Can Fed's New 'Twist' Prevent Another Recession?
Originally published on Sun September 25, 2011 5:26 am
The economic news has been nothing but grim lately: weak expansion, sluggish consumer spending and unemployment holding steady at just over 9 percent.
Overseas, the picture isn't any rosier, with Greece expected to default on its debts — possibly followed by Portugal and Ireland — and the International Monetary Fund predicting a global economic slowdown.
So is the U.S. heading for a double-dip recession? Or are we there already? And what can we do about it?
Planet Money's Adam Davidson tells Guy Raz, host of weekends on All Things Considered, that the Federal Reserve is taking action ... sort of.
"The Fed is constantly buying and selling U.S. government bonds," Davidson says. "And what they've decided to do is buy more 10-year, 30-year, more longer-dated bonds" in an attempt to get the economy going again by pushing down long-term interest rates and making mortgages and credit cards cheaper.
The Fed is calling its latest action "Operation Twist."
"I don't think anyone thinks this is going to have a big impact on the economy," Davidson says.
He says the Fed is doing massive things that in other times would cause out-of-control inflation or other distortions in the economy, but they're not having an impact.
Davidson says he doesn't think interest rates are the problem. He looks at Operation Twist as almost a cry for help: "Wow, no matter what we do, the central bank just can't have the kind of impact that it normally does."
The day after the Fed announced Operation Twist, the markets tanked.
"Clearly the Fed did nothing to make them feel optimistic," Davidson says. "In part, that might be a growing realization that the Fed is sort of out of bullets. There just isn't much more they can reasonably do, especially in the current climate."
No Magic Elixir
Laura D'Andrea Tyson, former chairman of President Clinton's Council of Economic Advisers, says she thinks the Fed's move is important, especially in conjunction with President Obama's recent jobs proposal.
But, she says, there's no easy fix for worried Americans. "Economists are trying to explain the reality we face. We can't give answers that don't reflect the underlying situation," she says. "There is no magic elixir for a situation like this."
Tyson, a professor of business at the University of California, Berkeley, is critical of economic plans that focus on deficit reduction.
"Right now, to embark upon a massive amount of austerity — that is, to slash government spending to reduce the deficit," she says, "that would be actually the wrong thing to do."
The deficit is important, she says, but right now we need to recognize we need more monetary support.
"We cannot say that there's some single cause of how we got into this situation or single bullet for solving it," she says.
Investor and economist John Hussman has a different analysis.
"Imagine trying to get out of a box, and you've got shackles on your legs and you've got paper handcuffs," he says. "Essentially what Fed policy has tried to do over the last several years is to actually tighten the shackles — by rescuing debt, for instance, that shouldn't be rescued — and at the same time playing around with the paper handcuffs when those aren't the constraints that are binding."
Hussman says what's holding the economy back is enormous debt burdens. He says the Fed needs to focus on restructuring debt in order to boost hiring and consumer spending.
"The amount of extra benefit that you're going to get by pushing interest rates a tiny bit lower really isn't going to provoke anybody to do anything different," he says.
A solution to this latest crisis really should come from somewhere other than the Fed, Hussman says. But, he adds, such a solution may not be possible.
Hussman says he doesn't think there's an option to stave off a second recession. "What I think is the option," he says, is recognizing that some of this debt is not going to be paid off and to "minimize the fallout."
No matter what plan the government pursues, Hussman says, we need to brace ourselves for the coming shock.
GUY RAZ, Host:
From NPR News, this is WEEKENDS on ALL THINGS CONSIDERED. I'm Guy Raz.
At some point this week, the road to economic recovery screeched to a halt at the edge of a cliff. The Dow saw its biggest two-day drop since 2008. The IMF cut its forecast for global economic growth next year. Europe is teetering closer to a possible banking collapse. Oh, and Congress, still no agreement on funding the government through next year. And that means in about a week, it could shut down. And all of a sudden, talk of a double dip recession is very real, which brings us to our cover story.
(SOUNDBITE OF MUSIC)
RAZ: This week, the Federal Reserve announced a new plan to stimulate the economy. They called it Operation Twist. And what is it? Here's Adam Davidson, host of NPR's PLANET MONEY.
ADAM DAVIDSON: The twist is a desperate attempt to make an incredibly boring monetary policy move sound a little more exciting, a little more active perhaps. The Fed is constantly buying and selling U.S. government bonds. And in normal times, that's just a very routine, you know, uninteresting thing. But obviously, we don't live in normal times. And what they've decided to do is buy more 10-year, 30-year, more longer-dated bonds. The idea being let's push down long-term interest rates so that mortgages will be low, credit cards interest rates will be low, companies that want to build factories will be able to borrow money even more cheaply so that they can build those factories, hire workers, get the economy going again. That's the idea anyway. Doesn't that make you want to fall asleep?
RAZ: Yeah. I don't understand how that's going to impact the economy. Can you explain what the thinking behind it is?
DAVIDSON: Sure. Now, first of all, I should say I don't think this is going to have a big impact on the economy. I don't think anyone thinks this is going to have a big impact on the economy. Even the Fed's own announcement was fairly equivocal in saying, this is an experiment. This is one of many tools we're trying.
We should say that at the core of monetary policy, at the core of central banks, at the core of the Fed is a mystery. In normal times, meaning most of the time, you know, times that are not the Great Depression or right now, the Fed does these tiny little tweaks to interest rates. And it will have dramatic impacts on the economy. And there's a lot of theories. There's a lot of ways to explain it. But fundamentally, when you talk to central bankers, they don't understand it. It's a mystery. It's a bigger impact than it should be.
RAZ: That makes me feel confident.
DAVIDSON: Well, yeah. It's like when you get a pill from the doctor and they say, hey, this works. We have no idea why, but trust us it works. Normally, the Fed does tiny little things, huge impact. Now they're doing massive things that in other times would cause, you know, out-of-control inflation perhaps or other huge distortions in the economy, and they just don't have an impact.
I don't think anyone thinks the fundamental problem is that interest rates are too high. You know, if I give you a credit card at 12.7 percent instead of 13.2 percent, would you run out and buy a bunch of big screen TVs, a new fridge?
RAZ: No. No. No.
DAVIDSON: That is not the core of our problem. And so I look at this Operation Twist - I think a lot of people look at this Operation Twist more as a - it's almost like a cry of help. It's like, wow, no matter what we do, the central bank just can't have the kind of impact that it normally does.
RAZ: And then a day after the Fed announced this change, the markets just tanked.
DAVIDSON: Exactly. You know, the stock market is a measure of how lots and lots of people all over the world think about the future, think about how companies are going to do over the coming months and years. And clearly, the Fed did nothing to make them feel more optimistic. In part, that might be a growing realization that the Fed is sort of out of bullets. There just isn't that much more they can reasonably do, especially in the current climate.
For years now, people have been asking me and other people who cover the economy, can't you give us some ray of sunshine? This is definitely a week where the rays of sunshine are fewer and farther. I mean, it's just as if we needed the lesson. It's just a lesson that this crisis is going to take longer than we thought, and it's a little deeper than we thought, even though we already thought it was going to take a long time and it was pretty deep.
RAZ: That's Adam Davidson, host of NPR's PLANET MONEY. Adam, thanks so much.
DAVIDSON: Thank you, Guy.
RAZ: We called up economist Laura D'Andrea Tyson. She headed President Clinton's Council of Economic Advisers back in the '90s. And she says the Federal Reserve and the Obama administration are doing about all they can.
LAURA D: I think what the Fed has done indicating that it will do more is very important. What President Obama has proposed in his Jobs Act is very important. Those are ways that could really help the U.S. economy avoid a double dip and continue to grow.
RAZ: You know, we talk to a lot of smart, very smart economists, you and Ken Rogoff and Paul Krugman and Greg Mankiw and Christina Romer and Peter Diamond, and I can go on and on. I mean, Nobel Prize winners among those names.
RAZ: And a lot of Americans are wondering why they can't get the kinds of answers they - maybe they want from economists. How do you explain that?
TYSON: Well, I think economists are trying to explain the reality we face. We can't give answers that don't reflect the underlying situation. There is no magic elixir for a situation like this. And I think what we're trying to do as economists is to point out, for example, that right now, to embark upon a massive amount of austerity - that is to slash government spending to reduce the deficit - that that would be actually the wrong thing to do.
So what economists are saying is, look, yeah, deficit reduction, very, very important. Stabilizing the debt, very, very important. That is not the problem right now. You want to put a plan in place to solve that problem. But please, please, please, right now, recognize we need more monetary support. What we cannot say is that there's some single cause of how we got into this situation or single bullet for solving it.
RAZ: And yet you say austerity is the wrong path, and that's precisely what the direction lawmakers are taking in Washington. There's a bipartisan commission now of members of Congress working on reducing the budget deficit. If they don't come to an agreement soon, the trigger sets off automatically that dramatically reduces government spending for fiscal year 2013 by almost - by about a trillion dollars.
RAZ: That is austerity, right?
TYSON: That is definitely austerity. If that were to come to pass in 2013, that hit to the U.S. economy would mean that we would not continue to recover. It's too big too soon.
RAZ: Laura D'Andrea Tyson chaired the president's Council of Economic Advisers and the National Economic Council under President Clinton. She's now a professor of business at the University of California, Berkeley. Laura D'Andrea Tyson, thank you.
TYSON: Thank you very much.
RAZ: Now the Federal Reserve and Ben Bernanke in particular has been accused by critics of coddling Wall Street and ignoring the rest of America. John Hussman is one of those Wall Street guys, but he's also an economist by training. And unlike his brethren on the Street, he says the focus shouldn't be on avoiding a double dip, but rather how to soften the blow.
JOHN HUSSMAN: Imagine trying to get out of a box, and you've got shackles on your legs and you've got paper handcuffs. Essentially what Fed policy has tried to do over the last several years is to actually tighten the shackles by rescuing debt, for instance, that shouldn't be rescued and at the same time playing around with the paper handcuffs when those aren't the constraints that are binding.
The real thing that's holding the economy back is enormous debt burdens that haven't been restructured. So consumers don't want to spend because they're trying to get their debt down. And companies don't want to hire because consumers don't want to spend.
RAZ: But plenty of people, right, are making money on Wall Street. So presumably, there are lots of investors, unlike you clearly, who do like what Ben Bernanke is doing.
HUSSMAN: Well, they liked it when they thought that it might work. We knew that it wouldn't work in practice, but everyone kept on hoping that it would still work in theory. And so once Ben Bernanke came in with this additional policy, this twist, people were already very skeptical that it would have any effect. And, in fact, you know, treasury yields are already at less than 2 percent. Mortgage rates are at record lows. The amount of extra benefit that you're going to get by pushing interest rates a tiny bit lower really isn't going to provoke anybody to do anything different.
RAZ: We just heard from Adam Davidson explaining how the Fed doesn't have any bullets left in its arsenal. So what - I mean, can the Fed realistically do anything at this point to help the economy along, or does that have to come from somewhere else?
HUSSMAN: I think it has to come from somewhere else. And I think what - one of the problems is, is that the Federal Reserve has openly encouraged this conceit that the Fed can actually change the economy by turning little dials.
RAZ: OK. So you're in the White House now and the president is saying, what can I do right now to stave off a possible second recession?
HUSSMAN: I don't think that that's an option that's available, staving it off. What I think is the option is to minimize the fallout. And if we prepare for that, if we, in some sense, grow up and recognize that some of this debt is not going to be paid off, then what we need to do is focus on how do we limit the fallout from that rather than saying that, oh, no, all debt is good. We're going to bail out everybody, because that just encourages really bad behavior.
Just because a bond holder doesn't get 100 cents back on the dollar doesn't mean, for instance, that the depositors of the bank lose any money. It just means that the people who were responsible for that might no longer run the bank. The people who own stock in the bank might no longer have much value in that stock.
And at the same time, there are a lot of things that the government should do. We shouldn't be pulling back dramatically on government spending here, even though we have a lot of debt, because we need to manage that transition.
RAZ: But no matter what, you're saying brace yourself, it's coming. Let's just try to mitigate it.
HUSSMAN: I think that's probably a reasonable way to phrase it.
(SOUNDBITE OF MUSIC)
RAZ: That's economist John Hussman. He's also president of the Hussman Investment Trust Funds. John Hussman, thank you.
HUSSMAN: Thank you. Transcript provided by NPR, Copyright NPR.