The Fed decided to cut rates to 2%. Here's the statement:
The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.
Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.
Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.
The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.
In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.
More later (in a conference on financial innovation as I write this), but quickly note the intent to pause, though that depends upon what future incoming data tell them about inflation and output. Also note that only four banks submitted requests to lower the discount rate indicating some disagreement over today's policy move.
The BEA announced today that growth in the first quarter is estimated to be .6%, though that figure could be (and probably will be) revised later.
There is a lot of discussion about whether this means we can say the economy is in a recession or not (Hamilton, Ritholtz, Krugman). Call it want you want - some people use the term growth recession to describe the current situation - but whatever we call it, a growth rate of .6% is slow (see Krugman's comments on employment as well).
The report was better than many people expected, but this isn't good news:
The U.S. economy didn't slump in the first quarter as some had feared it would, but its weak climb was the product of a likely unintended inventory buildup.
This isn't good news either:
Nonresidential fixed investment contributed -0.3%; a small factor in the total, but a development that worries Calculated Risk.
And a warning that there can be considerable lags in the adjustment process:
Four mega-dangers international financial markets face, by Dennis J Snower, Vox EU: Day after day new, alarming news emerges from the world's financial markets, and day after day the public is surprised by how bad it is. But instead of wringing our hands, let's ask ourselves an important, unconventional question: What is more surprising: that financial markets have turned from bad to worse, or that we continue to be surprised by each successive piece of adverse news?
I suggest that our repeated surprise should be more surprising. This issue is important, because if we were better at recognising the financial risks we face, we could do more to avoid them. If banks, investment houses, and American homeowners had done a better job in recognising the risks in the subprime mortgage market, we could have spared ourselves the current crisis.
Why does the public repeatedly underestimate the repercussions of the present financial crisis? The answer is simple: most of us are short-sighted; we can't imagine a future that is radically different from the present. In particular, most of us don't understand that economic events often unfold gradually due to the operation of important lagged adjustment processes embedded in the economy. The public, the media and politicians would do well to give them close attention. Lagged adjustment processes. After the Titanic's hull was punctured, it took hours for its hull to fill with water; thus the passengers couldn't imagine that it would sink.
In my judgment, there are currently four major dangers facing the world economy, and all of them are currently obscured by the fact they play themselves out slowly.
Four dangers The first danger we have witnessed since August 2007: The subprime mortgage crisis gave rise to a liquidity crisis in the international banking system, due to uncertainty about who holds the losses. This is leading to reduced lending to firms and households. But that is not the end of the story, because the reduced lending will lead to reduced consumption and investment. With a lag, reduced sales of goods and services will reduce stock market valuations. And, with another lag, the lower stock market prices will – in the absence of any favourable fortuitous events – intensify the banks' liquidity crisis.
The second danger lies in the dynamics of U.S. house prices. As more and more U.S. households find themselves unable to repay their mortgages, foreclosures are on the rise, more houses are put on the market, the price of houses falls further – with further lags – this leads to more foreclosures and declines in housing wealth. This dynamic process plays itself out only gradually, as households face progressively more stringent credit conditions and house sales gradually lead to lower house prices.
The third danger results from the interaction between wealth, spending and employment. As U.S. households' wealth – in the housing market and the stock market – falls, their consumption is beginning to fall and will continue to do so, again with a lag. This decline in consumption is leading to a decline in profits, of which more is on the way, which in turn will lead to a decline in investment. The combined decline in consumption and investment spending will eventually lead to a decline in employment, as firms begin to recognise that their labour is insufficiently utilised. The decline in employment, in turn, means a drop in labour income, which, with a lag, leads to a further drop in consumption.
And that leaves the fourth (and possibly the nastiest) of the dangers, one that concerns the latitude for monetary policy intervention. As the Fed reduces interest rates to combat the crisis, the dollar is falling. This is leading to higher import prices and oil prices in the United States, putting upward pressure on inflation. The greater this inflationary pressure – which is currently in excess of 4 percent – the more difficult it will be for the Fed to reduce interest rates in the future, without running a serious risk of inflaming inflationary expectations and starting a wage-price spiral. U.S. firms and households will gradually recognise this dilemma and the bleak prospect of little future interest rate relief will further dampen consumption and investment spending.
Eventually, of course, the decline in spending will lead to a decline in inflation, but this will only happen with a lag. The longer the lag turns out to be, the longer the period over which the U.S. economy will endure stagflation, that is, a cruel combination of rising prices and falling aggregate demand. Much hinges on how persistent U.S. inflation is. More persistent inflation will inevitably give rise to higher inflationary expectations, leading gradually to higher inflation, and so on. It took central banks over a decade, in the 1980s and early 1990s, to get inflationary expectations under control, and the fruits of this battle are now in danger of being lost.
Global implications The international financial crisis and the decline in the U.S. economy will inevitably have an adverse effect on the growth of the world economy. Europe and the emerging markets of Latin America and the Far East cannot fill the gap that the U.S. economy leaves. There exists no economic mechanism whereby a drop in the U.S. aggregate demand will be matched by a correspondingly large increase in aggregate demand elsewhere. Germany and other European economies highly exposed to the vagaries of international trade will certainly feel the pinch.
In the longer run, the prospects for the world economy look much brighter. Eventually U.S. house prices will stabilise, rising exports will help the U.S. economy recover, the fall in world demand for goods and services will reduce the price of raw materials, U.S. households will learn the importance of saving, and global imbalances will correct themselves. These rosy prospects lie in the mists of the future. Meanwhile, however, we are well advised to stay focused on the four dangers.
Brad DeLong says America will be much poorer if John McCain is elected president:
McCain and the decline of US, by J Bradford DeLong, Project Syndicate: Back in 1981, America's Republican Party gave up all belief that the government's budget ought to be balanced. The idea took hold that tax cuts should be undertaken all the time, at every opportunity, because reducing taxes supposedly raised revenue. ...
John McCain – who once criticised George W Bush's tax cuts as imprudent and refused to vote for them – has succumbed to this potion. He appears to be proposing further tax cuts that promise to cost the US Treasury some $300bn a year, to "offset" them with cuts in earmarked spending accounted for at $3bn a year, and somehow to balance the budget.
We know the consequences: McCain's fiscal policy is likely to be standard Republican fiscal policy – and since 1981, standard Republican fiscal policy has increased the ratio of gross federal debt to GDP by nearly 2% per year. By contrast, a typical post-WWII Democratic administration has reduced the debt-to-GDP ratio by more than 1% per year. This is one of the issues at stake in this year's presidential election.
Policies that ignore the level of government debt lead to the currency's collapse, depression (due to the resulting disruption of the sectoral division of labour), and high inflation – perhaps hyperinflation. Often, the guilty blame the economic catastrophe on the sinister manipulations of foreigners like the "gnomes of Zurich" or the IMF. The US is far from that point. But even in the shorter run – over the next two presidential terms, say – the costs of a high deficit and rapid debt growth would be substantial.
A growing debt-to-GDP ratio would ... crowd out investment, as resources that would otherwise go to fund productive investment instead support private or public consumption.
Since 1981, the US has been lucky in that inflows of capital from abroad financed the growth of government debt. At some point, this will stop, and increases in deficits will trigger capital flight from the US.
Suppose that over the next eight years larger deficits trigger neither extra capital inflows nor capital outflows, and suppose that a lower-investment America is a poorer America, with a gross social return on investment of 15% per year.
By 2016, America's productive potential would be smaller by an amount that would reduce real GDP by 3.6%..., or roughly $3,000 per worker. In a poorer America, fewer businesses would find it worthwhile to entice ... workers ... into the labor force, and perhaps 500,000 net jobs would disappear.
In getting from here to there over the next eight years, a higher-debt America would see productivity growth slow by perhaps a third of a percentage point per year. Average unemployment would then ... rise... The gross correlations between productivity growth and average unemployment found in the 1970's, 1980's, 1990's, and 2000's would increase the economy's natural rate of unemployment by about one-fifth of a percentage point, costing an additional 500,000 jobs.
And a higher-debt America is one in which savers and lenders would have a justified greater fear that the government would resort to inflation in order to repudiate part of its outstanding debt.
The Federal Reserve would then have to fight inflation – putting upward pressure on unemployment – in order to reassure savers and lenders of its willingness to guard price stability. There are not even crude gross correlation-based estimates of the size of this effect, but economists believe that it is very real. Would it cost a negligible number of jobs? A quarter-million? A million?
Add it all up, and you can reckon on an America that in 2016 that will be much poorer if McCain rather than Barack Obama or Hillary Rodham Clinton is elected president. ... [U]nder McCain, the wedge between public spending and taxes would be larger, Americans would feel richer, and they would spend more at the expense of "posterity" eight years down the road. Ronald Reagan might have approved. After all, as he put it: "Why should I do anything for posterity? What has posterity ever done for me?" Or was that Groucho Marx?
Jonah Gelbach emails that he has signed on to post periodically at Economists for Obama:
What to Do About Gas Prices?, by Jonah Gelbach: As an economist, as a person who worries about climate change, and as someone who believes the Democratic Party's electoral success is very important, if only to spare us more of the damage that the GOP has done over the last quarter-century of its hammer lock on federal policy, I find political discussion of gas taxes to be extremely frustrating to watch.
Democratic politicians regularly use high gas prices as a club with which to beat Republicans. I understand that politicians use the issues they think will work. And the nexus between oil company profits and GOP officials whose policies have been awful for most people in the bottom four quintiles of the income distribution (and probably plenty in the top one) has got to be pretty tough for Democratic candidates and officials to resist.
But the fact of the matter is that gas prices should be high. They should be high for the very simple and now very obvious reason that the pressure on the world's climate needs to be reduced. Our country's foolish policy of keeping gas prices low while providing implicit (and sometimes explicit) subsidies to the vehicles that get the worst mileage should have ended many years ago. Demand-side pressure on gas prices is finally pushing gas prices into the range they should have been for many years.
But that last paragraph tells only part of the story. One effect of the low-gas price policies we've pursued for so long is that it's induced many people to buy very fuel-inefficient cars and trucks. These are the people who are getting nailed hardest in the wallets by today's high gas prices, and I don't blame them for being upset. If you drive a vehicle that gets 18 miles per gallon for 12,000 miles a year, then you use about 670 gallons of gas a year. Even a $1.00 per gallon increase in the price of gas over a period of one year alone therefore translates into more than the stimulus tax rebate that a single person with sufficient income will receive over the next month. A married couple each of whom drives such a car 12,000 miles a year will receive a smaller rebate than the one-year cost of a $1 per gallon gas price hike.
By any reasonable standard, the increase in gas prices translates into real money for a huge number of people in this country, especially under current economic conditions.
But since the reason this is true is that American consumers have been induced to buy inefficient gas guzzlers, with serious environmental consequences, policies that would reduce the price of gas should be the last thing we consider. (On this score, the gas tax holiday that Sens. McCain and Clinton have proposed at least has the virtue that it would likely do very little, leading to at most a very small change in the price of gas; McCain's proposal would add to the deficit by increasing windfall profits of oil companies, while Clinton at least has proposed a new windfall profits tax to undo her proposal's provision of windfall profits.)
So what to do?
I propose the following two-pronged policy:
- Prong 1. No change in the gas tax until the economy improves. At that point, we would begin to increase the gas tax annually by some fixed amount that would be stated in advance, allowing people to make informed car-purchase decisions. Consumers would shift consumption toward more fuel-efficient vehicles, and automakers would see this coming, so they would shift R&D toward such vehicles. Over time, the efficiency of the U.S. auto fleet would improve, cutting emissions and making us less dependent on all that foreign oil over which everyone always frets.
- Prong 2. Every person who owns a car and files a tax return would receive a Gas Price Rebate (GPR). The amount of the GPR could vary with income if means-testing is desired to keep the overall cost of this program lower than it would otherwise be. However, the GPR would not vary according to the type of car people own. It could be set at something like. (12,000/avg MPG of U.S. fleet) x (the 2002-2008 change in the per-gallon price of gas)
We could adjust any particular component of the GPR. The point isn't the exact formula, but rather the fact that the GPR does not vary with the type of car that a person drives but does provide relief to the millions of Americans who responded to the bad incentives created by the misguided/chicken*$@# representatives the people themselves elected. People who want to keep driving those H2 and Mustang monstrosities (Ok, I admit it -- I used to drive a Mustang) can do so if they want, but they'll have to pay for it.
Thus, the two prongs together move incentives in the right direction (prong 1) while helping alleviate the real suffering going on out there due to gas price increases (prong 2). What I hope makes such a policy politically viable is the combination of the two elements. Yes, opponents will slam prong 1, but prong 2 is there as a retort.
As for paying for prong 2, some headway can be made with the increase in gas taxes in prong 1. It's a truism of microeconomic theory, though, that a tax-induced price increase will reduce equilibrium quantity, so it's likely that any GPR big enough to make prong 1 politically feasible will require additional funding. To deal with this, I propose ... you guessed it, an increase in taxes on upper-income Americans. And while I think the best way to do this would be those who make even more than I do, if need be, I'd be happy to pay more in taxes to help make this plan a reality.
Update: Here's Obama talking about the McCain-Clinton proposal today.
A few quick notes from the Milken Institute Global Conference:
"The president would not understand dynamic evolutionary stochastic processes," From "A Discussion with Nobel Laureates in Economics," Gary Becker, Edmund Phelps, Myron Scholes, and Michael Spence, Moderator: Michael Milken.
As I was riding down the elevator this morning, the car stopped and Muhammad Yunus got on. I said hi. He said hi back.
In a lunchtime quiz, 45% of the people in the audience thought the very first Nobel prize in economics went to Hayek.
When Steve Forbes used the words "flat tax," some people in the audience began applauding. The also applauded every time he used the phrase "tax cut."
The session "Harnessing Growth to Break Poverty's Grip on the Developing World," with Ricardo Hausmann, Myron Scholes, and Maria Eitel, and moderated by Michael Spence, was very good. Part of it was about monkeys in trees. Maria Eitel, president of the Nike foundation, was also very persuasive in arguing for more aid to women. Currently, only about a nickel of every development dollar is devoted to improving the economic prospects for women in developing countries, but there can be huge payoffs from investment in this area (Michael Spence consulted on this work). The political and social problems surrounding investment in women were also interesting. Essentially, even though there are large long-term benefits to helping women, it is in nobody's short-term interest to take women out of their traditional role in the family and community where they provide water, firewood, food for the family, care for sick family members, are expected to provide insurance for the family by dropping out of school if the family needs help, and so on. The key has been to stop trying to attack this as a political or social issue, and instead show families that it is in their economic interest to allow their daughters to attend school, marry later, etc., and then use targeted aid programs that create the correct incentives (e.g. micro loans that provide more help to the family than the daughter can, and are only available if the daughter is in school).
The session "State of the State of Wall Street: Creating Opportunity Out of Chaos," with Bennett Goodman, Senior Managing Partner, GSO Capital Partners LP; Kenneth Griffin, Founder, President and CEO, Citadel Investment Group LLC; Kenneth Moelis, CEO, Moelis & Company; Charles Ward III, President, Lazard Ltd.; Chairman, Lazard Asset Management Group; Peter Weinberg, Partner, Perella Weinberg Partners; Moderator: Paul Calello, CEO, Investment Bank, Credit Suisse was interesting. The panelists clearly understand that some sort of increased regulation of the financial sector will be forthcoming, but they are very worried about the form that regulation will take (and issued the usual threats, e.g. we'll move to other countries). It was clear they plan to be proactive in trying to shape the regulatory changes. They were very supportive of the Fed's bailout of Bear Stearns and changes to the discount window (no surprise there), though one panelist who ran a hedge fund did complain about not having access to the newly designed discount window while other firms did. They were very grateful that sovereign wealth funds were available to provide needed capital, and they were much more optimistic about economic prospects on Main street where they believe there is only a minor contraction and chance of a quick recovery, than about the prospects on Wall street, where they see a depression and a much more drawn out process of recovery.
Update: The elevator keeps messing with me. I was waiting to go down for the dinner thing, the door opens, it's crowded, so I wave it off. But some guy says no, there's room, get on, and people scrunch to make space. I look up and it's Michael Milken. It's the Beverly Hilton, he's paying for the room, my dinner, etc., so I did what I was told and got on the elevator. I did say thanks. Weird.
As for the panels during dinner, I discovered that I don't like Bill Bennett any more in person than I do on TV. Jerry Brown was better, CNN's Bill Schneider was more entertaining than I expected, though from an entertainment perspective John cleese in the earlier panel was better yet. Nobody said anything particularly surprising, except, perhaps, the begrudging (and somewhat backhanded) respect Bennett gave to Clinton for her toughness and perseverance. Still, the consensus was it would be McCain versus Obama, and that the identity each carries into the election will be the determining factor (e.g. McCain as feeble old man or tough war hero, and the extent that Obama will continue to be identified with Wright, elitism, Ayers, etc. - Brown was more optimistic than Bennett that these issues would fade over time).
I have more business cards than I can ever remember having at one time. I didn't bring any (because I've never bothered to get any), so when I'm given one I just take it and say thanks. I always feel kind of awkward at that moment. Then again, I can't put faces with the cards I've been given, so maybe being a big business card dork actually helps with the longer-term memory imprinting.
Because I'm a blogger, they gave me a press pass. That's kind of cool I guess, or so I thought at first, but it doesn't give you any extra privileges except a separate work area I had no use for. It's like a cat bell that tells people you might report on what they say, and that makes some of them reluctant to answer questions. It took me awhile to realize that.