Published on 08-11-2010
Ben S Bernanke, chairman of the U.S. Federal Reserve, last month stated that the Fed was “prepared to take further policy actions as needed.” Photographer: Joshua Roberts/Bloomberg
Federal Reserve officials decided to reinvest principal payments on mortgage holdings into long-term Treasury securities, making their first attempt to bolster growth since March 2009 to keep the slowing U.S. economy from relapsing into recession.
“The pace of economic recovery is likely to be more modest in the near term than had been anticipated,” the Federal Open Market Committee said in a statement in Washington. “To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level.” The Fed retained a commitment to keep its benchmark interest rate close to zero for an “extended period.”
With growth weakening in the second quarter and company job gains in July falling short of estimates, today’s step signals that risks of a downturn have increased enough for the Fed to delay its exit from unprecedented stimulus. Chairman Ben S. Bernanke told Congress last month that the Fed was “prepared to take further policy actions as needed.”
The Fed said it will “continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.” The reinvestment policy applies to agency debt and agency mortgage- backed securities held by the central bank.
The central bank left the overnight interbank lending rate target unchanged in a range of zero to 0.25 percent, where it’s been since December 2008. High unemployment, low inflation and stable price expectations “are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” the Fed said, repeating language from every policy meeting since March 2009.
“The pace of recovery in output and employment has slowed in recent months,” the FOMC said. The Fed will “continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”
U.S. central bankers repeated that inflation is “likely to be subdued for some time.” Prices in June rose 1.4 percent from a year earlier, the third straight month of slowing gains under the Fed’s preferred index, which excludes food and energy costs.
Kansas City Fed President Thomas Hoenig dissented from the decision for the fifth straight meeting.
Fed policy makers, at their last meeting in June, judged that the central bank “would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably,” according to minutes of the session. Records of today’s meeting will be released Aug. 31.
Bernanke said in an Aug. 2 speech that “we have a considerable way to go to achieve a full recovery in our economy.” Still, he avoided signaling that the central bank would reverse months of reductions in record stimulus and liquidity programs, including the end to $1.7 trillion in purchases of housing debt and Treasuries.
St. Louis Fed President James Bullard said July 29 that while he expects a continued recovery, policy makers should be ready to buy Treasuries if the economy slows further.
The Fed’s last move in favor of easier policy came in March 2009, when policy makers agreed to buy $300 billion of Treasuries and more than double planned mortgage-debt purchases to $1.45 trillion while starting a pledge to keep the benchmark rate close to zero for an “extended period.”
This year the central bank stopped buying assets, raised the rate on direct loans to banks and shut emergency-lending programs for corporations, bond dealers and money-market mutual funds. It’s also developed tools for raising rates with a near- record $2.3 trillion balance sheet.
Today’s decision defied easy prediction after a report Aug. 6 showed U.S. private employers added 71,000 jobs in July, below the 90,000 median estimate of economists surveyed by Bloomberg News. The unemployment rate was unchanged at 9.5 percent. Including government workers, the U.S. lost 131,000 jobs in July, compared with the median estimate of 65,000.
The weak job market has inhibited growth in consumer spending, which accounts for about 70 percent of the economy. Such expenditures rose at a 1.6 percent pace last quarter, down from a 1.9 percent rate in the previous three months that was smaller than previously estimated.
“They’re supposed to keep inflation under control, but they’re also supposed to promote full employment,” Christopher Low, chief economist at FTN Financial in New York, said in a Bloomberg Television interview before the announcement. “The Fed is starting to worry about hitting that full-employment goal any time in the next three or four years.”
Aeropostale Inc., a retailer to teenagers whose sales rose in July at one-seventh the pace analysts predicted, said changing consumer preferences and a “challenging” retail environment hampered spending. Sales at J.C. Penney Co., a department-store chain, fell 0.6 percent last month.
Still, Bernanke and other officials in recent weeks had maintained their outlook for a pickup in the economy over the next year. Corporate spending on equipment and software jumped at a 22 percent annual rate last quarter.
While weakness in housing and commercial real estate will restrain the recovery, and the job market’s “slow recovery” weighs on consumers, “rising demand from households and businesses should help sustain growth,” Bernanke said in a speech last week in Charleston, South Carolina.
United Parcel Service Inc., the world’s largest package- delivery company, raised its annual profit forecast last month and posted second-quarter earnings that climbed more than analysts estimated on increased demand overseas.
The S&P 500 Index has rebounded 12 percent as of yesterday from its low this year on July 1.
Investors don’t expect the Fed to raise the federal funds rate until late 2011, based on futures contracts on the Chicago Board of Trade.
The housing market has faltered since a federal tax incentive for first-time homebuyers expired in April. Sales of previously owned homes fell 5.1 percent in June from May, housing starts slid to the lowest level in eight months and the 330,000 annual pace of new-home sales was the second-lowest in data going back to 1963 after May’s 267,000 rate.
The National Bureau of Economic Research, an academic group with a committee that marks the start and end of recessions, has yet to announce a date for the end of the downturn that started in December 2007, even after four straight quarters of growth. Some panel members including Stanford University’s Robert Hall and Jeffrey Frankel of Harvard University have said it’s clear the contraction has probably ended.
Aug. 11 (Bloomberg) — Laurence Kotlikoff, an economics professor at Boston University, talks about the state of the U.S. economy. Kotlikoff speaks with Erik Schatzker on Bloomberg Television’s InsideTrack.” (Source: Bloomberg)
Let’s get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills.
What it can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy.
Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: “Directors welcomed the authorities’ commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP.”
But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: “The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.”
The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.
Double Our Taxes
To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.
Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It’s also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.
Is the IMF bonkers?
No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.
Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our “official” debt and our actual net indebtedness isn’t surprising. It reflects what economists call the labeling problem. Congress has been very careful over the years to label most of its liabilities “unofficial” to keep them off the books and far in the future.
For example, our Social Security FICA contributions are called taxes and our future Social Security benefits are called transfer payments. The government could equally well have labeled our contributions “loans” and called our future benefits “repayment of these loans less an old age tax,” with the old age tax making up for any difference between the benefits promised and principal plus interest on the contributions.
The fiscal gap isn’t affected by fiscal labeling. It’s the only theoretically correct measure of our long-run fiscal condition because it considers all spending, no matter how labeled, and incorporates long-term and short-term policy.
$4 Trillion Bill
How can the fiscal gap be so enormous?
Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today’s dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year.
This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.
Herb Stein, chairman of the Council of Economic Advisers under U.S. President Richard Nixon, coined an oft-repeated phrase: “Something that can’t go on, will stop.” True enough. Uncle Sam’s Ponzi scheme will stop. But it will stop too late.
And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.
Worse Than Greece
Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.
Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run.
This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14 percent of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance.
Demand-siders say forgoing this year’s 14 percent fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue.
My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no- pain, all-gain “solutions.”
(Laurence J. Kotlikoff is a professor of economics at Boston University and author of “Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking.” The opinions expressed are his own.)
To contact the writer of this column: Laurence Kotlikoff at firstname.lastname@example.org