Over the past several decades, many people adopted the view that monetary policy, almost alone, could effectively control the economy. Economists, politicians and scholars came to believe that the Federal Reserve was full of neutral technocrats who dutifully fine-tuned the economy. Through their careful orchestration of interest rates, the money supply and inflation, we assumed that they could guarantee a smoothly functioning economy. Fed officials seemed to do so well at their jobs that they were never doubted. But by depending on monetary policy and discounting fiscal policy as an effective way to secure economic stability, we have created a system that is now dysfunctional.

Randall Wray and Micah Hauptman have a piece in The Hill on the problems with our over-reliance on the Federal Reserve.  Due to the fact that fiscal policy is mired in political deadlock (more particularly, expansionary fiscal policy) we may be stuck relying on (inadequate) support from the Fed.

Wray recently wrote a policy brief with Scott Fullwiler (“It’s Time to Rein in the Fed”) that is relevant to this issue.  From their one-pager (referring here to QE2):  “…it’s truly remarkable that, three years into the crisis, the Fed still has not learned that monetary policy is about price, not quantity. The Fed is buying $600 billion in long-term Treasuries in the hope of bringing down the long-term rate. Yet, if it really understood monetary operations, the Fed would instead announce that it is standing ready to buy as many Treasuries as necessary in order to lower the long-term rate by a desired amount.”

This morning, it was announced that Thomas Sargent and Christopher Sims are the winners of the 2011 Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel (link to New York Times article here; link to official Nobel economics site here). Sargent and Sims’s approach is often thought to imply, among other things, that monetary or fiscal stimulus is unlikely to be of very much benefit to an economy, even one in deep recession.  Of course, the Levy Institute, as a proponent of the Keynesian approach, almost always disagrees strongly with this view on macroeconomic policy, though extreme pessimism about Keynesian stabilization policies is only one possible implication of Sargent and Sims’s extensive oeuvres.

Moreover, the technical aspects of Sargent and Sims’s work are also crucial to neoclassical macroeconomics, and their influence is felt in many ways. Of special interest to me as a researcher is their work on vector autoregressions (VARs), which has led to literally thousands of studies in academic journals, even some authored by heterodox economists. (Sims’s seminal contributions to the VAR literature are the main Sims accomplishment cited in the Nobel committee’s “scientific background” paper for today’s announcement.)

Nonetheless, as with any research in the social sciences, the VAR approach to empirical work in macroeconomics has been subjected to many critiques and revisions since Sims (and to some extent Sargent) got the VAR ball rolling in the late 1970s and early 1980s. continue reading…

Since it’s Friday…

This one is for every graduate student who’s been on the receiving end of a glazed/skeptical/bemused expression after trying to respond to a “so what’s your dissertation about?” query.  Your elevator pitch would go over much better if it were more kinetic.  Via GonzoLabs, Science magazine and TEDxBrussels are sponsoring a competition for PhD students in science-related fields for the best dissertation interpreted through dance.  There don’t seem to be many entries from economists (dismal, dismal), but these physics students look like contenders (incidentally, there’s still time for some last-minute, ill-considered choreographing.  The deadline is Oct. 10.):

“For years I have been trying to explain to my mother what it is I do. This video was aimed at her. She now finally understands what the point of my research is. If I had known that all it would take was a little dancing, I would have done this a long time ago.”

According to Floyd Norris at Economix.  Norris includes this chart, comparing our ongoing shedding of state and local government jobs to the one in the early ’80s:

I haven’t been looking at any employment reports lately, but I can only assume that this has sparked a massive boom in private payrolls.

The prevailing anxieties of elite opinion are focused relentlessly on the deficit and debt, with sporadic bouts of indigestion reserved for the slump in jobs.  This is a complete reversal of what ought to be the case.  But let’s say you really can’t get over the idea that there’s no major short-term economic problem currently being caused by high deficits.  Well then, if you are such a person, you ought to be deeply concerned that the economy is operating below potential.

Rep. Chris Van Hollen recently requested an estimate from the CBO (hat tip TPM) regarding what portion of the federal deficit can be attributed to cyclical factors—e.g. the non-recovery in the job market.  The answer:  roughly a third.  There’s nothing new here, but it is an excuse for futile repetition of the following upshot:  attempts to cut the deficit right now are self-defeating, to the extent that they drag down growth and employment.

Gennaro Zezza has been all over this.

Let’s look at the reasons to doubt that the big six are solvent.

1.The economy is tanking. Real estate prices are not recovering, indeed, they continue to fall on trend. No jobs are being created. Defaults and delinquencies are not improving. GDP growth is falling. Isn’t it strange that Wall Street has managed to remain largely unaffected? Finance is an intermediate good. It is like the tire that goes on a new Ford automobile. Auto sales are collapsing but somehow tire sales to auto manufacturers are doing just fine? Does that make sense? Banks are making no loans, yet, they remain profitable?

2.Not only are the financial institutions NOT doing any of the traditional commercial banking business—lending—they aren’t doing much of the investment banking business either (remember that the last two remaining investment banks were handed bank charters so that they could scoop up insured deposits as a cheap way to finance their business). How many IPOs have been floated? Corporate debt? Trading? Well, one of the two investment banks that survived, Morgan Stanley (the sixth largest bank—barely squeaking into my “dirty half dozen” biggest banks), just released a pretty poor trading outlook—blamed on “high costs, historically low interest rates and market volatility that has pushed clients to the sidelines”. (Reuters Global Wealth Management Summit News).

3.Europe is toast. US bank exposure to Euroland is huge. But US banks are doing just fine, thank you? Hello?

4.Commodities are tanking. Equities markets are at best horizontal. Other than making profits by cooking their books, these were areas open to banks to make profits. And, yes, both commodities and equities had been doing quite well—climbing back up from the depths of the crisis. This should be put in perspective, however, because at best they only recouped losses. Still, those bubbles are now history. Losses are going to pile up. Yes, I know financial institutions hedge their long positions in commodities with some shorts—but who do you short with? Does anyone remember AIG—the insurer of first and last resort? Hedges are only as good as counter-parties, and counter-parties are no better than you are when markets collapse. In a crisis, correlations reach 100%.

5.Hedge funds have not done particularly well over the past couple of years. And yet banks have? Even though all they are doing is trading (plus cooking books and reducing loan loss reserves), the banks are far more successful than hedge fund managers at picking winners? Does that make a lot of sense?

6.And, as mentioned above, they’ve got all these lawsuits—which requires hiring lawyers, paying fees and fines, and employing Burger King kids to falsify documents. The document shredding services alone must be crimping net returns.

Ok, is there any evidence that might cause one to question bank solvency? Real hard stuff? continue reading…

By Gal Noir*

In his Congressional testimony on October 4th, Federal Reserve Chairman Bernanke uncharacteristically praised the benefits of fiscal policy, calling it “of critical importance” and conveying concerns with the looming deficit reductions. He cautioned: “an important objective is to avoid fiscal actions that could impede the ongoing economic recovery.”

Many economists expressed worry that such advocacy of fiscal policy will erode America’s (already) wavering confidence in the Fed and will further weaken their support for austerity measures. More troubling still, the economists said, was the possibility that the public may follow suit and start demanding from Congress bolder government action on the jobs front.

A few dissenting scholars thought that it was high time for Bernanke to put his money where his mouth was, so to speak. Among them was Dr. Tcherneva, who had studied Bernanke’s academic proposals for government action during crises and his actual policy moves as Fed Chairman during the Great Recession (2011).**   “I am not at all surprised that Chairman Bernanke is making the case for fiscal policy” Tcherneva said. “I am only astonished that it took him so long. After studying his policy prescriptions for the case of Japan, I am left with the nagging conclusion that Bernanke actually favors fiscal policy over monetary policy. And while the reasons for this position are tucked away in his 2000 paper,***  they were nowhere to be found in his testimony before Congress. This too was very surprising. Considering his scholarship, I was expecting a very different speech today” Tcherneva said.

And indeed Tcherneva may have been right. In a breaking development, housekeeping personnel at the Federal Reserve Board building in D.C. have found a crumpled draft of what appears to be the original speech Chairman Bernanke had intended to deliver. In an exclusive, we reprint the original draft below. Paragraphs in bold are the only ones that made it into the final version.
continue reading…

James Galbraith talks about the mechanisms by which obstacles are placed in the way of dissenting and original voices in economics, as well as the failure of most in the forefront of the profession to see the global financial crisis coming (via INET):

Galbraith has written about this before; surveying the work of those who got it right, as well as the narrow parameters of prevailing doctrine:  “This is the extraordinary thing. Economics was not riven by a feud between Pangloss and Cassandra. It was all a chummy conversation between Tweedledum and Tweedledee. And if you didn’t think either Tweedle was worth much—well then, you weren’t really an economist, were you?” (read it here).

(continued at EconoMonitor)

“We’ve put this off for too long.  We need debt relief and jobs and until we get these two things, I think recovery is impossible”—Randall Wray, quoted in a Reuters article examining the possibility of negotiating massive consumer debt relief.

Although household borrowing has been declining, debt burdens remain sky high:

(from the latest Levy Institute Strategic Analysis)