Gagnon complicates things

In “desperation”, Joe Gagnon “goes for broke”:

First and foremost, the Federal Reserve should announce an additional $2 trillion of asset purchases, including longer-term Treasury bonds, agency mortgage-backed securities (MBS), and foreign exchange. This is more than three times the size of the woefully underpowered quantitative easing of late last year (dubbed QE2) and it should be accompanied by a clear statement that more is forthcoming if the economy continues to underperform. The goals are to push down bond yields and mortgage rates, to push down the value of the dollar in terms of foreign currencies, and to boost stock prices. All of these help households deleverage their balance sheets and encourage consumption, investment, and exports (which would become cheaper for foreign buyers as a result of the dollar’s depreciation). Businesses would need to hire more workers to meet the additional demand.

And he goes on to propose “unpleasant stuff”:

The Obama Administration can help in two important respects: First, the Administration should use its control of Fannie Mae and Freddie Mac to force them to invite all homeowners whose mortgages are already guaranteed by Fannie and Freddie, and who are not delinquent in their mortgage payments, to refinance their current mortgage balance at the new low rates regardless of loan-to-value ratio. There should be no requirement to gain the approval of the current mortgage servicers, and the Administration should use moral suasion (and a publicity campaign if necessary) to prevent holders of second liens (home equity lines) from blocking the refinancings. Lowering mortgage interest payments on underwater loans would be the best way to prevent future defaults that would harm Fannie, Freddie, the holders of second liens, and US taxpayers. It is a win-win for all involved. In addition, a renewed push on mortgage modifications for homeowners behind on their payments could also yield broad benefits to borrowers and lenders alike at little cost to the government. Low long-term interest rates brought about by Federal Reserve policy would maximize the benefits to US households from resolving the mortgage mess.

Second, the Administration needs to acknowledge that the strong dollar policy, as enunciated for many years, is defunct and opt to embrace moderate further dollar depreciation consistent with monetary easing. Developing economies are spending more than $1 trillion each year manipulating the values of their currencies to subsidize their exports to the United States and Europe. Fiscal austerity in Europe and countervailing currency manipulation in Japan mean that the United States bears most of the cost of this modern mercantilism. As the world’s largest net debtor, it is time for the United States to just say no to trade deficits. We need the high-paying jobs that come from exports.

Forget about the two “suggestions” about how the Obama Administration can help. It will likely make things harder.

As to the suggested action by the Fed, I don´t think a “gigantic” QE3 would fly. Not with this inflation obsessed Fed. And promise that “more would be forthcoming” if the economy continues to underperform! No way Renée!

State a clear objective, preferably a NGDP target, much the same way FDR did in 1933 when he announced a Price level target. From a “Fireside chat”:

Finally, I repeat what I have said on many occasions, that ever since last March the definite policy of the Government has been to restore commodity price levels. The object has been the attainment of such a level as will enable agriculture and industry once more to give work to the unemployed. It has been to make possible the payment of public and private debts more nearly at the price level at which they were incurred. It has been gradually to restore a balance in the price structure so that farmers may exchange their products for the products of industry on a fairer exchange basis. It has been and is also the purpose to prevent prices from rising beyond the point necessary to attain these ends. The permanent welfare and security of every class of our people ultimately depends on our attainment of these purposes.

The results were immediate. Industrial production went up by 55% in just 4 months. An all time record. Commodity prices reversed their decline and the money stock (M1) which had dropped by 20% between 1929 and 1932 went up by 55% from 1933 to 1937.

Yes, NIRA was a spoiler, and in 1937 the Fed, worried about the robust price rise after April 1936, decided to “step on the monetary brake”, just as prices were at a “striking” distance of FDR´s goal. The four year recovery stalled and then dropped steeply, with industrial production falling 31% from May 1937 to May 1938. At that point FDR “intervened”, “asking” the Fed to abandon its restrictive policy.

The pictures below provide visual evidence of the effectiveness of FDR´s policy.


9 thoughts on “Gagnon complicates things

  1. Well, this is an interesting proposal.
    I am of mixed sentiments regarding the political feasibility of certain economic policies.

    They say only Nixon could have “gone to China.”

    So a right-winger could make certain economic policy choices and “get away with it.”

    I am beginning to think what may happen is that a GOP president gets elected, and the Fed does in fact begin to stimulate, while the right-wing braying about inflation becomes muted.

    Still, as of today, there is plenty of commentary declaring inflation to actually be immoral, and theft, and if a nation debases its currency, then what is next ? (a gay brothel in the White House).

    The right-wing wants Obama finished.

  2. Nada. The Fed will do nada. BTW, the CPI-U was at 219.964 in July 2008. It is at 225.722 for June 2011.

    Let’s get scared! The CPI up 2.62 percent in three years!! Run for the exits! Your currency is debased and next stop is Sodom and Gomorrah.

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