A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Tuesday, October 13, 2009

Demand Side Forecast: No V, No W, No square root

Our forecast has not changed over the past six months, so we have not drawn too much attention to it. Today we will, along with an explicit description of the current state of the economy and the obstacles to a complete recovery. Forecast: Stagnation. Currrent State: Failing. Obstacles: Continued Fed Obtusess, Unwillingness to pay bills in cash, and the Meanness that arises from a general Me-ness.

We will expand from these brief descriptions in the forecast section of today's podcast.

Later we will dig a bit deeper into the Fed on Idiot of the Week, and we have comment on the Taylor Rule and other nonsense, taking off from Paul Krugman.

First, though, complete and unedited, the statement by Barack Obama on the Financial Products Safety Commission. We view this new regulatory body as essential to moving out of the current case of market domination by big banks and bad practice.

As we've said before, this is a non-intrusive means of regulation. This has nothing to do with audits, pay restrictions, capital requirements, or any of your back rooms. One must ask Why the big banks have marshaled their money and purchased representatives in opposition to such a bill. As I said, it is not intrusive. One is examining products, not producers. Legitimate real economy firms welcome such consumer safety regulation as a way of weeding out the less competent and presumably less well-funded and at the same time increasing confidence among purchasers.

We suspect that it is precisely because such a financial products safety commission would bring order to the market and prevent exploitation by the well-positioned that it is being resisted by those well-positioned. And we are extremely pleased that Obama has invested political capital in this venture. Here he is, beginning with a calling of the roll.


Barack Obama

If nothing else, the current crisis has demonstrated how thoroughly the financial sector has captured its main regulator, the Fed. This new agency is an important escape from that corrupt arrangement.

Now. The Forecast.

First let's line up the opposition.

The consensus of economists suggests recovery proceed before too long into an equilibrium of high unemployment and lower trend growth, what I will a recovery, that is, slight improvement, into stagnation. Not a V-shaped, not a W-shaped, but a square root shaped -- down, up and out at a lower level.

This is mistaken because of the stable tail.

Another camp, primarily at the Fed, predicts a somewhat stronger rebound and posits a danger, even mortal danger, from an inflation arising from the need to unwind the Fed's injections of liquidity with a fire hose.

These guys have long been clueless and serve only as powerfully placed voices standing ready to sabotage any real recovery in the real economy.

The true context for policy is an economy that is highly fragile and posed for another leg down. The financial sector is a millstone, the zombie banks are hardly rowing, and the prospect of further weakness in residential and commercial real estate and continued negative contributions from derivative and commodity speculation are already on the charts.

Specifically, zombie banks are profitable because they are gouging consumer credit users, playing in commodity and futures casinos, and eating the interest payments from the toxic securities which are still on their balance sheets. The financial sector is not enabling productive investment activity because they don't have to. They have the government. Besides, the prospect of profit from new investment in the context of overcapacity and a retreating consumer is very low.

Aside from propping up the zombie banks and other formerly private sector markets, the Fed's policy has done nothing. There are no more bubbles to blow up, even at zero percent, that will generate private investment. No more high tech booms, no more residential housing booms, no more commercial real estate booms. There are only financial market casinos to play in. Fine if you have the zero percent chips and are playing with the house, but for people looking for productivity in the real economy. Not so much.

The only route to real recovery and a return to strong growth is through the Demand Side. Only with a renewed job market and a recovery of incomes can we escape the blunders of the past few decades. As we've said, this demand side recovery does not need a return to the consumer economy. The consumer economy, after all, was premised on borrowing and the idea of selling houses back and forth to each other. Consumer baubles large and small were the end point of this economy.

The public goods of infrastructure, education, public health and climate change mitigation are ample and productive occupations that can support prosperity. As incomes grow, the overcapacity of the private sector will shrink. But more to the point for private investment, a new emphasis on public goods opens new industries where there is currently NO overcapacity and where new investment would not be redundant. (To be clear for the simple, spending on public goods is income to private economic actors, whether employees or contractors.) These types of industries are very much not currently dominated by foreign industry. Health care, education, domestic infrastructure, energy retrofitting, reengineering transportation and energy and information infrastructure. All domestic activities. All productive activities, in that they generate improvements in the productive framework. These are not BMW's or flat screen tvs or perfume in one hundred dollar bottles.

Three main obstacles are likely overwhelming, however.

1. Fed intransigence in its error.
2. Political opposition to paying cash for public goods, and
3. A social psychology which believes the good of the whole is code for taking away from me.

The Demand Side way out is really the only way out. And that's why we've outlined it here in the context section. Insofar as the path diverges from this prescription, and by the same dimension, it will be a reduction from the optimal outcome.

The three main obstacles are likely overwhelming, however.

Demand Side is not revolutionary in the sense it is new or complicated, but only because it is fundamentally separate from these errors.

Oh, and four, such a solution likely means inflation in non-core commodities like energy and food. That is because any investment-led growth would mean inflation, as we read Minsky. No less investment-led growth tied to public goods. In the early stages, such inflation would be very mild. In every stage it could be controlled by tax policy -- by reducing inflationary demand via increases in taxes. (This would make sense in that we have bills to pay, but see below.)

But lets go back to one through three.

One, the Fed stands ready to kill any recovery with monetary policy. We have hammered the Fed elsewhere and we have debunked the effectiveness of monetary policy relentlessly. We will do it again next week, but soon we will begin to leave them alone, not because they are unimportant or are gaining a new comprehension, but because they are hopelessly wedded to their doctrines.

Two, Consumer and mortgage credit inflated the housing bubble. It may take public borrowing to create the public goods that can lead us forward. But not because it is necessary or advisable, only because it has been one of the signal successes of the Rovian or Reagan Right to turn the word "taxes" into a synonym for "incest." Since taxes are the way we pay for public goods in the absence of deficit spending, the prospect of paying outright is diminished. One of the continuing marvels of this age is that the non-results from tax cutting fevers have been ignored. The rhetoric continues that cutting taxes will lead us to water even as we go further into the desert.

Three. The Me culture. To some extent "Don't tax me" is a function of this broader "Me" culture. The focus on consumerism and the consumer is also a function of this "Me." And the resistance, as before, to strengthening the whole is very often an affirmation that what is mine is what is most important.

In previous generations, the influence of and dependence on family was felt strongly. Community was essential. "Me" was impolite, at best. The religeon of primitive economics is 180 degrees divergent. Greed is good. Getting what I can is not only all right, it is of positive benefit to everyone. Beliefe that strong community, stable environments, planning, and public goods produce a positive sum game is viewed as dangerously naive. So we keep digging.

All Right. All right. Forecast.

Yes, if you've noticed, we've drawn back in from DemandSide dot net to get more proprietorial. We've decided if we're going to be right, we should look into getting paid for it. Nevertheless, we'll be dropping those charts back onto another vehicle soon, for those of you who have been cribbing off our work.

Forecast continued recession.

The happy talk on Wall Street of recovery is based on a definition of recovery as two successive quarters of positive GDP growth. This is, of course, not a very sophisticated description of the economy, and it is not the formula used by the NBER when they make their official determination. If it were, they wouldn't need twelve months. It is our belief that even considering the strong political winds now blowing in favor of quote recovery unquote and the flimsy increase in activity that is needed to justify such a determination, the NBER will not be persuaded to declare recovery in the same quarter as rising unemployment and continued industrial stagnation.

Our Demand Side descriptions are not recovery and recession, which have peculiar and not well understood technical definitions, but on the three levels of failing, weak and strong economies. The current situation is failing.

We have the stimulus and recovery potential of the Recovery Act on one hand. On the other, we have the negative stimulus of no private investment and contracting state and local governments.

Specifically, real GDP growth will be somewhat volatile around zero. Nominal GDP volatile around 1.5. Unemployment in the narrow measure will continue to trend upward into 2010. Unemployment in the broad U-6 measure will go up less quickly than it has over the past 18 months, but at a steeper slope than the narrow measure.

We have a idiosyncratic measure called Net Real GDP, which is essentially GDP minus the federal deficit needed to make it happen, that will continue to decline. That will likely be our first chart up on the new site.

Demand Side does not see forecasts as a crap shoot, which is the consensus view, but as the evidence of understanding. Neither do we put stock in precision. Better to be approximately right than precisely wrong, as John Maynard Keynes said. Nor do we see economic outcomes as independent of policy choices. All of which creates a different platform than the typical statistical model based forecasts.

(We notice Ellen Zentner, a chief advocate of "The recovery began in June" camp, reserves the right to tweak forecasts up to the day before the next official data come out. This displays sensitivity to statistical trends, but not really forecasts.)

So, having been right, we will continue to tell you about it until we are wrong. Not a V. Not a W. Not a square root. There is upside, but not until the employment situation has been fully addressed and the drag from the financial sector's systemic meltdown is cut away. There are upturns on the charts, and strong ones, but these depend on policy choices not yet made. Until then, it is the Great Stagnation, with a distinct risk of another leg down.

1 comment:

  1. Great article.You have provided some unusual politics movements to us.The forecast is interesting.