There’s certainly plenty of blame to go around for the recent recession. I’ve been pretty hard on my fellow economists, who almost totally ignored the need for monetary stimulus in late 2008; enough stimulus to keep 2009 NGDP growth expectations around 5%. But the press has also played a role. Back in early 2009 my worst nightmare was that the Fed wouldn’t try to create enough AD for the economy to recover to its previous 5% growth trajectory, but rather would be content to resume growth along a new 5% growth trajectory that was 9% lower than the old one.
What actually happened even was worse than my worst nightmare. We aren’t even recovering at 5%, a number that would now seem pretty good. In the 4th quarter of 2011 NGDP grew a measly 3.9%, a number which would normally be viewed as substandard, even if we weren’t in recession, even if we weren’t trying to recover. Ed Dolan recently suggested that trend growth has fallen to 2.3%, implying a 4.3% path for NGDP—but we’re even below that. And how did the press treat this disgraceful number? They called it “strong.” It represented “good news.” The economy finally seems to be showing some strength. Talk about low expectations! How can 3.9% NGDP growth during a so-called “recovery” be a number that leads journalists to suggest that it makes monetary stimulus less likely? And I’m not just talking about conservatives; even liberals treated it as if it was an indication of adequate growth in aggregate demand. Bernanke said NGDP growth is how the Fed should be judged—OK, let’s start judging them on that basis.
This really is a lot like the Great Depression. During the 1930s people started to think of even severely depressed periods like 1936 as “boom years.” Here’s Lewis Carroll:
‘When you say “hill,” the Queen interrupted, I could show you hills, in comparison with which you’d call that a valley.’
‘No, I shouldn’t, said Alice, surprised into contradicting her at last: ‘a hill can’t be a valley, you know. That would be nonsense-’
And speaking of the press and nonsense, here’s a Bloomberg article on Ben Bernanke testifying to Congress:
“You want to make a credible, strong plan, but one that phases in over a period so that the economy will not hit a huge pothole,” the Fed chairman told the Senate Budget Committee in Washington on Feb. 7. “If no action is taken on Jan. 1, 2013, between expiration of tax cuts, sequestration and a number of other measures, there will be a very sharp change in the fiscal stance of the federal government, which by itself, with no compensating action, would indeed slow the recovery.”
If you were a Congressman what would your follow-up question have been? I searched the rest of the article and could find no evidence that Bernanke was even asked what his “compensating action” would be if Congress failed to extend the tax cuts. But there was this comment from a former Fed economist:
Bush-era tax cuts and expanded unemployment benefits are set to expire at the end of the year, and a deficit-reduction law requiring $1 trillion of cutbacks also kicks in if lawmakers can’t agree on a new plan. The Fed may keep rates low for longer because the budget-balancing measures slated for 2013 — including those automatic cuts, known as sequestration — threaten to weigh on expansion, said Ward McCarthy, chief financial economist at Jefferies & Co.
They “would certainly take a bite out of growth,” McCarthy, a former senior economist for the Federal Reserve Bank of Richmond, said in a telephone interview from his New York office. “The fact that we have a dysfunctional fiscal policy is a contributing factor to why we have such extraordinarily accommodative monetary policy.”
McCarthy’s obvious right that Fed policy would be more contractionary if fiscal stimulus had been more expansionary, it doesn’t take a rocket scientist to figure that out (although I must say lots of Keynesian economists still haven’t figured that out.) The real question is why isn’t the Fed doing even more?
The press seemed to improve slightly at the January Bernanke press conference, asking some pointed questions. But what they really need to do is pin Bernanke down whether he would let a change in fiscal policy affect the long run inflation rate, or whether he’d have the Fed take offsetting action to keep inflation on target. And if he wouldn’t take offsetting action, would it be because the Fed was OK with growth faltering, or because they were out of ammunition?