting the deficit by raising taxes or cutting spending] the least painful is cutting the budget deficit. Judging from today's blue elephant abortion of a budget, that isn't going to happen. Of the remaining two, which is less painful?

Given that the Congress is Republican and reasonably likely to remain so, which is the most likely?


calmo comments, "For Charles it seems that higher interest rates is an insurance policy against a dollar crisis....But the next point, the Bush-wastrels needing to be slowed down by using the interest rate hike, seems highly unlikely. "

The only surefire way to stop the wastrels is to vote them out of office. Both houses need to be cleansed to take the necessary actions: raise taxes by ca. $200B/year and cut spending by $200B/year (easily done from defense waste and corporate pork).

Given the very high number of safe seats, the paucity of Democratic challengers, and the Republican dominance in fundraising, that seems unlikely. What I suggest is a second-best alternative: threaten them with being directly and provably responsible for a national economic crisis.

Posted by: Charles on March 26, 2004 08:28 AM


The Medicare Muddle

In advance of Tuesday's reports by the Social Security and Medicare trustees, some credulous journalists wrote stories based on tips from advocates of Social Security privatization, who claimed that the report would offer a radically downgraded vision of the system's future. False alarm: projections for Social Security are about the same as last year. Projections for Medicare, however, have worsened: last year the trustees predicted that the hospital insurance trust fund would last until 2026, and now they've moved it back to 2019.

How should we react to this news?

It has become standard practice among privatizers to talk as if there is some program called Socialsecurityandmedicare. They hope to use scary numbers about future medical costs to panic us into abandoning a retirement program that's actually in pretty good shape. But the deteriorated outlook for Medicare says nothing, one way or another, about either the sustainability of Social Security (no problem) or the desirability of private retirement accounts (a lousy idea.)

Even on Medicare, don't panic. It's not like a private health plan that will go belly up when it runs out of money; it's just a government program, albeit one supported by a dedicated tax. Nobody thinks America's highways will be doomed if the gasoline tax, which currently pays for highway maintenance, falls short of the system's needs — if politicians want to sustain the system, they will. The same is true of Medicare. Rising medical costs are a very big budget issue, but 2019 isn't a drop-dead date.

The trustees' report does, however, give one more reason to hate the prescription drug bill the administration rammed through Congress last year. If deception, intimidation, abuse of power and giveaways to drug companies aren't enough, it turns out that the bill also squanders taxpayer money on H.M.O.'s.

A little background: conservatives have never mounted an attack on Medicare as systematic as their effort to bully the public into privatizing Social Security. They do, however, often talk about Medicare "reform." What this amounts to, in practice, is a drive to replace the traditional system, in which Medicare pays doctors and hospitals directly, with a system in which Medicare subcontracts that role to private H.M.O.'s....

Posted by: anne on March 26, 2004 01:31 PM


"Given that the Congress is Republican and reasonably likely to remain so, which is the most likely?"

I've been arguing since last summer that the Republican congress is more vulnerable than people think. And the numbers continue to back this up.

I feel that we are very likely to have a threesweep of Democrats in the fall, and that the probable course of action will be to have a tax overhaul designed to bring in a big hit of revenue, a restructuring of the deficit to shift it to longer term debt, increases in upper income brackets and capital gains taxes, large cuts in defense and homeland security, and a mixed cocktail of job stimulus.

Posted by: Stirling Newberry on March 26, 2004 01:35 PM


recent posts on the vulnerability of the Republican Congress

Posted by: Stirling Newberry on March 26, 2004 01:36 PM


Kerry to Propose Eliminating a Tax Break on U.S. Companies' Overseas Profits

WASHINGTON — Responding to widespread anxiety about the movement of American jobs overseas, Senator John Kerry plans to propose on Friday a sweeping revision of international corporate taxes intended to prompt companies to invest more money in the United States.

Aides said Mr. Kerry, the presumptive Democratic presidential nominee, would also challenge President Bush by saying his administration would spawn 10 million additional jobs over four years. Democrats often point out that more than two million jobs have been lost since Mr. Bush became president.

In a speech he is scheduled to deliver at Wayne State University in Detroit, a city that has been plagued by job losses in manufacturing, Mr. Kerry is to propose eliminating a major tax break on profits earned by American companies overseas and using that money to reduce the tax rate for all corporations.

"You know, economic plans aren't just about dollars and decimals — they're about choices," Mr. Kerry plans to say, according to excerpts of his prepared text provided by his campaign Thursday evening. "Time after time, this administration has put ideology first and jobs last. Today, I'm announcing a new economic plan for America that will put jobs first." ...

Posted by: anne on March 26, 2004 02:31 PM


Ethical Fallibility, Economics, and Debt Deflation

By way of introduction I want recognize ethical fallibility. The concept is simple. To admit ethical fallibility is to admit that, “I may be wrong.” Socrates suggested that we should search for the truth and arrive at our best answers always recognizing the fact that we might be wrong. Not only do I admit that I might be wrong, but I hope that I am wrong. I hope that we have not had “Clown Shows” for financial and political policy-making that span long periods of American and US history.

Since I’m a complex systems person, I may overcomplicate things, hence making analysis and accompanying insight a bit difficult. But the opposite danger must be admitted too. Others, including many economists, oversimplify, often tending to reduce things to absurdity.

Nobel Laureate Herbert Simon recognized this latter problem of overly reductionistic methods. He called it Mathematician's Aphasia:

"It is easy for the operations research enthusiast to underestimate the stringency of the conditions for applicability of his methods. This leads to an ailment that might be called mathematician's aphasia. The victim abstracts the original problem until the mathematical or computational intractibilites have been removed (and all semblance of reality lost), solves the new simplified problem, and then pretends that this was the problem he wanted to solve all along. He hopes the manager will be so dazzled by the beauty of the mathematical formulation that he will not remember that his practical operating problem has not been handled." (p. 59) Herbert A. Simon
THE NEW SCIENCE OF MANAGEMENT DECISION (Revised Edition) 1960, 1965, 1977 Prentice-Hall, NJ.


Let’s now look at one explanation as to why we might want to pull the punch bowl from the International speculators party.

First some things to ponder, some perspectives I hold relative to US and International policy framing:

· Poor energy policy, (US now more dependent on foreign oil than even 30 years ago)
· Poor international and domestic monetary policy (little agreement on proper course, some call it economic warfare),
· Poor domestic private and public savings policy (or alternatively stated, massive credit bubble),
· Excessive, fanciful entitlement promises,
· Structural current account deficit problem
· Pushes for protectionism in the face of “offshoring,” "jobless recovery, etc."
· Reinflation of asset bubbles,
· Continued inflation of housing bubbles,
· Maldistribution of income (growing gap between rich and poor, disappearing middle class)
· Ever-increasing tendencies toward monopoly
· Massive fraud and corruption in business, accounting, banking and government
· Productivity boom,claims of "new economy" (forgetting Joseph Schumpeter’s “creative destruction,” Karl Polyani’s The Great Transformation.)
· Deflationary fears
· Inflationary fears (short term: imports, metals, etc; longer term fears of generally too-high inflation/stagflation)
· Turning a blind-eye toward external effects, externalities
· What else?

Ever since 1995 I have believed that somehow the “Federales” (the Federal Reserve and the US Treasury) ought to have taken the punch bowl away from the US/worldwide party that encourages average citizens to believe that they too will get rich off ebullient markets. This advice, recently echoed by Germany's Fed-Chairman counterpart Otmar Issing
follows an old bit of disputed wisdom that says a main role for the Fed is to remove the punch bowl just as the [speculative] party gets rolling.

John Kenneth Galbraith and Hyman Minsky both argue that forces in society tend sometimes toward irrational exuberance, which sow seeds for great crashes or corrections or adjustments as they are sometimes called. (See in particular Galbraith's book THE GREAT CRASH 1929, and more recent warnings and reiterations of similarities between then and now that abound on the internet, including this from Galbraith 7/14/1998
See Also Steve Keen’s “Finance and Economic Breakdown,” 10/18/2002

Furthermore both Galbraith and Minsky argue that generally these things take their course in part because there is not sufficient political will (and accompanying political prescience) to deal with such things before collapse. Unfortunately, according to both, there is little that can be done to help in the aftermath either -- it takes time (a decade or more to even begin, part of which is full of sucker holes) to restructure confidence in the game and get things rolling again.

Often it takes another decade to help generate more confidence, followed by a generation (another twenty years) of relatively stable times. Then begins the corruption that ultimately ends in yet-another-crash. Cycles vary, but they have in the past come back time and again, after the sages of each era believed they had tamed these wicked cycles. (Get and read the 1996 best-seller “THE FOURTH TURNING: What the Cycles of History Tell Us About America’s Next Rendezvous with Destiny,” William Srauss and Neil Howe. Get and read SUPPPLY-SIDE SUSTAINABILITY, by T.F.H. Allen, Joseph A. Tainter, and Thomas W. Hoekstra (which has nothing to do with the “supply-side economics.”)

This brings me to what might be billed as either "Alan Greenspan's End" (or Robert Rubin's and others depending on who gets blamed) or simply a trap laid for bearish pessimists like me. It takes the form of a commentary by Bob Hoye titled "Precedent Set for Secular Bear to Resume," 3/8/2004. Hoyes commetary is just the latest in a long line of these, but it does cover some interesting territory in terms of long waves, bubbles, and debt deflation.

Try as I might I see little hope that we will weather this storm well.
Somebody please give me some reason to believe that "This time it will be different" Somebody please offer up hope that we can avoid a Kondratieff Winter.


US policymakers fail to recognize similarities between this cycle and the one that predated the 1920-30s crash. They wrongly believe that that creative destruction inherent in global communications, just-in-time processing, and more “productivity gains” will create new jobs automatically, rather than destroying more jobs than are created. They believe in naïve comparative advantage to trade without recognizing more corrosive aspects of “trade” when used as economic warfare. In short, the fail to see race-to-the bottom possibilities in play.

So they pump more money into a world system that it already over-filled with speculation (Minsky’s “Ponzi Finance” ) Speculators are only too happy to sap up the money and in the process crowding out productive investment since the speculators will out-bid anybody. So the speculators create and expand bubbles that ultimately burst, leaving “pigs” (those who are suckered into these speculative frenzies late in the game) to lose.

It is only after the bubbles pop, people lose their retirements, and some who are gleefully purchasing toys and other frivolity off “refis” lose their houses, that people sour on debt and understand that the world is a risky place. But such aversion lasts for decades and the world finds itself in a prolonged slump—a Kondratieff Winter.

What about those structural deficits? What about those entitlements? Aren’t we likely to face steeply higher interest rates when a day of reckoning arrives? Aren’t we likely to have to renege on the entitlement promises (which unfortunately include my fast-approaching retirement)?

Note that I’ve highlighted works of Galbraith and Minsky here. I could have framed the arguement on the works of other Post-Keynesians like Paul Davidson, Robert Blecker and others. I could have framed the argument on the works of several of those who engage in cross-disiplanary discussions called Ecological Economics. I could have framed the arguments on the basis of Critical Theory that has grown from Marxian roots. And so on…

I will quit for now. Very few will have read past the first sentence anyway. “Free market screech monkeys” in particular will have long since quit reading. Happy Friday, dave.

PS.. If nothing else, remember the words of Frank Akelman from his paper subtitled “Alternative Theories of Free Trade and Globalization”—

“…there are undeniable benefits of specialization and trade.” And
“… the unregulated market does the best possible job of producing things that consumers are willing to pay for – IF we accept a long seriew of unrealistic assumptions about how the world works.”

Posted by: dabbler dave on March 26, 2004 02:46 PM


Stirling Newberry says, "I've been arguing since last summer that the Republican congress is more vulnerable than people think. And the numbers continue to back this up."

While I generally agree with this (thanks for the links), I wouldn't bet the economy on it. That's why I believe a small rise in interest rates is cheap insurance.

Posted by: Charles on March 26, 2004 05:49 PM


Count me in the camp of the sado-monetarists if only for vile, corrupt personal reasons. Having exchanged all of my 8-10% debt for 3.9% debt, there is now no debt to refinance or reason to assume new debt. Meanwhile, my savings account is paying a paltry 1-2%. If interest rates rise, my debt repayment will be unaffected while my interest income will rise. In fact, the whole reason for carrying the debt is to take advantage of the eventual rise in interest rates.

Then again, maybe this is what the inside of a liquidity trap looks like.

Posted by: turtleboy on March 26, 2004 07:10 PM


Ummm ... the Economist was right about the bubble.

Posted by: Oldman on March 27, 2004 04:38 AM


Not exactly on topic, my polemical defense of free trade. Essentially, free trade is the legal line which defends other freedoms, since, sooner or later, to restrict freedom must rest on a restriction of trade. Which is why I feel that, rhetorically, we should think of it, not merely as the "Interstate Commerce Clause" but "The Free Trade Clause".

Posted by: Stirling Newberry on March 27, 2004 12:44 PM


Not exactly on topic, my polemical defense of free trade. Essentially, free trade is the legal line which defends other freedoms, since, sooner or later, to restrict freedom must rest on a restriction of trade. Which is why I feel that, rhetorically, we should think of it, not merely as the "Interstate Commerce Clause" but "The Free Trade Clause".

Posted by: Stirling Newberry on March 27, 2004 12:45 PM


Brad, Brad, Brad, Brad, Brad!!! What of BushCo would possibly make you believe they give a rat's ass about US economy or the average home owner, or the price of gasoline for that matter.

They want to raise the Fed rates for one reason only. Just One! It's called "April 15th", and that's the day those ultra-rich hogs have to roll-over their T-bill positions to pay their tax accountants. This time they want something better than 1/2% ROI after inflation!

When are you going to get it through your thick skull that it's not a fraternity party anymore? This is blood sport, by ultra-rich so powerful some few can outspend all the nations of Europe. You think they give a RIP what CG thinks?

Penis-for-heads-rule. Thank God they're so easy to spot, and their plays are so well documented. Get in on the action before it's the only action.

Posted by: Blood Simple on March 27, 2004 07:42 PM


I criticize by creation -- not by finding fault.

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