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Friday, May 7, 2010

Transcript: 380 Forecast Friday, Endogenous Money and News 0507

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Today on the podcast, Joseph Stiglitz introduction to his talk at INET -- the Institute for New Economic Thinking -- last month, followed by another look into endogenous money and how it blows up the pretenses of financial policy, and finally Forecast Friday. We've been swimming against the consensus that the economy is in recovery for nearly a year now. I don't see that we've been washed away yet.

But first the news. You don't come to Demand Side for news, but for information and an angle on economic theory.

But they do connect in the real world. If not, what we're doing is hypothetical, say, like market fundamentalism.

The stock market crash of Thursday and now into Friday has its roots, it seems in the high frequency trading. Incredibly, this practice of computerized trading which Goldman Sachs developed to get a jump on market moves was not shut down, even after Chuck Shumer's promises, and now accounts for more than half of the volume on some exchanges.

“We have a market that responds in milliseconds, but the humans monitoring respond in minutes, and unfortunately billions of dollars of damage can occur in the meantime,” said James Angel, a professor of finance at Georgetown University’s McDonough School of Business.

Indeed, it is the Demand Side view that the liquidity so thoughtfully provided by the Fed has financed positions in the market and these computerized algorithms have facilitated activity that is not substantial, all to inflate the market. The current experience is not just an air pocket, but an indication that the floor is made of imagination.

Next, the jobs report.

We get this from Barney Frank, commenting on the April Jobs Report:
“The significant increase in jobs for April, added to the upward revision for March, marks the beginning of a recovery from the job-killing Bush recession. More than a half million jobs have now been created in the last two months, which if we take further steps to build on this progress means an annual job increase of well over three million."

This statement marks a reversion to the Bush era happy talk. Let's agree that the return to the job market which let the unemployment rate rise at the same time jobs were added, is the mirror image of the departures from the job market that kept the rate low in spite of month after month of job losses.

And we are happy to report that our prediction earlier in the week that oil prices would weaken as a result of the catastrophe in the Gulf has come true in real time. Oil is now at $76 instead of $86.

Finally, for some comic relief. The first voice you hear is the BBC's Andrew Walker. The second is the IMF's deputy managing director John Lipske. The exchange occurred after Lipske explained how shrinking the Greek economy at the command of the financial markets was a painful, but necessary adjustment.


Don't look into the past, but learn. But we're learning. Pretty rich. What we're going to learn -- again -- is that the Neoliberal prescriptions don't work. Also watch Ireland, which has swallowed the medicine with more grace than Greece. I guess one of the reasons we don't do more news is our disgust that the policy controls are still in the hands of the engineers who ran the train off the track in the first place.

On tomorrow's relay we'll have the full talk from Joseph Stiglitz at the kick-off of the Institute for New Economic Thinking which took place at King's College Cambridge April 8 to 11. Here is his introduction:


Joseph Stiglitz, who goes on to discuss the failures of particularly monetary policy models and assumptions. Get the full Monty tomorrow on the relay.

Another mind with a full grasp of the limitations of standard monetary theory was Hyman Minsky, and we'd like to recall today some of his insights.

One key to understanding what went wrong with monetary policy is that the money supply is substantially endogenous and the monetary policy authorities pretend the Fed makes the money.

Backing up. One of the favorite economic theories of the 1980s and 1990s was Rational Expectations. We see now the absurdity of this hypothesis that economic actors understand the effects of macro events and move to counter them. Most famously, individuals will see that government deficits mean higher taxes in the future and so will save more now and frustrate the intended stimulus effect of tax cuts.

Yes, that was the official rational expectations line. That was the belief system of many of the economists who are now in positions of policy power.

But if we say that rational expectations does not hold for the population at large, at least it might hold for the economically sophisticated. That is the bankers and corporations with vital interests in the affected markets. Well, no, we have seen that euphoric expectations seems to have influenced many of these, and more to the point, it was in the rational interests of these bankers to ride the wave upward, since they only collected bonuses, accolades from management and advanced in their careers, while those with more caution got the sack. But if not bankers, Why not the Fed? Surely the Fed can keep to its mission to avoid calamity by reining in the money supply when things get too hot.

And lets further pretend the Fed actually restricted reserve growth. Banks with insufficient reserves to fuel their part of the boom have two options -- borrowing either from the discount window or on the private money market.

Here following from Gary Dymski and Robert Pollin.
"Because of the high frwon costs associated with discount window borrowing, banks generally opt to raise funds from the money market. In the money market, financial institutions with excess reserves will lend to those with reserve shortages, either through repurchase agreements, the federal funds market, CDs, the eurodollar market, or some similar avenut -- that is, through the set of practices known as 'liability management'

It is easy to understand how a single institution could meet its reserve needs in this way. Whether rising credit demand in the aggregate can be accommodated through the private money market, however, is another question. Minsky argues that through increases in the velocity of circulation, rising credit demand can be met to a considerable degree within the private money market."
Indeed, this use of innovations IS THE VEHICLE THROUGH WHICH VELOCITY RISES.

Velocity is the V in the monetarist equation PQ = MV. PQ is price times quantity, or output. MV is money times velocity, the rate at which it turns over. As we've noted before, Monetarists like Friedman wanted to ignore V so money would be a lever of control. But V can be one or one hundred, so the size of M is not relevant.

Steve Keen has a simple model which explains a lot which has a key element the observation that as one entity lends it creates cash accounts in the borrowing entity, as well as those of its employees and suppliers. These create reserve capabilities and tend to abet the boom.

What is true of the boom is true of the bust, and vice versa. We should expect the various plans for reining in the money supply so forcefully argued by some at the Fed to fall flat when put in practice, should a boom occur. On the other hand, the painful lessons of the bust may favor the more sober voices, should they ever get back to positions of prominence.

On Forecast Friday today we bring up the embarrassing fact that we have still not called an end to the recession that others picked for June of 2009. And in fact, we suggest that with weakness in the next few quarters, the consensus will shift back in our direction.

May not happen.

On the other hand, it's ten months of hanging out there without being chopped off yet.

Here is a mainstream view from Calculated Risk.
There are several analysts forecasting GDP growth to pick up in the 2nd half of this year, with annual GDP growth of over 4% for 2010 (the advance Q1 GDP estimate was 3.2%, so over 4% for 2010 would require a nice pick up in the 2nd half). This is not a "v-shaped" recovery - that didn't happen - but these forecasts are still above trend growth.

Unfortunately I think we will see a slowdown in the 2nd half of the year, but still positive growth. Last year I argued for a 2nd half recovery ... and that was more fun!

Here are a few reasons I think the U.S. economy will slow:

1) The stimulus spending peaks in Q2, and then declines in the 2nd half of 2010. This will be a drag on GDP growth in the 2nd half of this year.

2) The inventory correction that added 3.8% to GDP in Q4, and 1.6% to GDP in Q1, has mostly run its course.

3) The growth in Personal Consumption Expenditures (PCE) in Q1 came mostly from less saving and transfer payments, as opposed to income growth. That is not sustainable, and future growth in PCE requires jobs and income growth. Although I expect employment to increase, I think the job market will recover slowly (excluding temporary Census hiring) because the key engine for job growth in a recovery is residential investment (RI) - and RI has stalled (until the excess housing inventory is reduced).

4) There is a slowdown in China and Europe has some problems (if no one noticed) ... and that will probably impact export growth, and also negatively impact one of the strongest U.S. sectors - manufacturing (when was the last time manufacturing was one of the strongest sectors?)

Of course monetary policy is still supportive and it is unlikely the Fed will sell assets or raise the Fed Funds rate this year. Maybe some commodities like oil will be cheaper and give a boost to the U.S. economy ... maybe the saving rate will fall further and consumption will continue to grow faster than income ... maybe residential investment will pick up sooner than I expect ... maybe. But this suggests a 2nd half slowdown to me.
As we covered above, monetary policy is not in the hands of the Fed, no matter what conventional wisdom says, so we can expect monetary easing to have no effect. The money supply will increase when there is demand for money. Sez demand side.

Personal consumption expenditures and GDP should be tracking generally, net the noise of the inventory correction, neither displaying the health of the economy, both marking activity rather than vitality. There is no substantial investment, no dramatic long-term development of infrastructure, energy, education or other public good, so there is no recovery possible. As we've said, investment must be the base, and there will be no investment from the private sector.

1 comment:

  1. The US economy will have problems for a while. Housing investment may not recover for a considerable period. Then there will be the release of the shadow housing stock, that will depress prices further and delay any further investment.

    As for investment, with the banks still trying to rebuild capital they are not lending or not at interest rates that will actually be taken up. If the sovereign debt crisis continues then end user rates will continue to rise.