Thursday, September 2, 2010

What Can Be Done to Hasten the Recovery?

I believe the Fed can and should be doing more to create a more stable macroeconomic environment.  There is much they can yet do to stabilize aggregate spending and improve economic certainty.  However, even if we were to get this from the Fed it still would not solve all our economic problems. We are in the midst of a massive deleveraging cycle by households and unless something radical happens like swapping  the underwater portion of household mortgages for equity  this process will probably take years to unfold. Ken Rogoff reminds us of this point in a recent article:
What more, if anything, can be done? The honest answer – but one that few voters want to hear – is that there is no magic bullet. It took more than a decade to dig today’s hole, and climbing out of it will take a while, too. As Carmen Reinhart and I warned in our 2009 book on the 800-year history of financial crises (with the ironic title “This Time is Different”), slow, protracted recovery with sustained high unemployment is the norm in the aftermath of a deep financial crisis.
The only palliative he sees is higher inflation:
Given the massive deleveraging of public- and private-sector debt that lies ahead, and my continuing cynicism about the US political and legal system’s capacity to facilitate workouts, two or three years of slightly elevated inflation strikes me as the best of many very bad options, and far preferable to deflation. While the Fed is still reluctant to compromise its long-term independence, I suspect that before this is over it will use most, if not all, of the tools outlined by Bernanke.
I too don't want to comprise the Fed's long-run inflation credibility.  That's why I want a NGDP  level target (my first choice) or price level target (my second choice... I really don't like this one but I will settle for it). It would create some higher (catch-up) inflation until we hit some target level and stabilize thereafter. If this policy were made explicit it would do much to stabilize economic expectations, a big plus in our current mess.  Again, this will not fix our structural problems, but it would create a more stable macroeconomic environment in which to make the needed structural adjustments.  Now if we could get more discussion on  proposals to hasten the restoration of household balance sheets, such as the one to swap underwater mortgage debt for equity, maybe the structural adjustments could  be expedited too.

1 comment:

  1. The most effective policy initiative would be a full court press aimed at reversing the tidal wave of regulation that Bush and Obama have unleashed on the private sector and state/local governments. This cuts government spending, increases tax revenues, reduces the cost of living, increases consumer spending and accelerates business investment.