The Federal Reserve Chairman Ben Bernanke gave a speech entitled – Economic Challenges: Past, Present, and Future – on April 7, 2010 in Texas. It emphatically demonstrated why he should never have been appointed to the position he is in and why his reappointment just compounds that initial mistake. While he has been largely quiet on fiscal matters over the last few years this speech outlines without doubt that he doesn’t really understand the monetary system he supervises and has an understanding that is seemingly limited to that found in any erroneous mainstream macroeconomics text book. The only other interpretation is that he does understand the system yet chooses to deliberately deceive the wider public so as he can support ideological attacks on government activity. Either way, he is part of the problem we face.
Bernanke notes at the outset that while “(d)uring some of the worst phases of the crisis, a new depression seemed a real possibility … today the financial crisis looks to be mostly behind us, and the economy seems to have stabilized and is beginning to grow again”. I think that is a fair assessment.
But as he notes “we are far from being out of the woods”, many people everywhere “are still grappling with unemployment or foreclosure, or both. Cities and states are struggling to maintain essential services. And, although much of the financial system is functioning more or less normally, bank lending remains very weak, threatening the ability of small businesses to finance expansion and new hiring”.
So that all sounds to me as though there is a continuing need for expanded fiscal support to ensure that all those who want to work can find employment and generate the income necessary to keep paying their debts. While the sub-prime mortgage crisis started to impact in the second-half of 2007, which was prior to the escalation in unemployment in early 2008, the latter drove the former through 2008 and 2009.
This Washington Post article from 2009 says:
The country’s growing unemployment is overtaking subprime mortgages as the main driver of foreclosures, according to bankers and economists, threatening to send even higher the number of borrowers who will lose their homes and making the foreclosure crisis far more complicated to unwind … During the first three months of this year, the largest share of foreclosures shifted from subprime loans to prime loans, according to the Mortgage Bankers Association. The change to prime loans — traditionally considered safer — reflects the growing numbers of unemployed who are being caught up in the foreclosure process, economists say.
So the initial crisis would have been significantly attenuated had the government put a ceiling on the rising unemployment. Once a growing number of people could no longer afford to pay their commitments the mortgage crisis escalated. The failure of the US government (and almost all national governments) to prevent the rise in unemployment via appropriate fiscal expansion targeted at job creation caused the crisis to persist.
Bernanke’s speech was focused on “the origins of the financial crisis and economic downturn, with a particular focus on the policy response of my institution, the Federal Reserve … [and the] … near-term and longer-term challenges facing our country”.
I won’t say much about his view on the origins of the crisis. By way of summary he thinks:
- “The financial crisis that began in the summer of 2007 was an extraordinarily complex event with multiple causes. Its immediate trigger was a downturn in the national housing market that followed a long period of rapid construction and rising home prices.”
- “The housing slump in turn brought to light some very poor lending practices…”
- “… the shadow banking system … proved deeply flawed.
- The dispersal of credit risks by securatisation and the “use of derivative financial instruments such as credit default swaps” and no-one “fully appreciated the risks that those securities entailed.”
- “These risks grew rapidly in the period before the crisis” and the “significant gaps in the regulatory framework itself also contributed to the inadequate government response”.
- “… the unraveling that began in the summer of 2007 and continued throughout 2008 … [and] … “investors – stunned by the resulting losses … pulled back from a wide range of credit markets and financial institutions. As funding dried up, losses mounted, and confidence plummeted, a number of major financial firms, both here and abroad, came under severe pressure”.
- Major financial institutions collapsed and significant government intervention – bailouts, managed sales etc was required.
- “The rapidly worsening crisis soon spread beyond financial institutions into the money and capital markets more generally … [and] … Equity prices fell precipitously, large firms and banks hoarded cash, and short-term credit became available, if at all, only at very high interest rates and for very short terms”.
- By now the financial crisis was becoming a real crisis as “(b)usinesses slashed production and payrolls, including in countries that had not thus far experienced much effect. International trade collapsed, and many nations dependent on trade experienced even sharper slides in economic activity than the United States.
If you read my blog from early last year – The origins of the economic crisis – and subsequents blogs you will realise that I think Bernanke’s view of the crisis is very superficial and does not go to the heart of the problem which he himself is part of.
The crisis has it origins back in the 1970s when the OPEC oil price shocks led to a change in the dominant macroeconomic paradigm from Keynesian to Monetarist (which has morphed into other schools of thought just as evil). In this broadly neo-liberal era, the fundamental changes to the distributional system – via the attacks on unions and the redistribution of national income to profits was a fundamental building block of the current crisis. For it presented the capitalist system with a realisation problem.
If you are going to cut workers wages and entitlements and keep real wages subdued while productivity growth was strong then how were the goods and services being produced going to be purchased and consumed? Answer: bring in the financial engineers who loaded the workers up with debt.
But how did they get to have so much room to move? Answer: deregulate the financial markets and make it easier for the big banks and hedge funds to grab an increasing share of real income. The fact is that these industries are mostly unproductive and so had to be given government support (via deregulation etc) to get access to their increasing real income shares.
What other things helped? Answer: privatisations also gave financial markets assets to expropriate and speculate on.
Then top all this with the fundamental shift in macroeconomic policy-making during this period away from the dominance of fiscal activism which was aimed at maintaining continuous full employment to an inflation-obsessed concentration on monetary policy with fiscal policy playing a passive role to keep aggregate demand subdued. This passive role was interpreted as being best achieved by running budget surpluses. In other words, governments now adopted the use of fiscal drag as a primary policy position. This further required the financial engineers to load up the private sector with debt to keep the economies growing.
I cover these developments in detail in the blog mentioned above.
To some extent the things Bernanke thinks “caused” the crisis were superficial manifestations of these major ideologically-motivated changes in the institutions of our societies over the last 35 years or so. The dominance of the neo-liberal ideology – which forced us to adopt a misplaced trust on the efficiency and robustness of self-regulated mostly free markets and the reduction in government regulation and activity – was the major driver of the crisis and the sub-prime market and the rest were just reflections of this underlying malaise.
Given that, you will not be surprised by this interpretation of the challenges ahead.
His speech also covered his interpretation of the federal reserve’s policy response which I leave to you to read. It is mostly just an account of the litany of interventions that the federal reserve (and other central banks) made in response to the credit crisis.
He then moves on to discuss the future of financial regulation and supervision which I will leave for another blog because there is a very interesting juxtaposition between what he is saying is required and what the Governor of the Bank of England sees as being essential reform. The differences between the two conceptions is telling and doesn’t reflect well on Bernanke.
The final part of Bernanke’s speech was devoted to the “Economic Challenges” ahead and this is where you realise that he is Mankiw-bound – meaning that his understanding of the way the monetary system works and the role of a sovereign, currency-issuing government within it, is no more accurate and sophisticated than you will find in the mainstream macroeconomics textbooks.
Question: how accurate is that understanding? Answer: appallingly inaccurate. Question: How sophisticated is that understanding? Answer: totally unsophisticated.
Bernanke notes the continuing rise in “(m)ortgage delinquencies for both subprime and prime loans … [and] … foreclosures” and the troubled “commercial real estate” and that the “toughest problems are in the job market”.
But under the influence of “the Federal Reserve’s stimulative monetary policy” growth will “slowly reduce the unemployment rate over the coming year” and “we should see increased optimism among consumers and greater willingness on the part of banks to lend, which in turn should aid the recovery”.
He also said in the “near term, inflation appears to be well controlled” and that “(p)roductivity improvements have helped firms control costs, and little pricing power is evident”.
Then he turned to the longer term and said:
The economist John Maynard Keynes said that in the long run, we are all dead. If he were around today he might say that, in the long run, we are all on Social Security and Medicare. That brings me to two interrelated economic challenges our nation faces: meeting the economic needs of an aging population and regaining fiscal sustainability. The U.S. population will change significantly in coming decades with the combined effect of the decline in fertility rates following the baby boom and increasing longevity. As our population ages, the ratio of working-age Americans to older Americans will fall, which could hold back the long-run prospects for living standards in our country. The aging of the population also will have a major impact on the federal budget, most dramatically on the Social Security and Medicare programs, particularly if the cost of health care continues to rise at its historical rate. Thus, we must begin now to prepare for this coming demographic transition.
All of which is probably correct in countries where the populations are ageing. Japan will lead the way. Dependency ratios are rising although as I point out in this blog – Another intergenerational report – another waste of time – we take a very narrow perspective when talking about dependency ratios.
The mainstream debate focuses on the dependency ratio as 100*(population 0-15 years) + (population over 65 years) all divided by the (population between 15-64 years). This clearly rises when the birth rate falls and the population remains alive for longer.
However, if we want to actually understand the changes in active workers relative to inactive persons (measured by not producing national income) over time then the raw computations are inadequate.
Then you have to consider the so-called effective dependency ratio which is the ratio of economically active workers to inactive persons, where activity is defined in relation to paid work. So like all measures that count people in terms of so-called gainful employment they ignore major productive activity like housework and child-rearing. The latter omission understates the female contribution to economic growth.
Given those biases, the effective dependency ratio recognises that not everyone of working age (15-64 or whatever) are actually producing. There are many people in this age group who are also “dependent”. For example, full-time students, house parents, sick or disabled, the hidden unemployed, and early retirees fit this description.
Most importantly, we should count the unemployed and the underemployed within the “dependent” category although statisticians count them as being economically active. If we then consider the way the neo-liberal era has allowed mass unemployment to persist and rising underemployment to occur you get a different picture of the dependency ratios. Under the mania of the NAIRU construct which uses unemployment as a policy tool to fight inflation – a policy approach which is totally supported by Bernanke in his academic work and his role in public life – we have deliberately increased the dependency ratios over the last 35 years.
By abandoning a commitment to full employment, governments have since 1975 (or thereabouts) deliberately and systematically undermined the capacity of their citizens to provide for a better future as the demographic ageing process unfolded. Why doesn’t Bernanke note that?
Sure enough dependency ratios will rise (however defined) if the population ages, but by deliberately maintaining pools of underutilised labour resources, governments have worsened the situation.
Now the clues to Bernanke’s failure to understand the true nature of this problem lies in his emphasis on “costs” of the retirement pension and health care systems and their “major impact on the federal budget”. Note in his introductory foray into this debate there was no mention of “real resource availability”.
The costs are linked to the budget as financial entities not real things. Once a person enters the intergenerational debate in this way – financial rather than real – you know they do not understand the true nature of the issue they are discussing.
Or as I noted in the introduction – they may well understand the true issues but for ideological reasons wish to represent the problem as a financial one because this allows them to target the size of government per se which is their true agenda. Either way it just demonstrated they are crooks. On the one hand, it is a case of the ignorance feigning expertise. On the other hand, it is the deliberate deception of the wider public.
The economist Herb Stein once famously said, “If something cannot go on forever, it will stop.” That adage certainly applies to our nation’s fiscal situation. Inevitably, addressing the fiscal challenges posed by an aging population will require a willingness to make difficult choices. The arithmetic is, unfortunately, quite clear. To avoid large and unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above. These choices are difficult, and it always seems easier to put them off–until the day they cannot be put off any more. But unless we as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor healthy economic growth.
None of this is an accurate depiction of the challenges ahead. However, given the way the debate is constructed in the public arena by the dominant conservative ideology, the reality is that governments will see Bernanke’s challenges as the constraints they have to address and will attempt to follow a course of action consistent with the argument outlined in the Bernanke quote.
And, moreover, in taking that course of action, the US government will actually worsen the real underlying challenges generated by the demographic trends. That is the tragedy of this whole debate – the idiots are going to make things worse for the current generation and certainly worse for future generations.
So how do I conclude that?
First, something is very wrong with Ben Bernanke’s arithmetic. In fact, the arithmetic is fortunately rather than unfortantely, quite clear. Government deficits can go on forever! Please forget this notion that the current deficits are just a response to the crisis and that governments will soon be able to drive their fiscal positions back into surplus.
Nothing could be further from the truth for most nations. In fact, the last twenty years has been the outlier where national governments have pursued and often achieved fiscal surpluses while at the same time their private domestic sectors have been running up massive deficits. These deficits in turn manifested in stock terms as ever increasing indebtedness. Economies cannot sustain ever increasing private sector indebtedness.
The normal state of affairs over the period for which coherent data has been available has been for governments to run fluctuating deficits with the private sector runnning fluctuating surpluses (that is, net saving overall). This is certainly the case for nations that run fluctuating but persistent current account deficits.
In fact, if you compare the periods of continuous deficits with the more recent period you will find that barring cyclical episodes, economic and employment growth was stronger; investment growth was stronger; unemployment was lower; growth in per capita income was stronger; inflation rates were lower; and interest rates were lower – in the former period.
The greatest con of them all is that neo-liberal period has delivered better outcomes in the form of higher and more stable growth; better labour market outcomes; lower interest and inflation rates. None of that is true overall.
So there will be no financial constraints on the US government or any sovereign government running deficits in perpetuity. Ultimately, these deficits are endogenous which means they are driven by the non-government sector spending. If the latter wants to net save as an overall sector then the government sector has to run deficits for growth to be stable. Get used to it!
Second, an ageing population will require choices to be made but whether they are difficult or not depends on the circumstances. The baby-boom of the 1950s and beyond also required nations to make choices. What choices are we talking about here?
The only choices that matter are the real resource allocation trade-offs. Will there be enough real resources available? This question places the climate change and related environmental concerns at centre stage but is rarely integrated into the ageing population debate. Its centrality to the issue of whether the natural environment will be capable of delivering material increases in our standards of living is largely ignored by the mainstream debate. If I had have been Bernanke it would have been my opening challenge.
This is not a financial matter – it is a matter of whether there will be real goods and services produced in sufficient volumes for us to buy. If there are then the government will always be able to afford to purchase them and provide them to our advantage.
What might stop the government should the real goods and services be available are political constraints. The younger generation might exercise their political sway and prevent governments from devoting a desirable share (from the point of view of the elderly) to health care, for example.
This is just the same sort of political choices that are made by neo-liberal infected governments which have deprived the current children of adequate public education and squeezed higher education of funding to the detriment of academic standards now and future productivity growth. The government can afford to provide first-class health care and education now but it politically pressured to reduce the standard of its provision.
The outcomes in the future will be resolved by political means in similar ways to now. But financial constraints will never be binding on a government with a political mandate to pursue high quality health care etc.
Clearly, if there are finite real resources then choices have to be made about what gets produced and provided.
So amidst all this hoopla about the fiscal crisis that is emerging the remedies that Bernanke thinks will have to be taken miss the point completely. It is not a financial crisis that beckons but a real one.
Are we really saying that there will not be enough real resources available to provide aged-care at an increasing level? That is never the statement made. The worry is always that public outlays will rise because more real resources will be required “in the public sector” than previously.
But as long as these real resources are available there will be no problem. In this context, the type of policy strategy that is being driven by these myths will probably undermine the future productivity and provision of real goods and services in the future.
It is clear that the goal should be to maintain efficient and effective medical care systems. Clearly the real health care system matters by which I mean the resources that are employed to deliver the health care services and the research that is done by universities and elsewhere to improve our future health prospects. So real facilities and real know how define the essence of an effective health care system.
Further, productivity growth comes from research and development and in Australia the private sector has an abysmal track record in this area. Typically they are parasites on the public research system which is concentrated in the universities and public research centres (for example, CSIRO).
For all practical purposes there is no real investment that can be made today that will remain useful 50 years from now apart from education. Unfortunately, tackling the problems of the distant future in terms of current “monetary” considerations which have led to the conclusion that fiscal austerity is needed today to prepare us for the future will actually undermine our future.
The irony is that the pursuit of budget austerity leads governments to target public education almost universally as one of the first expenditures that are reduced.
Most importantly, maximising employment and output in each period is a necessary condition for long-term growth. The emphasis in mainstream integeneration debate that we have to lift labour force participation by older workers is sound but contrary to current government policies which reduces job opportunities for older male workers by refusing to deal with the rising unemployment.
Anything that has a positive impact on the dependency ratio is desirable and the best thing for that is ensuring that there is a job available for all those who desire to work.
Further encouraging increased casualisation and allowing underemployment to rise is not a sensible strategy for the future. The incentive to invest in one’s human capital is reduced if people expect to have part-time work opportunities increasingly made available to them.
But all these issues are really about political choices rather than government finances. The ability of government to provide necessary goods and services to the non-government sector, in particular, those goods that the private sector may under-provide is independent of government finance.
It also clarifies what the true “costs” of the demographic changes are. They are not the numbers that will appear in the government budget papers. The true costs are the real resources that the government will have to muster should they be given a political mandate to provide adequate retirement incomes and high-quality health care.
Bernanke closed that quote by saying that “unless we as a nation demonstrate a strong commitment to fiscal responsibility” things will be bad. Well his speech demonstrates he has no understanding of what a fiscal responsibility actually involves. His depiction of fiscal responsibility would be the exemplar of fiscal vandalism.
I would suggest you read the following suite of blogs – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3 – where I cover the issue of fiscal sustainability and how we should perceive it in great detail.
The idea that it is necessary for a sovereign government to stockpile financial resources to ensure it can provide services required for an ageing population in the years to come has no application. It is not only invalid to construct the problem as one being the subject of a financial constraint but even if such a stockpile was successfully stored away in a vault somewhere there would be still no guarantee that there would be available real resources in the future.
Discussions about needing to cut back deficits and increase taxes completely misunderstand the options available to a sovereign government in a fiat currency economy.
Second, the best thing to do now is to maximise incomes in the economy by ensuring there is full employment. This requires a vastly different approach to fiscal and monetary policy than is currently being practised.
Third, if there are sufficient real resources available in the future then their distribution between competing needs will become a political decision which economists have little to add.
Long-run economic growth that is also environmentally sustainable will be the single most important determinant of sustaining real goods and services for the population in the future. Principal determinants of long-term growth include the quality and quantity of capital (which increases productivity and allows for higher incomes to be paid) that workers operate with. Strong investment underpins capital formation and depends on the amount of real GDP that is privately saved and ploughed back into infrastructure and capital equipment. Public investment is very significant in establishing complementary infrastructure upon which private investment can deliver returns. A policy environment that stimulates high levels of real capital formation in both the public and private sectors will engender strong economic growth.
If we adequately fund our public universities to conduct more research which will reduce the real resource costs of health care in the future (via discovery) and further improve labour productivity then the real burden on the economy will not be anything like the scenarios being outlined in the doomsday reports. But then these reports are really just smokescreens to justify the neo-liberal pursuit of budget surpluses.
Successive US governments have made the mistake of initially appointing then subsequently re-appointing this man to an influential position in the macroeoconomic policy structure.
I would sack him and offer him a job in a Job Guarantee program that I would have in place in the US as a priority.
The Saturday Quiz will be back sometime tomorrow – even harder than last week!
That is enough for today!