Saturday, October 17, 2015

Getting History Right

Lumping the stimulus and bailouts together is a mistake

In “Don’t Look Back in Anger at Bailouts and Stimulus” (WALL STREET JOURNAL, Opinion, Oct. 15, 2015) Alan S. Blinder and Mark Zandi provide a valuable service by trying to sort out fact from fiction surrounding steps taken during the financial crisis.  They are undoubtedly correct in their subtitling of their opinion piece: “Without the emergency measures of 2008-09, the U.S. economy would be far worse off today.”  However, they do a disservice by lumping together monetary policy initiatives and fiscal policy initiatives and not separating them from initiatives directed at financial stability.

It pays to look at each separately.  Part of the authors’ motive for writing the opinion piece is the difference between the public's perception of the initiatives versus the actual impact of the initiatives.  Given that focus, it seems reasonable to start with the initiatives directed toward financial stability since they seem to be the subject of the most marked misinterpretation.

If one were to pick a poster child for misinterpretation, it would be TARP.  As such, it can be representative of the initiatives to promote financial stability.  It is worth noting, however, that TARP was only one of many programs directed toward financial markets.  They range from other asset purchase programs to extension of FDIC insurance to non-bank liabilities such as money market funds.

All of them had as their guiding principle Bagehot’s dictum regarding the appropriate central bank posture during a financial panic.   The dictum is often summarized as lend freely at a high rate of interest on good banking securities.  Following the dictum is essential to the central bank’s roll as lender of last resort.  Those who object to the Federal Reserve's role as a lender of last resort would benefit from a fuller understanding of the context in which the dictum was developed.  The dictum was designed to provide guidance for ending a financial panic, but quoting it just in that context without noting the full statement is a disservice.  A more accurate characterization would add “and you are sure to make money.”  One should keep in mind that when Bagehot wrote LOMBARD STREET: A DESCRIPTION OF THE MONEY MARKET (1873) he was addressing the operation of the Bank of England which was a profit-making institution.  The advice was not designed to bailout anyone: it was designed to end panics and make money in the process.

Consequently, as early as October 2, 2010 it was possible to write a posting for The Hedged Economist entitled “TARP: A ,success not being acknowledged.”  That posting could cite data that made clear that efforts to ensure financial stability were far from a bailout.  Clearly, they were going to make money for the US government's Treasury.  Those who stick with the bailout terminology are clearly under the false impression that loans, regardless of the terms, represent a subsidy of some sort.  Lending money to individuals or organizations who can provide collateral and pay it back with interest is simply good business, not a subsidy.

Separating out monetary policy also clarifies who is receiving benefits.  Lumping zero interest rates and quantitative easing in with the TARP loans is absurd.  The principal beneficiaries of zero interest rates and the lower long-term interest rates generated by quantitative easing can legitimately be described as having been bailed out.  They have been bailed out in the sense that they are the beneficiaries of zero interest rates. 

Financial institutions are hardly the major beneficiaries of zero interest rates.  After all, the regulations under which they operate guarantee that they will hold a substantial amount of the low-interest government debt.  The WALL STREET JOURNAL on 10/15/2015 in an article entitled “$1.17 Trillion at Zero Percent Interest” pointed out: “Investors are handing the federal government a lot of free money.”  If anyone is being bailed out by zero interest rates, it is the federal government.  The near zero interest rates give the federal government the option to borrow the money that they lent to financial institutions at a profit.  Granted, the government could just as well have printed the money, but zero interest rates gave them an additional option.

It would be very easy to lose sight of the macroeconomic role of monetary policy by pursuing a totally useless witch hunt for who benefited from zero interest rates.  It is worth noting, however, that it is widely recognized that the macroeconomic benefits of expansionary monetary policy are often purchased at the expense of the banking industry.  The banking industry's current net interest margins strongly reinforce the impression that the benefits of expansionary monetary policy occur despite their negative impact on the banking industry.

Lumping the financial and monetary policy initiatives in with the fiscal policy effort is even more unfortunate.  The fiscal policy initiatives that spanned two administrations constitute a mixed bag even when taken alone.  The Hedged Economist spent all of September 2010 on postings addressing fiscal policy.  At the time, it was appropriate to refer to them as a failure.  But, they were a failure in terms of their own definitions of success.  They were not a failure in the sense of having no merit.

Alan S. Blinder and Mark Zandi provided one of the better analyses of the potential impact of the fiscal policy efforts.  At that point, their analysis was projecting what they felt the impact of the fiscal initiatives would be. Their analysis was the subject of postings on the Hedged Economist on 9/15 and 9/28/2010.  The postings explained reasons to believe that they were overestimating the impact.

At the time it seemed they were overestimating the potential impact.  The reason for feeling that was the case is summarized by the quote below, especially the portion of the quote highlighted in bold type:

“My concern is that the public will judge the effectiveness of fiscal stimulus by the Recovery Act. Stimulus started with Bush's approximately 200 B tax rebates to middle and lower income tax payers. But, the total over the two administrations is going to come in being well over a trillion dollars, probably in excess of $10,000 per household. Some partisans will also stick in any deficit and come up with multiple trillions….From my perspective, the issue is whether the multiplier stays linear as the size of the stimulus grows.

If the quote seems questionable, consider this: the opinion piece makes a comment that “But it was no coincidence that the Great Recession ended in June 2009, just four months after the Recovery Act’s nearly $800 billion-plus stimulus package was passed.”  It is clearly falling into the trap of assessing the fiscal measures as if the Recovery Act was the only fiscal initiative.  Further, while it contends that it is “no coincidence” that the recession ended four months after the Recovery Act, it fails to explain how the Recovery Act could produce that result before it had been implemented.

One does not have to disagree with their belief that fiscal stimulus contributed to the recovery.  Even if one agrees, as I do, that the beneficial impacts of fiscal policy are real, it is clear that demonstrating that relationship is far more complicated and subtle than recognizing the success of financial and monetary policy.  Further, the cost benefits analysis of fiscal stimulus is different from an acknowledgment that there were some benefits. 

Consequently, it would benefit Alan S. Blinder and Mark Zandi’s efforts to ensure that history gets this right, if they would focus on the most obvious successes.  That is especially true given that the most obvious success is the financial stabilization effort, and it is also the one most frequently mischaracterized as a bailout.  Fiscal stimulus has a natural constituency among liberals.  Monetary policy similarly has a constituency among monetarists.  But the only constituency for the financial stabilization efforts is the facts.

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