Econ Pt.2 – If I Had Been Fed Head

A story on the NBC “Today” show this week I think effectively made 2 points.  The story was about a young lad who started having some serious physical problems.  Initially the idea was that he might get better on his own.  When that didn’t work, several different doctor specialists were seen.  Based on the symptoms, there were a series of presumed problems which were treated without effect.  Finally, because his Mother persisted, they found a doctor who made the correct diagnosis, and all his multiple problems were fairly quickly and easily fixed.

  1.  The first point is that, whether medical science or economic science, a proper diagnosis is critical. This story affirms the adage that “a problem well-defined is a problem half solved”.
  2. Sometimes our systems can repair themselves, but sometimes they need more help to get better.  It can be important to recognize which situation we have.  We may need treatment, but treatment often can have unintended consequences (if you doubt this, read the warnings on your next medical prescription).

While most of our economic recessions have similar symptoms, they all seem to have different causes.  The best book on this was written by Charles P. Kindleberger (the Ford Professor of Economics at MIT for 33 years) titled Manias, Panics, and Crashes.  He defines “mania” as a “speculative excess” which is like a virus that can spread through groups of individuals.  Part of the problem is that we don’t recognize it as a “speculative excess”  until it’s too late.  Then panic sets in, and the crash happens.  What causes the mania is usually different in each case, since most of us try not to make the same mistake twice. The first mania that Kindleberger references in his book was caused by tulips – “Tulipmania” – which happened in 1636-37.  We apparently got over that without a lot of outside help and although the sale of tulip bulbs is not regulated, we haven’t had another “Tulipmania” since then.

The cause of the 2001-2002 down turn was different from the one that started in 2008.  In 2002 the Fed dropped their rate from about 6% to 1%.  By 2006 it was back to about 5%, which is where it was when the Great Recession started.  Some have said the unintended consequence of the Fed’s low-interest rate in that period was the financial crises of the Great Recession. I don’t believe that the 2002 decrease in the Fed Funds rate was bad, but I did think it went lower than it needed to, and was not raised fast enough.  To me, with the Fed Funds rate, the Fed has a tool for controlling the economy that is like the reins of a horse-drawn wagon.  Raising rates, like pulling the reins, will slow things down.  But lowering the rate is like putting slack in the reins.  Once the reins go slack, the wagon won’t go faster unless horses decide they want it to.  Slack in the Fed rate I think happens around 1.5-2.0%.

So what would I have done?

The 2002  recession was brought on by the bubble in IT and Electric company stock which became over-priced.  It was a stock market crash.  The 2008 Great Recession was a threat to the financial systems brought on by the housing bubble, and mortgage loans gone bad. A free market economy needs a stable monetary system to function effectively.  The monetary system is the one for which the government clearly has responsibility.  So the things done to keep some large financial organizations from failing, needed to be done to stabilize our monetary system.  I would have done this.  The initial drop in Federal Funds rate was helpful by giving  individuals a chance to re-finance their mortgages at lower rates  and thus avoiding foreclosure as well as providing a little extra spending money each month.  Like the previous recession, I think they went too low.  The interest rate is effectively the price of money. A rate of  1.5%-2%, gets the Fed is out-of-the-way and lets the market set rates based on supply/demand.

Lower rates, while helping homeowners with mortgages, hurts people who need to earn interest from bank savings accounts or money market funds.  In 2007, my bank premium money market account that was paying nearly 5.o% interest.  In 2013 it paid about 0.4%. For someone in retirement or savings for retirement with $100,000 in the account, his earnings could have dropped from $5,000/year to 400/year.  Mortgage rates went down, but rates only dropped about half that much.

The Quantitative Easing programs (Q E’s) seemed to be an attempt to get money back in circulation.  The theory here is that the supply of money in the economy can affect the level of economic activity.  The broader definitions of money supply include cash in circulation plus available credit.  In the type of financial crash that we had, the amount of available credit obviously dropped, so these efforts may have helped.  This was a new innovative effort, which was a little controversial.  Both the Q E programs and the low-interest rates signaled an abnormal environment.  And in both cases, there was concern about what negative consequences might happen when they ended.  To be in a normal environment,  most of us believed the Q E program would need to end and interest rates needed to rise.

On the fiscal side, Federal expenditures took a big jump in 2009, largely because of the “infra-structure” expenditure package.  But only about 15% was actually for infra-structure.  Had it been 100% for infra-structure it would have been much better.  We’ve heard a lot about the need to repair roads and bridges, which is one of those things we have given government the responsibility to do.  It not only would have provided jobs, it would have provided benefits that would have lasted for years.  It also could have been could have been reduced more easily than transfer payments to individuals.  In 2009, the Federal budget went up significantly, taxes went down because of the recession, and the Federal budget deficit was more than twice the deficit for 2007 and 2008 combined. Federal expenditures have not reduced from that level since then.  The deficit has been reduced because of increased taxes so in 2014 it is only about twice what it was in the worst year of the previous recession.  With the first of the baby boomers reaching 65 in 2011 and the total employment numbers declining, the chances of balancing the budget in the near future appear slim.  I think I might have done the infra-structure spending, but would have planned to lower the expenditures after those projects were done.  People need some hope that the Federal Budget will be balanced again in their lifetime.

By the end of 2011, it appears that the Crash had landed.  Bank failures were coming downs rapidly and the stock market was headed up.  The Fed Funds Rate had been under 1% since December of 2008, so mortgage rates were down and people had a chance to refinance.  Individuals and  companies had reduced their debt.  Most of us were hoping for a return to normal.  But the Fed and other Government branches were not acting normally.  The crash phase of this cycle had ended , and it was time for a recovery – a return to “normal”.  But our government was still acting like we had a crises.  The government is not going to get the people to act “normally” until it does.  I would have started to try to raise interest rates back to normal in 2012.  People with longer term interest paying investments (CD’s and bonds) would not have suffered much income drop in the first 2 or 3 years.  So at that point the lower rates might have done more good than harm, but the after that it may have reversed. At that point, the crash was over, but there was still some fear and uncertainty about the when things would come back to “normal” and what might happen in the process.  The other thing we did, that has probably hurt the recovery is that we have tried to regulate tulip bulbs.  We might need some of that, but we might want to re-think how much.

We said at the beginning tot this post that intervention can cause unintended negative consequences.  Today, with the Fed rate still at an all time low, more people who are retiring and need investment income.  Many stock yields are now higher than interest yields.  With growth rates in the economy at about half what they have been in previous recession recoveries, the stock market is about double what it was at the recession low. (the Dow Jones average was almost back the pre-recession high by the middle of 2011.) This has been one of the biggest stock market run ups in recent history. Is there any chance that people are investing in stocks, rather than going to more secure fixed rate bonds and CD,s because they need the income?  Are we building another bubble?

I’m not sure that macro-economics has an answer for this by itself.  So in the next post, I will tell you why I think micro-economics is important also.

Advertisements

About tjc13

BE - Chem Engineering, Vanderbilt Univ, MBA, University of Tulsa - Worked for an energy and chemical company for many years and then started a management consulting business working for both for-profit and not-for-profit organizations.
This entry was posted in Business, Economics, History, Uncategorized and tagged , , , , . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s