Having heard the “historic” Press Conference held by Ben Bernanke, the Chairman of the US Federal Reserve Bank (April 27, 2011), I confirm the advice I gave on December 20, 2009 that – Bernanke should quit or be sacked. During that conference he chose to wade into the fiscal policy debate claiming that the priority of the US government was to reduce its budget deficit by cutting spending. He gave no justification for those statements and there is no supporting research paper available which might give us a clue as to the rationale for this extraordinary intervention into the policy debate. The fact is that Bernanke is another mainstream macroeconomics stooge who in my view has chosen to abuse his position of power to misinform and distort the policy debate. It is clear that the US Federal Reserve chairman has lost his independence and even mainstream economists who put the concept of independence on a pedestal of virtue should be calling for his resignation.
The UK Guardian provided a blow-by-blow account of the Bernanke Press Conference today.
The Press Release (April 27, 2011) from the Federal Open Market Committee explaining their monetary policy action said:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
In other words, they are not predicting that unemployment is going to fall very fast.
Much is being made of the historic nature of this event – being the first regularly scheduled press conference in the Federal Reserve’s 98-year history. I think history is very important and transparency like this is compelling.
But it also brings out in the open how the Chairman of the US central bank thinks and sadly that isn’t very compelling. He is basically a mainstream economist who adopts all the neo-liberal myths that go with that status.
There was a lot of talk at the Press Conference about the inflation threat and Bernanke claimed the US was running out of trade-off room – between inflation and real output growth. Those remarks seem like dogma when you get behind the projections they provided (see Table below).
The projections forecast a benign core inflation environment over the next three years and an unemployment rate well above their “longer-run” rate.
So the discussion moved to inflationary expectations? But with relatively modest growth and large pools of idle capacity, why would anyone think inflationary expectations would be diverging from the low core inflation outcomes at present. Even mainstream economic theory separates transitory factors such as energy price spikes from core trends.
The Cleveland Federal Reserve Bank publishes estimates of inflationary expectations. Their latest data shows that inflationary expectations are benign and trending downwards. So even if you believed the mainstream view that inflationary expectations will drive spiralling prices when there is deep tranches of idle capacity, you could not mount that case at present.
So I see no basis for the statement that the “trade-off” is becoming harder. There is plenty of non-inflationary (core) real growth potential in the US economy at present and fiscal policy should be used to generate that and to more quickly reduce the unemployment rate.
The Federal Reserve Chairman admitted that:
We don’t have any tools for targeting long term unemployment specifically.
Which is true and that is why monetary policy should be subjugated by fiscal policy to fulfill the obligations of government to create an environment of full employment and price stability which the FOMC claims is their central charter.
I noted with disgust that he was claiming long-term unemployment was a “structural” problem that required specific labour market (supply-side) policies to address.
The evidence from a number of studies (including my own research) is that when the economy grows fast enough jobs are gained not only by those in the short-term unemployment pool but also those who are long-term unemployed.
The supply-side approach pushed by the OECD Jobs Study has failed badly to reduce unemployment since it became the status quo in the early 1990s.
Long-term unemployment is a problem of insufficient jobs and that is a policy choice of government.
While mainstream economists claim that the central bank should be independent (from the legislature) it seems that it is fine for the central bank chairman to make statements about fiscal policy which are controversial and reinforce one side of politics. Bernanke’s statements today about the US budget deficit were nothing short of disgraceful.
The real crunch came when he was asked about the S&P shenanigans of last week. He said that:
Well, in one sense S&P’s action didn’t really tell us anything. Anybody who read a newspaper knows that the United States has a very serious long-term fiscal problem.
That being said I’m hopeful that this event will provide at least one more incentive for Congress and the administration to address this problem. I think it’s the most important economic problem at least in the longer term that the United States faces.
We currently have a fiscal deficit which is simply not sustainable over the longer term. And if it is not addressed it will have significant consequences for financial stability, for economic growth, and for our standard of living.
It is encouraging that we are seeing efforts on both sides of the aisle to think about this issue from a long run perspective. It is not a problem that can be solved by making the case only for the next six months. It’s really a long-run issue.
He also claimed that addressing the deficit is a “top priority” and that the Congress has to “make credible commitments to cutting programs”. He emphasised the long-run problem but said that if “changes are focused entirely on the short-run then it will have negative consequences for growth”. I will come back to that point.
But in making these statements he is on the one hand he is giving undeserved credibility to S&P when he knows that their input is irrelevant (ultimately) and that the ratings agencies have been found to be corrupt organisations carrying major culpability in terms of the current crisis.
He knows full well that S&P have no power over governments. The US central bank can effectively set interest rates. Yes, it would have to be prepared to purchase all the bonds on offer should bond markets decline to participate in the tender – but so what? Japan showed in the early 2000s how meaningless the sovereign debt ratings of the agencies are.
The raters can hold an EMU nation to ransom because everyone knows these governments face a default risk given they surrendered their currency-issuing monopolies. But the currency issuing monopoly that the US government posseses is exactly the reason why the raters are irrelevant.
Bernanke is also prepared to give unwarranted oxygen to the deficit terrorists who have built a destructive narrative based on the myths about budget deficits without fully explaining his position.
Apparently, the American “newspapers” provide factual explanations of fiscal policy which are beyond dispute. I found that inference to be disgraceful. I rarely read anything that is worthy of merit in the financial press. The electronic and written media, particularly in the US, provides a barrage of misinformation and wheels our mainstream economists on a daily basis to reinforce this deception.
Bernanke claimed there would be “significant consequences for growth, financial stability, standards of living etc” unless the deficits were cut. But that is as far as he went. That represents an abuse of his position.
He should have been compelled to spell out how he thinks that will happen. As it stands, he was just mouthing the erroneous textbook mantra’s that students are fed in the mainstream macroeconomics classes all around the world. It is the same mantra that helped create the crisis and is currently ensuring the negative consequences are dragging out for the next several years.
There is no credibility in that position.
He admitted (as above) that if deficits were cut now there would be adverse consequences for economic growth which would jettison the Fed’s projections.
But then you have to ask what is the long-run? This is a construct mainstream economists use to justify their belief that deregulation and balanced budgets will provide optimal outcomes after all the short-run fluctuations are exhausted. It is a construct that allows them to sit back in their secure jobs while they advocate policy positions that destroy growth and drive up unemployment.
“Don’t worry”, they say, “It will be fine in the long-run”.
I especially liked the view that the great Polish economist Michal Kalecki took on this charade. In his 1933 book – An essay on the theory of the business cycle, Kalecki outlined a very sophisticated theory of effective demand (prior to Keynes’s General Theory – which was published in 1936 and popularised the notion that business cycles moved in response to effective demand fluctuations. Kalecki had got the notion from the works of Marx.
His macroeconomic model – which still stands scrutiny today and puts the mainstream textbook models to shame – showed how capitalism was essentially unstable and prone to cycles.
One of the contributions of this work was a repudiation of the notion of a “long-run”. Kalecki constructed the concept of a “short period-equilibrium” (where change was suspended temporarily). He considered capitalism was pronte to generating periods of mass unemployment without any innate tendency to correct that malaise. This clearly was in contrast to the mainstream notion that markets were self-correcting.
But he also considered the “long-run” to be just a sequence of short-runs. You are where you have been!
The reality is that if deficits are reduced now – the long-term growth path is compromised. Bernanke is in denial about that and offered no clue as to how you have fiscal contraction expansion. That is the same myth that the British government is propagating and real GDP growth has been virtually zero since they took power.
The Federal Reserve Projections
Here is the Table describing the US Federal Reserve Bank’s latest projections – released today for the period 2011-2013.
To put those projections in context, the following Table provides five-year average growth rates for labour productivity, the labour force (data from the US Bureau of Labor Statistics and real GDP (data from US Bureau of Economic Analysis) for five-year periods back to 1975. It provides an historical reality check for those who think that the US can growth, for example, at 4.2 per cent indefinitely. It hasn’t achieved that growth trajectory for any extended period in the last 35 years.
I also wanted to do some analysis of their unemployment rate projections. The great American economist Arthur Okun left some very useful concepts indelibly etched on those who appreciated his work. I should add he was a mainstream economist who supported Keynesian demand-stimulus policy when unemployment was high. He also brought a very applied bent to the profession and had a good feel for the underlying statistics and interrelationships between them. He taught me a lot when I was a young academic and student.
One such concept was his rule of thumb about the way unemployment reacts to growth. He developed what has become known as Okun’s Law arithmetic to estimate the deficiency in GDP growth which leads to rising unemployment rates. Okun’s Law (it was in fact a statistically estimated relationship with stochastic variation) is the relationship that links the percentage deviation in real GDP growth from potential to the percentage change in the unemployment rate.
The algebra involved in the conceptualisation of this “law” can be manipulated to come up with a “rule of thumb” which is a way of making guesses about the evolution of the unemployment rate based on real output forecasts.
What is a rule of thumb? It is not a rigid exact relationship. There are no such relationships in social sciences. It is rather a recognition that labour market and product market aggregates are intrinsically linked by construction and behaviour and over time allow us to make guesses about the future of one variable based on the evolution (hypothesised) of other variables.
Here is a simple explanation of this rule of thumb. We can relate the major output and labour-force aggregates to form expectations about changes in the aggregate unemployment rate based on output growth rates. A series of accounting identities underpins Okun’s Law and helps us, in part, to understand why unemployment rates have risen. Take the following output accounting statement (which is true by definition and not a matter of opinion or conjecture):
(1) Y = LP*(1-UR)LH
where Y is real Gross Domestic Product, LP is labour productivity in persons (that is, real output per unit of labour), H is the average number of hours worked per period, UR is the aggregate unemployment rate, and L is the labour-force. So (1-UR) is the employment rate, by definition.
Equation (1) just tells us the obvious – that total real output produced in a period is equal to total labour input [(1-UR)LH] times the amount of output each unit of labour input produces (LP) .
Using some simple calculus you can convert Equation (1) into an approximate dynamic equation expressing percentage growth rates, which in turn, provides a simple benchmark to estimate, for given labour-force and labour productivity growth rates, the increase in output required to achieve a desired unemployment rate.
Accordingly, with small letters indicating percentage growth rates and assuming that the hours worked is more or less constant, we get:
(2) y = lp + (1 – ur) + lf
Re-arranging Equation (2) to express it in a way that allows us to achieve our aim (re-arranging just means taking and adding things to both sides of the equation):
(3) ur = 1 + lp + lf – y
Equation (3) provides the approximate rule of thumb which in English says that – if the unemployment rate is to remain constant, the rate of real output growth must equal the rate of growth in the labour-force plus the growth rate in labour productivity.
Remember that labour productivity growth reduces the need for labour for a given real GDP growth rate while labour force growth adds workers that have to be accommodated for by the real GDP growth (for a given productivity growth rate).
It is an approximate relationship because cyclical movements in labour productivity (changes in hoarding) and the labour-force participation rates can modify the relationships in the short-run. But it should provide reasonable estimates of what will happen once all the cyclically-sensitive components of the economy return to more usual values.
For example, labour participation rates in the US prior to the downturn were around 66 per cent whereas over the 11 months in 2010 for which data is currently available the average was 64.6 per cent. The average over the entire period 2000-2010 was 66 per cent. So in the short-term as growth strengthens we will expect the labour force participation rate to rise again back towards 66 per cent or thereabouts.
In other words, the labour force growth in the short-run will be more brisk than it will be once growth is sustained which will tend to mean our rule of thumb will overestimate the decline in the unemployment rate in the short-term although over a longer period the rule of thumb will be more accurate.
So I applied this arithmetic to the US Federal Reserve Bank’s latest projections outlined in the Table above. I created the following Tables based on the low and high (central tendency) projections from the US Federal Reserve and added plausible assumptions about labour force and productivity growth rates for 2011, 2012 and 2013. The Tables show what the annual change in and the year-end unemployment rate would be under these assumptions.
In January 2011 the US unemployment rate was 9.7 per cent. So if there is a drop of -0.6 points over the course of 2011 then it would end the year around 9.1 per cent.
The labour force and productivity growth assumptions are plausible and conservative. The bias is to understate the magnitudes under the assumption that there is real GDP growth of the stated magnitudes.
So the Required real GDP growth rate is at the bottom end of plausibility under these conditions.
The High real GDP growth results are not plausible given the history of the US economy over the last 3 decades or so. Notwithstanding the damage that cutting the deficit will cause, the US economy would struggle to maintain real GDP growth at 4.2 per cent in 2012 and 4.3 per cent in 2013. But if it did, then I largely agree with the US Fed’s projections that the unemployment rate would come down to around 6.8 per cent by the end of 2013.
Even the low real GDP growth assumptions are optimistic given the way the political process is heading at present. But they give a much more sobering view of things. By the end of 2013, under these assumptions, the US economy would still have an unemployment rate of 8.5 per cent – so a very long and drawn out recovery without much opportunities for workers to improve their job prospects.
I do not agree with the Fed’s projections here that the unemployment rate would be at 7.2 per cent by the end of 2013. Even if their projections were accurate it would still represent a disgraceful abdication of responsibility for the elected representatives to allow unemployment to remain so high for so long.
Remember the government chooses the unemployment rate every week of every year. It can lower the unemployment (to some irreducible minimum) whenever it wants to by directly creating public sector jobs.
Just to see what the evolution of the unemployment rate would be under these assumptions I constructed the following chart. So assuming that the US Fed’s lowest central-tendency growth assumption for 2013 persists (that is, 3.5 per cent real GDP growth per annum) and the labour force and productivity growth assumptions in the previous table are maintained, the blue line shows what the unemployment rate trajectory would be. By 2024, the unemployment rate would reach what the Fed calls the longer-run rate of 5.2 per cent.
Using the logic adopted by the Federal Reserve (NAIRU-mentality) there would be no inflation threat emanating from the labour market over this period (to 2024) because the actual unemployment rate would remain above the “longer-run” rate – that is, the NAIRU.
This is an enormously long period of time for policy authorities to allow the unemployment rate to be so high.
The more likely assumption is that the political malaise that is crippling policy making in the US at present and will bias the outcome to fiscal withdrawal, aided and abetted by the moronic and patently false assessments provided by the Federal Reserve Chairman, which will diminish the US real growth prospects.
Depending on how savage the ultimate cut-backs are the simulated unemployment rate would likely represent the lower envelope that I would expect.
To all the unemployed Americans who cannot get a job because there is not enough spending to invigorate real output – and hence employment growth you can blame the government for your plight.
I guess that is the government extended to Wall Street. I did an telephone interview for a US network today and outlined some ideas in a book I am writing at present where I detail how democracy has been usurped by the top-end-of-town. More later perhaps on that theme.
The point is that if the US Congress follows Bernanke’s advice to make deficit cutting the priority, then these projections will not be achieved. As they stand – they lock the US labour market into an unacceptably high unemployment situation for the next several years.
If growth falters – then the situation will be even more dire.
Bernanke offered no clue as to how deficit reduction will also be consistent with those projections. He failed in his main task.
That is enough for today!