Mike Rosenberg (Bloomberg) notes that, when viewing the policy mix from the perspective of fiscal and financial conditions, we are on the following path, even as there is a large amount of slack in the economy [0]:
Figure 1: Source: Michael Rosenberg, Global Economic and Exchange Rate Outlook (not online).
The withdrawal of fiscal stimulus has been discussed often, but I think the tightening of financial conditions is often overlooked. According to Bloomberg’s financial conditions index (BFCIUS), which is a composite measure based on money market and bond market spreads and equity prices, [1] (p.10) tightening is occurring.
Figure 2: Source: Michael Rosenberg, Global Economic and Exchange Rate Outlook (not online).
Tightening fiscal and monetary policy, when the output gap is still large and negative by most measures, is not an example of counter-cyclical policy. Speaker Boehner’s plan makes no attempt, as far as I can tell, to address any of the issues of job creation and demand creation in the short run. [2] Rather, he argued for a continued move south in the Figure 1 matrix.
I guess Greece should try bigger deficits too.
W. C., we have an excellent way of determining whether borrowing money is a good idea, or a bad idea. They’re called “interest rates”. Greece has very high interest rates, so they shouldn’t borrow. We have very low interest rates, so we should. They teach you to look at interest rates when making decisions on like day 1 of business school.
Household debt service plus total gov’t spending, including personal transfers, now exceeds wage and salary disbursements and is 124% of private wages and salaries.
It required $6 of total credit market debt by ’08 for $1 of private GDP, and the figure is $5.5 today. To get 4% nominal private GDP growth today, we need $2 trillion equivalent in additional debt per year, or nearly $7,000 per capita of new debt.
Total credit market debt grew $22 trillion from ’00-’01 to ’08 to date, or nearly $71,000 per capita, yet private payrolls per capita are 11-12% lower than ’00 and back to the levels of the late ’80s to early ’90s.
Moreover, despite $47 trillion of debt added to the US balance sheet since the early ’80s, $151,000 per capita at today’s population, full-time employment per capita is no higher than in the late ’70s and early ’80s.
Debt service and gov’t spending to GDP and wages precludes any further net growth of private business and employment hereafter.
Were the US debt/private GDP to have sustained the rate of growth from the 1950s to early ’80s, the debt/GDP would be 3-4 today through ’20-’25 rather that near 6.
Debt/private GDP must fall 30-35% hereafter at the post-’00 trend rate of private GDP, which will require 10-15 years for GDP to catch up to debt’s decline.
However, that the post-’00 private GDP trend rate is likely to decelerate further from the lack of growth of credit, investment, employment, and incomes, debt/private GDP is likely to fall more than 30-35%, perhaps as much as 50%, taking debt/private GDP back to the level of the mid- to late ’90s, when the faster-than-exponential rate of growth of debt/GDP began.
Fed printing, taxing, borrowing, and spending by gov’t will only increase debt service and gov’t to GDP and wages, costing the private sector even more in the years ahead.
Choose your poison: ouzo or sake, Greek or Japanese? Then swallow hard and prepare for the nasty hangover lasting a decade or longer.
Walt,
Really? That’s how they taught you to make borrowing decisions? What business school is that?
Walt,
What they don’t teach you even on the last day of business school is how central planners/bankers can totaly distort investment decisions for decades and help push countries and even entire continents down a black hole.
Tyaresun –
So the markets are no guide, you’re just flying blind? Pardon me for choosing to ignore somebody who chooses ideology over empiricism.
@Varones–Greece differs from the rest of the European Union primarily in that it collects lower income taxes. The United States has the same problem. From 1945 to 1980 income taxes averaged near 12% of GDP. Reagan reduced marginal tax rates so much that they fell to 9%. Clinton increase them back to 12%; and Bush/Obama reduced them again to 9 %. However, on budget expenses have remained close to 12%(+/-1%) of normalized GDP throughout. The deficit in income taxes has been financed by borrowing, mostly from the Social Security trust fund. But, not only can we no longer continue to borrow from the trust funds, we have to start paying money back as beneficiaries start relying on the trust funds. In the short term, we have to raise income taxes to 12%, simply to cover on budget expenses. In the long term, income taxes must rise above 12% in order to pay back the trust funds.
Dave L,
Free markets would be a great guide.
Pity we don’t have any.
“Speaker Boehner’s plan…argued for a continued move south in the Figure 1 matrix”
mcconnell has said thats the plan; tank the economy & win in 2012…
“Tightening fiscal and monetary policy”–Menzie
The Federal govt will spend more money in 2012 than in 2011, with little prospect of a smaller portion of the spending being borrowed.
The Monetary base is currently 33% higher than 12 months earlier. M1 is 21% higher; M2, 10.5%. None of these measures shows signs of declining.
Will it never be enough?
I just refinanced my 30-year at 3.875 pct. The ten year treasury is under 2.0 pct. I have a hard time understanding how Menzie can call this “tight financial conditions”. What distinguishes them at tight?
@Walt: Lehman (or Bear Stearns, Enron, et al) had a very tight credit spread in the days leading up to their failure. Are you suggesting that they should have borrowed more? Yah, leverage >30x is a brilliant idea. What many fail to realize is that when you run leverage ratios of this magnitude (debt / gdp ratios > 100%), your creditworthiness can change in a *very* short period of time (too short to address the problem). In other words, long term solvency issues can become liquidity issues virtually overnight.
Bryce,
Exactly!
KevinM,
Exactly! I had a similar experience on my mortgage and sent Ben a letter about it here.
KevinM “I just refinanced my 30-year at 3.875 pct.” So now your anecdotal experience is an indicator for monetary policy as a whole? Let’s try this: how many people are currently underwater with a mortgage? How many people have the ability to refinance in that condition? How many people have taken a hit to their credit scores in the last 3 years? How many of these people are able to refinance? What is the unemployment/under-employment rate? How many of these people have the ability to refinance?
Come on, the blog comments here are usually better than Fox talking points.
Bryce Menzie was referring to financial tightening of the kind represented by the Bloomberg index shown in the picture. It measures various market spreads. Similar to the way in which economists look at the LIBOR as an index of financial tightening. The monetary aggregates you mentioned don’t particularly mean much.
As to fiscal tightening, my reading of the news is that Boehner & Cantor are calling for austerity measures. Obama has proposed a rather tepid jobs plan (better than nothing but not great) which has no chance of getting through a GOP Congress more interested in ensuring economic panic for political purposes than getting us out of the recession. And state and local governments have been cutting back at a furious pace. So yes, there’s plenty of fiscal tightening going on just when we ought to be going in the other direction.
You asked when it will be enough. The answer is when the economy is at something close to full employment and we see some inflation. Then it will be time for finanicial tightening and fiscal cutting back.
“I guess Greece should try bigger deficits too”
Hey W.C. last time I checked (3 seconds ago) Greece does not issue its own currency; it uses the Euro. The US (and Japan and UK) issue their own currencies. That makes a big difference in fiscal policy. Did you notice when Greek credit was downgraded interest rates went up on Greek debt. When the US was downgraded interest rates on US debt when down. That alone should give you a wake up call that there is a difference. Too bad University professors (except a few like Randy Wray) don’t teach the difference (I guess you can’t teach what you don’t understand).
Walt,
Did your business school teach you that mature businesses should spend 150% of revenues every year?
No Varones, but there are times when it is good business to spend 150% of revenues.
Doesn’t your ideology allow you have any judgement or discretion?
Does everything have to be ALWAYS ?
To tighten financial conditions during a liquidity trap before private demand is supported is a recipe for trouble.
Private demand is not going to come back until the debt is defaulted or inflated away.
Policy makers would be wise to consider this.
No more temporary stimulus. All it does is move us 6 months down the road, but then we are right back where we are today, and another half trillion in debt.
No job creator is goint add permanent jobs in response to a temporary bump in demand. We all know this. We also know this recession/slow growth period is going to persist. The solution requires permanent policy and regulatory changes.
The US$-adjusted annual rate of change of private GDP to M1 to industrial production began contracting as of Q2, implying that another recession has already begun.
Since ’70 under the recessionary conditions above, the S&P 500 fell on average 20-30% (~50% in ’73-’75, ’00-’02, and ’08-’09), and the U rate rose 50-75% to 100%+.
Stock market bullies don’t yet get it, just as they did not in early to mid-’73, late ’00 and early ’01, and late ’07 and early ’08; but they will.
The historical self-similar secular bear market pattern implies that we are aligning in time during the progression of a debt-deflationary secular bear market with Japan in the early ’00s and the US in the late 1930s, 1890s, and 1830s.
Were the pattern to repeat, we face another 50% or larger cyclical bear market, with the worst 5-, 10-, and 20-yr. returns over the next 2 to 8-9 years.
The secular bear market will coincide with the peak rate of change acceleration of the number of peak Baby Boomers reaching age 60-65 between now and ’18-’21. This period is likely to coincide with increasing risk aversion and liquidity preference, continuing falling interest rates and stock, unreal estate, and commodities prices, a rising U rate to an all-time post-WW II high, and new lows persisting for consumer CON-fidence.
It’s again time to get out of stocks and be liquid, friends.
tj No job creator is goint add permanent jobs in response to a temporary bump in demand. We all know this.
All of which is a good argument for a robust stimulus plan rather than a weak middle-of-the-road thing. A good stimulus plan that emphasized the govt purchasing of goods and services from the private sector would reduce inventories, restore paychecks, allow individuals to repair balance sheets and be self-sustaining. That’s why we cannot make the mistake that CoRev kept wanting to make, which is to think a stimulus program can only be frontloaded and then disappear.
On the other side of the coin, there are two bad possibilities with this recession. The first is that there are multiple equilibria positions and we find ourselves permanently stuck at a low output equilibruim point. Since it’s an equilibrium point that means there is no tendency for the economy to move away from that point. The second possibility is even worse, and that is deflation coupled with rising interest rates due to misguided policies from hawkish Fed presidents. That would lead to a case of output diverging from an equilibrium, but diverging in a very bad way.
The one thing we know about financial recession is that unlike your father’s garden variety recession, they are not self-correcting in anything like an acceptable time horizon. You’re talking in terms of decades.
The one thing we know about financial recession is that unlike your father’s garden variety recession, they are not self-correcting in anything like an acceptable time horizon. You’re talking in terms of decades.
By George, I think you’ve got it!
WCV,
Free markets would probably be a very bad thing. We very rarely see free markets at work, usually in places without a functioning government. The general rule is that “free” markets are highly disfuctional.
Mixed markets – transactions between private parties taking place within a web of law and regulation enforced by government – prevail in every civilized place in the world. So please, if you want to give “free” markets a try, head for Somalia. I’m sure you’ll have the time of your life.
Bryce,
What evidence do you have that the federal government will spend more next year than this? The budget for next year hasn’t been written, and proposals for continuing resolutions all impose steady spending levels, or less in some cases. So far in calendar 2011, spending is just a bit higher than in the same period in 2010, with the deficit smaller. You may have misconstrued “fiscal tightening” as meaning less spending, but it actually means a smaller deficit.
KevinM,
There are lots of different kinds of credit, and many of them are less available now than in recent months. Commercial paper outstanding has been falling steadily. European bank borrowing from US money markets has been falling steadily. Mortgage rates are low, but mortgage origination is also low – lots of people don’t have access to those low rates. In fact, if you click the link, you’ll get an extensive look at the index Menzie mentioned. That link should give you a good impression of the sources of the tightening in financial conditions.
tj,
“We all know this.” Actually, no. Anytime “everybody knows” or “we all know this” is the crux of an argument, we have to assume it’s because the person making the argument has no real evidence. Relying on what you “know” is a sure way to be wrong a lot.
Seriously, folks, you need better spin if you want to undermine good arguments made in front of smart people. Hackery is hackery. The points you guys are making were all refuted long ago.
The US Federal government is not a business and it’s economically unsound to ask it to act like one. Spending too much is a poor choice, but spending much under the growth rate leads to …
a lower growth rate, less revenue, more slack.
Plenty of unused capacity, almost free money to borrow, 10% or more true unemployment. Why tighten? What’s the purpose? Fear of a Social Security shortfall in 2085?