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May 5, 2015

QE Failures Highlight Failed Solution Based on Macro Variables

Austerity has become a loaded concept, not the least of which has been tied to the very growing desire of issuers of past policies to delink them with our current situation. Primary among those is Ben Bernanke who has taken to blogging as a sort of obvious attempt at rehabilitation. Last week, I think, he really came out the worst having taken on directly a Wall Street Journal editorial openly questioning his legacy – and responding to it with what was clearly desperation (the unemployment rate was the “best” he could use in his defense).
Parallel to all the great success, in Bernanke’s mind, in labor utilization stands the economic disfavor of his QE’s. He is, at the same time, saying QE worked well and that it did not work well; it made the unemployment rate drop far quicker than anyone thought possible (because it fell for reasons that have nothing to do with improving economic fortune) but also that it didn’t work fully because of “austerity.” When not championing the ill-suited labor indication, Bernanke has taken to highlighting limitations of monetary policy. The zero lower bound is a real bear to overcome, as he tells it, making QE much more difficult of a transition into real progress.
That is, of course, nothing like what he was saying contemporarily, especially in that November 4, 2010, oped introducing QE2, but he has at times spoken out on monetary limitations. It has the effect of covering all bases simultaneously, hedging his bets on QE without appearing plainly doing so. This was a prime topic back in 2013, ironically, during the taper debate when Bernanke was far more likely to assail the unemployment rate because of his very own “forward guidance.”
QE was terrific, he and his supporters said, but if it doesn’t work it’s not my fault:
You can easily imagine a scenario where congress screws up and creates a huge fiscal drag, then Bernanke unleashes QE4 to try to counteract it and he’s partially successful. Then he’s going to take a double hit for “printing money” and presiding over poor economic performance. He’d much much rather that congress handle its business. In fact his first choice would be for congress to not just handle its business, but enact a large short-term stimulus paired with a huge long-term deficit reduction plan thus allowing him to stabilize nominal growth without doing any more asset purchases or novel communications strategies. [emphasis in original]
As it turns out, that first suggestion, “printing money and presiding over poor economic performace”, has come to fruition and thus all the fuss over reputation and repositioning for posterity – to not be the Fed chief that wholly disproved monetarism. Into that mess has been dragged the various reasons for what is now essentially admitted-impotence (oh, the contrasts between now and then, in terms of proclamations) even “secular stagnation.” Bernanke has recently written his disfavor of the theory, but in so doing has found himself united in preferred process with the economist who first proposed it; Larry Summers.
Secular stagnation is a more complex concept, but it has at its heart the notion that “the economy” is suffering from a zero or even highly negative natural interest rate. If that is the case, the economy is itself responsible and thus renders policy nearly blameless in all its faults; so you can see why it has become very attractive to orthodox economists that keep saying policy will work only to find policy won’t work. To many, this explains what Paul Krugman describes as a “deflationary vortex” and thus defines the “answer.” The problem is and has been, to those that follow secular stagnation and the ZLB problem, austerity.
But austerity does not mean what it has meant in the past, having been transformed by economic malformation into essentially the meaningful departure from a magic, and apparently secret, formula. In the Krugman version, austerity is really just the departure from the optimal level of government spending largely and intentionally through deficits. In other words, if the economy is not pulling itself out of the negative natural interest rate bounds, then the government is not doing enough fiscal pulling regardless of how much fiscal pulling it has done to this point. Seven and a half trillion in accumulated deficits since FY2008 began, in this view, amounts to too much “austerity” because it obviously did not perform the miracle.
In Larry Summers’ reply to Ben Bernanke on the topic, this is made plain:
Imagine a secular stagnation world with a zero real interest rate. Then, government debt service is very cheap. As long as a public investment project yields any positive return it will generate enough revenue to service the associated debt. This effect will be magnified if there are any Keynesian fiscal stimulus effects of the project or if there are any hysteresis effects. Notice that with sufficiently low real interest rates, even fiscal stimulus, which does not have supply effects, can pay for itself through mulitiplier effects.
Notice the central conceit right at the outset here, not that there exists a positive multiplier in the fiscal version of stimulus (a topic well-worn by the ARRA academic debates) but that he refers to “hysteresis effects.” Hysteresis can refer, in this context, to several points of reference, but it usually amounts to sensitivity to initial conditions, venturing into chaos theory (almost). In terms of economic control, especially of the kind he is proposing, it essentially means that once a huge push is made it does not take much effort or energy to keep it moving.
In essence, that was the entire point of the ARRA itself – to be a massive push on the economy in deep recession, and once the “stimulus” reached full potential there would be little need for anything beyond. This is because, as all of these economists contend, demand for the sake of demand leads to further activity of and on its own. The very fact of additional QE’s further on offers itself a refutation on that point, but so too does additional scholarship of the ARRA.
The St. Louis Fed last month published a study of the ARRA effect in education. This was not a minor point of that “stimulus” as the bill itself was targeted at local governments, especially school districts, as an intentional delivery method. What the St. Louis economists found undermines all the “stimulus” ideas from their roots, and gives insight into why expectations for time critical components (hysteresis) are likely far too simplistic.
To conduct this study, we used data on expenditures, both ARRA and non-ARRA revenue, and staffing levels for over 6,700 school districts from both before and during the ARRA period. We found that, during the first two years following the act’s passage, each $1 million of grants to a district increased education employment by 1.5 persons relative to a no-stimulus baseline.1 Moreover, all of this increase came in the form of nonteaching staff. The jobs effect was also not statistically different from zero.
That is the usual findings that we have come to expect from the ARRA, namely spending to something astronomical just gain a few jobs, and not all of them “created.” But that isn’t the extent of the ARRA’s malformation, as there were other projects involved – shovel-ready too.
We also found that each $1 million of grants increased expenditures at the district by $570,000 relative to a no-ARRA baseline. Approximately 70 percent of the expenditures took the form of capital outlays, such as construction, land purchases and equipment acquisition. The gap between the two numbers, $430,000, might be accounted for by states’ cutting their own contributions to school districts upon the districts’ receipt of ARRA grants.
That is one explanation, but in the real world school district administrators are not blind to the one-time impulse. This is, of course, the fiscal version of Milton Friedman’s permanent income hypothesis. School districts were not going to permanently alter their behavior because the federal government handed them even obscene amounts of cash; instead they reacted as you and I would and treated them as one-time windfalls. As the St. Louis Fed makes plain in the paragraph preceding:
Moreover, districts that received relatively generous ARRA grants may have been less willing to hire new staff for risk that, once the short-lived grants were spent, the new staff would need to be let go.
What’s missing from that is the central component of all orthodox “aggregate demand” treatment, namely that school districts should not have been worried about the end of the grants because the massive recovery would have made up for their disappearance. Implicit in acting as if the ARRA was a windfall is the very expectation that it does not lead directly to a rebound in the real economy, and thus the school district’s tax receipts.
In this central case of local government education spending, that may be more readily explained by the housing bust itself. In other words, local school districts realized that tax receipts were tied to real estate and not necessarily or directly the general economy. Taking a realistic assessment at that stage, in contrast to anything orthodox economists were forecasting and promising optimistically going back to 2006, these actual economic agents of the intended “stimulus” were never going to be swayed by generic spending for the sake of spending.
While that accounts for some of this piece of the fiscal letdown, it is not comprehensive. In short, the housing bubble does not alone explain the broad failure of fiscal “stimulus” – instead, it suggests that there is no simple mechanism of expectations or action in which to intentionally direct a recovery. In fact, the ARRA dispensations did not take place in 2009; the vast majority was forwarded into 2010 and then 2011. When viewing ARRA receipts and how to act about them, economic expectations were clearly involved in setting that “multiplier.” By then, the lack of recovery and true success of all the “stimulus” was clear to everyone but the people still offering them. In other words, the more it was certain that the various forms of “stimulus” were not that at all, the more fiscal spending recipients treated them as far less meaningful one-off windfalls unsupportive of further stages of actual recovery mechanics.
In one sense, this seems to suggest that stimulus needs but belief to work, but in reality it is far deeper than that – again, chaos theory and sensitivity to initial conditions. What fails is this generic sensibility that spending in any form creates further spending in any form, and that even that “success” is wanted and beneficial. The economy is not just some random arrangement of individually meaningless transactions taking place just because, rather it is an unintelligible, from the perspective of those that wish command and control, complexity that occurs for and of its own purposes. It is only socialization of economic function that takes the conceit that individual transactions arising from organic processes are unimportant – that all that matters in an economy is the appearance of macro variables.
All these various forms of “stimulus” have failed to stimulate anything except highly inefficient and wasteful distortions of finance; bubbles to immense leverage in many forms, including all those governments supposedly practicing “austerity.” The solution to the recovery’s conspicuous absence is not more waste, it is attention to detail. “Aggregate demand” is worthless as an economic theory because it assumes, right at the front, that there is no worthwhile complexity. 
Even a few seconds taken in the majesty of markets and the real economy shows that assumption utterly stupid. Bernanke, Krugman, Summers, etc., are really all the same, dithering amongst macro variables and looking for a solution only there that can’t realistically exist. Even the academics are starting to question.
Courtesy Jeffrey P. Snider, Alhambra Investment Partners (Author Archive Here)

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