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Martin Wolf: Please, Please, Please, Please Listen to the Bond Market

Hoisted from the Archives: Who, Exactly, Was Sure That the Economic Recovery Was Well-Established in the Late Summer of 2010?

Back in September 2010 I wrote:

The Bank of Englands Adam Posen Joins the Reanimation Caucus: We have moved beyond mere need for more stimulus to get the recovery on track.

The recovery is dead.

We are now at the stage where what is needed is more: the reanimation of dead tissue.

David Wessel listens to Adam Posen as he joins the reanimation caucus and says: "GIVE THE ECONOMY... LIFE!!!":

Bank of England’s Posen: Central Banks Should Do More — A Lot More: Adam Posen, an American who sits on the Bank of England’s Monetary Policy Committee, is no on-the-one-hand-this/on-the-other-hand-that economist.  In a speech at the Chamber of Commerce in Hull today, Posen made the case that the world’s central banks — not only in the U.K. — urgently need to pursue more aggressive bond-buying to rescue the world economy from stagnation that clouds the future as well as the present.

Along the way, he adds a few new metaphors to the debate over central banking: “Fear of looking ineffective should not be a deterrent to doing the right thing," he said:

When facing a worsening situation, you work with the tools you have, whether you’re a central bank in the aftermath of a financial crisis, or someone stranded on the road with a car problem when night is falling. And you try to get help. In every major country, actual output has fallen so much versus where trend growth would have put us, and trend growth has not been above potential for long enough as yet, that there remains a significant gap between what the economy could be producing at full employment and it currently produces. Thus, policymakers should not settle for weak growth out of misplaced fear of inflation….

The risks posed by doing too little monetary easing far exceed risks posed by doing too much, he argued, making a case for looking beyond the economic metrics:

There are… some very serious risks if we make policy errors by tightening prematurely, or even if we loosen insufficiently. Those risks are not primarily the potential for a double-dip recession or even of temporary measured deflation. While bad, those situations would still be within the range of short-term cyclical developments, and could be weighed against simple inflationary pressures from monetary policy trying to stimulate too much. The risks that I believe we face now are the far more serious ones of sustained low growth turning into a self-fulfilling prophecy, and/or inducing a political reaction that could undermine our long-run stability and prosperity. Inaction by central banks could ratify decisions both by businesses to lastingly shrink the economy’s productive capacity, and by investors to avoid risk and prefer cash. Those tendencies are already present, and insufficient monetary response is likely to worsen them…. We will only know we will have done enough with QE [quantitative easing] or other monetary stimulus when we have clear indications that our policies are moving the desired variables — market interest rates, wages, output, employment, and inflation expectations — sufficiently and in the right directions on a sustained basis. I do not think that is not enough for a central bank to say, ‘Look, we expanded our balance sheet more than any time in history,’ or ‘we did things we never did before,’ and argue that therefore we must have done a lot, if not too much (not that the Bank of England has done so). In my opinion, that is backwards logic. It would be like saying ‘that fire must be out, because we’ve already pumped more water than for any previous fire we’ve fought,’ or ‘we must have gotten to our destination, because I’ve been driving for hours and we’ve already used a full tank of gas’

This is a worse fire than any of us have ever seen in our lifetimes, and we are farther from home than we have ever been, and so we cannot judge our progress by how much effort or resources we have already put in,” he continued. “We can only gauge the success of our efforts by our results, and until we achieve those results, there is no danger from our heavy use of the available instruments. This is not a normal situation with finely balanced risks on both sides or with monetary policy able to finely calibrate to an outcome..."

I hoist this from the achieves because Digby reminds me that I did not exist in September 2010 by sending me to:

Both sides surprised by bad economy: With today's dismal jobs report confirming that the political landscape will likely be shaped by a sense of economic crisis, it's easy to forget how recently the leaders of both parties were expecting a recovery. This March, I wrote a story with the now-ludicrous headline, "Barack Obama’s dilemma: When to declare recovery." In it, Paul Begala reflected on something that was really on the Administration's mind:

“The hard part is now — you have nascent recovery, the economists say it’s headed in the right direction, but the country doesn’t feel it at all,” said former Clinton White House aide Paul Begala. “It’s a tough line, because you want to be a cheerleader but you don’t want to look like you’re out of touch.”

This reflected a real, bipartisan consensus -- though one that had begun to wane by Spring. Last September, none other than Mitt Romney boiled it down…. This isn't the campaign either Obama or most Republicans expected to run, and if they seem caught off guard, it's because they were.

And Digby asks:

Hullabaloo: Does anyone know why in the world everyone was so confident at that point? It seemed to me at the time to be wholly faith-based, as if recessions were on a schedule ordained by God…. I don't happen to think the president "reluctantly" adopted deficit reduction--- he'd been planning to do it back when he was riding the wave of a huge mandate for change. And the reason they refuse to accept that it was the single worst decision of the term is simple rationalizing of what's turned out to be a major mistake.

But beyond that strategic cock-up was the apparent bipartisan belief that Obama's first term was following a sort of Gipper logic, by which it was assumed that there would be Morning in America, despite the fact that the actual economic details differed greatly from that time and they were facing rabid Republican extremists rather than fat and lethargic Democrats as Reagan had. Where that came from I still don't know.

In any case, there can be no doubt that those two strategic decisions -- assuming the economy was recovering on its own and emphasizing deficit reduction even in the face of evidence that it wasn't --- were huge error. But then the austerity error is in vogue all over the industrialized west, so perhaps someone just put something in the water at Aspen and Davos.

My first response is to say that if you are taking your economic forecasts from Paul Begala you are already in a world of hurt. You should look at economists.

FRED Graph  St Louis Fed 5

And the interesting thing is that the economists were not at all confident in the summer of 2010 that the recovery was well-established.

Here is what Christy Romer was saying in the late summer of 2010, as she left the Obama Administration. She was not confident that the recovery was well-established, not confident at all:

Not My Father's Recession: The Extraordinary Challenges and Policy Responses of the First Twenty Months of the Obama Administration: [T]he turnaround has been insufficient. Though the unemployment rate has come down six-tenths of a percentage point, it is still 9½ percent -- an unacceptable level by any metric. Real GDP is growing, but not fast enough to create the hundreds of thousands of jobs each month needed to return employment to its pre-crisis level.

It is clear that the Recovery Act has played a large role in the turnaround in GDP and employment…. The nonpartisan Congressional Budget Office, CEA’s own estimates, and estimates from a range of respected private sector analysts suggest that the Act has already raised employment by approximately two to three million jobs relative to what it otherwise would have been….

The thing I do regret is that there is still so much unfinished business. I would give anything if unemployment really were down to 8 percent or lower. The American people are suffering terribly. Policymakers need to find the will to take the steps needed to finish the job and return the American economy to full health, and no one should be blocking essential actions for partisan reasons.

That the economy remains as troubled as it is despite aggressive action reflects the fact that this has not been a normal recession. Just as the downturn was uncharted territory, so is its recovery. Because the recession began with interest rates at low levels, we can’t just have interest rates fall and housing, investment, and other interest-sensitive sectors come roaring back as they typically do in recoveries. Rather, because of overbuilding in housing and commercial real estate during the bubble, construction is likely to remain subdued for some time.

Indeed, the economy faces numerous headwinds not normally present in recoveries. In addition to the oversupply of housing, households have been through a searing crisis that is likely to make them more prudent for years to come -- in much the same way that the Great Depression gave rise to a generation of high savers and cautious investors. Likewise, the decline in wealth is likely to lead to increased saving to replenish retirement accounts and pay off debt. Such saving and prudence are healthy for the economy in the long run, but in the near term they mean that consumer spending will likely be less robust than before the crisis.

State and local governments have also been hit particularly hard by this recession. Their tax revenues are notoriously cyclically sensitive and the decline in house prices has further impacted property tax revenue. State and local budget-cutting reduced GDP growth over the past year and is likely to continue to be a drag on GDP going forward. And while the private sector has added jobs every month so far this year, state and local governments have reduced employment by 169,000 since last December.

The Administration understood that the recovery would be difficult precisely because many of the usual drivers of growth were missing. That is why we included $266 billion of additional temporary recovery measures in our 2011 budget. Congress has taken some important steps, including extending unemployment insurance, allocating funds to prevent teacher layoffs, and passing the HIRE tax credit to encourage firms to hire unemployed workers. However, it has enacted substantially less than what the Administration proposed. As a result, the economy has not had all the additional support that it needed.

Early in the spring, there was hope that new drivers of growth, particularly investment and exports, would substantially compensate for some of the headwinds.  Business investment in equipment and software rose at an annual rate of more than 20 percent in the first two quarters of 2010 and exports grew rapidly. Unfortunately, both those sources of demand have taken a hit in recent months. The Greek debt crisis and anemic growth in much of Europe contributed to a decline in both stock prices and confidence, and to a rise in the value of the dollar. The latest data on durable goods shipments suggest that equipment investment is growing only modestly, and last Friday’s GDP revision for the second quarter indicates that our exports are growing substantially less rapidly than our imports.

The result of these powerful headwinds and recent developments is that the United States still faces a substantial shortfall of aggregate demand. GDP by most estimates is still about 6 percent below trend. This shortfall in demand, rather than structural changes in the composition of our output or a mismatch between worker skills and jobs, is the fundamental cause of our continued high unemployment. Firms aren’t producing and hiring at normal levels simply because there isn’t demand for a normal level of output….

The pressing question, then, is what can be done to increase demand and bring unemployment down more quickly. Failing to do so would cause millions of workers to suffer unnecessarily. It also runs the risk of making high unemployment permanent as workers’ skills deteriorate with lack of use and their labor force attachment weakens as hope of another job fades….

While we would all love to find the inexpensive magic bullet to our economic troubles, the truth is, it almost surely doesn’t exist. The only surefire ways for policymakers to substantially increase aggregate demand in the short run are for the government to spend more and tax less. In my view, we should be moving forward on both fronts…. We have tools that would bring unemployment down without worsening our long-run fiscal outlook, if we can only find the will and the wisdom to use them…

Note that the last economic forecast she ran--the summer 2010 midsession review forecast--predicted that unemployment would average 9.1% in calendar 2011 and 8.1% in calendar 2012 if congress enacted all of the stimulative policy measures that the president proposed in his budget. Since congress did not do so, her conditional mid-session review forecast corresponds to an unconditional forecast of a 9.3% unemployment rate for calendar 2011 and a an 8.7% unemployment rate for calendar 2012--still optimistic relative to what we think now, but not fully out of the ballpark.

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