Wednesday, September 2, 2009

Meltzer on the Downturn

In a WSJ Op-Ed, Alan Meltzer makes some noteworthy points about the downturn. I don't agree with everything he has to say, but here are his points that I can't argue with:

The current recession is also much less severe than the 1937-38 Depression. A more accurate comparison is to the 1973-75 recession...

So why do many opinion makers insist on inaccurate and frightening analogies that overstate the severity of present conditions? I believe there are several reasons.

First, there is a strong political motivation to make this recession out to be worse than it actually is. The Obama administration wanted to make it appear as though it saved us from an incipient disaster, so it overstated its achievements. The White House also wanted to foist its huge "stimulus" program on the country in order to redistribute income. That pleased many Democrats, but did very little to restore growth.

Many others repeated the administration's hyperbolic claims. One reason is because there is genuine uncertainty about what has happened and what is likely to come. Short-term forecasts have major errors, and extrapolation of current data adds to misinformation. Then there are economists who would like to see government take a larger role in the economy. They've chosen to use the recession as a pretext for arguing for this change.

New York Times columnist Paul Krugman and the International Monetary Fund repeatedly proclaimed that more government spending was a necessity. Most economists now believe that the recession is expected to end before much of the government spending takes hold. And while the improvement in recent GDP data reflects a big increase in government spending, consumer spending declined again in the second quarter. The $787 billion of fiscal stimulus has done little for consumers. Keynesian economists always fail to recognize the powerful regenerative forces of the market economy. The financial press—many of whom share their same political assumptions—endlessly reproduces their beliefs...

Many pundits argue that we need another stimulus package. I disagree. The proper response now is to repeal what remains of the misguided stimulus and avoid the cap-and-trade program.

In their response to the recession, Congress and the administration were more interested in redistributing income than encouraging growth. They also ignored the lessons of the successful Kennedy and Reagan reductions in marginal tax rates. They added to their mistakes by enacting a temporary tax reduction as a main element of the $787 billion stimulus. Don't they know that Presidents Ford, Carter and Bush failed to stimulate spending with temporary tax reductions?

A sensible administration would revise its policy. It should start by scrapping what remains of the stimulus. As the world economy recovers, the United States should choose to expand its exports so that it can service its large and growing foreign debts. That means reducing corporate tax rates to increase investment. Instead of implementing policies that increase regulation and raise business costs, we need to increase productivity.
Where do I disagree with Meltzer?

He pretty much sees this recession as over. Clearly, he is not watching the stop-go-stop monetary policy of Bernanke, which is on stop right now. Thus, the potential for the recession to get much worse is very real. Further, like Tyler Cowen, Meltzer call for a decrease in the current reserves outstanding. He writes:
And the Fed should soon begin to reduce the massive volume of outstanding bank reserves, which is the raw material for future money growth.
Meltzer doesn't get Bernanke's switch in methods to control the money supply. Since a lot of what Bernanke bought to create the reserves is junk that he can't sell anyway, Bernanke is going to attempt to control money supply by one of his new "tools", i.e. by paying interest on reserves. By paying interest on reserves, Bernanke fully believes that he won't have to drain reserves to prevent rapid money creation.

3 comments:

  1. >>Since a lot of what Bernanke bought to create the reserves is junk that he can't sell anyway, Bernanke is going to attempt to control money supply by one of his new "tools", i.e. by paying interest on reserves. By paying interest on reserves, Bernanke fully believes that he won't have to drain reserves to prevent rapid money creation.<<

    Since the tool is new, we don't know exactly what the effect of this policy will be - but is it your expectation that the rates that he will pay on these reserves will cause highher rates across the board?

    ReplyDelete
  2. Very true. The impact may not be thought out properly from all angles.

    Yes, it will result in higher rates, since what the Fed pays will be the floor. Why would a bank put money at a lower rate? But more significant than setting a floor, I think market rates may force the Fed to move rates higher sooner than they otherwise might, since if they don't it will mean the banks will start lending out against those excess reserves.

    ReplyDelete
  3. Wenzel,

    Your comments about Bernanke's money supply machinations relative to the economy make no sense to me. But relative to financial market performance, it makes perfect sense.

    Read thoughtlessly, you sound like you're arguing the opposite of what I know you believe, that being that government printing can and does result in real economic growth.

    ReplyDelete