Fed the wrong line
In his baccalaureate address at Princeton this year, the Fed chairman Ben Bernanke defined economics as “a highly sophisticated field of thought that is superb at explaining to policymakers precisely why the choices they made in the past were wrong.” He added, “About the future, not so much.” Put another way, economics is a science that can mean what economists want it to mean. As W.C. Fields replied when asked whether poker was a game of chance: “Not the way I play it.”
Within two weeks of proffering advice to new Princeton graduates trying to find a job in a hesitant economy, Bernanke may have wished he had taken his own counsel. After issuing a cautiously worded statement about the Fed members’ current thinking on quantitative easing, the chairman gave a press conference and, contrary to his predecessor Alan Greenspan, made the mistake of speaking in plain English.
“The committee currently anticipates that it would be appropriate to moderate the pace of purchases later this year,” he said. “We would continue to reduce the pace of purchases in measured steps through the first half of next year ending purchases around midyear.” Like most financial reporters, and almost every analyst, I have omitted the many conditions Bernanke carefully placed on such an eventuality. Bernanke’s loose tongue tripped mayhem in stock markets, interest rates, bond yields, and currency prices around the world.
Economics isn’t meant to work like this. There is a school of thought in economics that claims that stock prices and other market indicators are the repository of all wisdom. For those who believe that markets not only hold the truth but discount future events that are then reflected in today’s prices, Bernanke’s 700 brief words have highlighted three economic contradictions that govern our lives and take a good deal of ingenuity to untangle.
The first contradicton resembles a circular firing squad that even Quentin Tarantino could not have scripted. On hearing good news, markets usually rise. Yet hearing Bernanke’s catalogue of good news (that the Fed may revert to some form of normal in the money supply), markets in America sank. On hearing bad news, markets tend to drop. Yet the markets had to wait until the Department of Commerce revised gross domestic product downwards before they started to rise again. Markets, buoyed since 2008 by an addiction to the Fed’s cheap money policy, are slumping under the prospect of having the juice turned off. In fact Bernanke did not propose quantitative tightening for at least four years. Nonetheless, the market has prematurely plunged us into economic cold turkey, and it is profoundly unpleasant.
Bernanke is right about the recovery. It may be patchy, but it is on the mend. Business spending plans are strong, house prices are leaping, and building is booming. Car sales are roaring back and consumer confidence is at a five-year high. Small business growth is flourishing. But the economy could be doing even better if we were not, through the sequester, arbitrarily cutting the public sector, with its depressing knock-on effect on the rest of the economy. If there were no sequester, the nonpartisan Congressional Budget Office estimates our economic growth would be double what it is. America is driving with the parking brake on.
And here’s the second paradox of today’s economy: the plan to increase growth depends upon deliberately contracting the economy. “The easiest and most comfortable way to pay down the deficit, according to Keynesian orthodoxy, is to increase growth without delay and reap the tax revenue from the surge in jobs that would result.”
By cutting public spending and raising taxes, as the sequester demands, we are deliberately causing growth to slow, meaning we are taking the long and painful route to recovery. Once, simply the threat of the sequester threw Washington into a tizzy. Then the deadline came and went, the sequester was imposed, Congress shrugged, and carried on as before.
The third key paradox is that those who would like the Fed to stop interfering in the economy through quantitative easing are ensuring that it continues far longer than necessary. And the very people demanding we cut public spending and reduce public debt quickly are the same people who demand an early end to quantitative easing. The sequester is quantitative easing’s dearest friend. If the economy were growing faster, QE would end sooner. But so long as the sequester slows growth, QE will remain with us, for Bernanke’s conditions forending easy money are that joblessness falls below 6.5 percent and inflation remains below 2 percent. This is the topsy-turvy world we live in, where bad ideology overrules good economics, common sense goes out the window, and lunatics run the asylum.
Bernanke ended his Princeton homily with a generous assessment of his friends and enemies on Capitol Hill. “Honest error in the face of complex and possibly intractable problems is a far more important source of bad results than are bad motives,” he said. Whatever the motives of those in Congress who are curbing growth, keeping Americans out of work, and making us all poorer for longer, their intransigence in the face of ample evidence they are misguided is inexcusable.
Nicholas Wapshott is the author of Keynes Hayek: The Clash That Defined Modern Economics. Read extracts here.
PHOTO: U.S.Federal Reserve Chairman Ben Bernanke speaks to the press following the Fed’s two-day policy meeting at the Federal Reserve in Washington, June 19, 2013. REUTERS/Jason Reed