...against fictions and other tall tales

Thursday, 17 May 2012

Interview: Raymond Lombra on the US economy and economic policy

The optimism about the US economy that took hold earlier this year is fading.  Consumer confidence fell last week to the lowest level in four months and the US job market is weakening, as evidenced by the higher than expected number of unemployment claims.  And on the stock market front, the month of May has been a disappointment as major US indexes fell back to levels not seen since January.

One economist who did not expect 2012 to be very different from last year is Raymond Lombra, a Professor of Economics at Penn State University and former Fed staff economist.  In an interview last September, Lombra explained to host Peter Schiff that the US economy's "lack of momentum" was set and that there was very little that the US fiscal and monetary authorities could do in the short-term to improve the situation.  Rather, Lombra's take is that the US government should continue to support aggregate demand to ensure the recovery takes hold and focus on promoting long-term growth and stability.

I highlight the views of Lombra for three reasons.  Firstly, there are very few people in the US who know more about the banking system, central bank operations and economic policymaking overall than Lombra.  Secondly, the views expressed by Lombra in the interview are strikingly similar to those of Chairman Bernanke in his February 2, 2012, testimony before the House of Representatives' Committee on the Budget, one of Bernanke's better performances in recent months.  Here is an important excerpt from Bernanke's testimony entitled The Economic Outlook and the Federal Budget Situation:
Even as fiscal policymakers address the urgent issue of fiscal sustainability, they should take care not to unnecessarily impede the current economic recovery. Fortunately, the two goals of achieving long-term fiscal sustainability and avoiding additional fiscal headwinds for the current recovery are fully compatible--indeed, they are mutually reinforcing...[A] more robust recovery will lead to lower deficits and debt in coming years.
The last reason why I'm highlighting this interview is that the exchange between Schiff and Lombra is actually quite interesting.  Although Schiff interrupts Lombra throughout the interview, I thought Lombra did a good job in refuting the radical views of the host.  Lombra covers a lot of ground in his responses and provides some very good insight on economic policy, the state of the US economy and on ways to improve the current economic situation. 

The interview is dated September 22, 2011. Here is also the transcript of the interview:

Peter Schiff: Joining the conversation is Dr. Raymond Lombra. He is a Professor of Economics at Penn State University. He is Associate Dean of Research and College Advancement. He is a former Associate Professor of University of the District of Columbia and George Washington University. He is also a former staff economist at the Federal Reserve Board of Governors. He has actually consulted with the US Banking Committee in Congress, the Federal Reserve, the Congressional Budget Office, the US Congress Joint Economic Committee, the IMF, the Senate Banking Committee and the US Treasury. Dr. Lombra, welcome to the show. 

Raymond Lombra: Morning Peter.

PS: So have you consulted with anyone in Congress or at the Fed recently?

RL: Well, I’d say informally with various staffers and I also consult with some Wall Street firms. But just because they talk to us doesn’t mean they follow the advice they get! (laughter)

PS: Ok, so then it’s not your fault if they are not following your advice. They are ignoring it! (laughter)

RL: Yes, but I’m not saying we have the right answers either.

PS: What is your advice? I mean, I just went before Congress last week to testify on what they can do to help the economy, or more importantly, how they can stop hurting it. But what is your advice? What are you telling Congress and the Fed? What should they be doing right now?

RL: Well, I think we need to dial back a little here. We’ve obviously entered the "silly season" – the run up to the next election. And you can ask yourself “what reasonably can be accomplished over the next thirteen months?” And I think a lot less than people are imagining.

PS: Well, I don’t think we should be pursuing monetary and fiscal policy with the goal of an election in mind. Our leaders need to be thinking longer term.

RL: Oh, I agree with that. But we know that – more the Congress and the President, of course, than Ben Bernanke and his colleagues – they certainly are fixed on the next election. As you are suggesting, this is going to lead to bad policy. I mean, the whole idea of setting the Fed they way they were set up was to give it the freedom to act in the best long run interest of the nation even if not in the best short run and political interest of its elected leaders.

PS: But it never seems to do that. It always seems to try to re-elect who the incumbents are. That’s generally how they pursue policy.

RL: I think there have certainly been periods like that. And I don’t know if you want to turn this into a discussion about Ben Bernanke, but I’m sure you’ve talked about the Republican’s letter to him in front of the Federal Open Market Committee. I mean, he’s worried about the economy and the question is “what, if anything, can the Fed do?” Well, I would say that the actions they took yesterday are pretty modest. I think that if we got him hooked up to a lie detector and said “do you really think this alone, these two actions that were announced, are going to make a big difference?”, he would say “probably not”.

PS: Well, I think if we hooked him up to a lie detector, it would probably break due to the excess activity. (laughter) You know, I think he’s going to ultimately give the market what it wants, which is more money from helicopters because this economy is imploding. The problem is that they are trying to resurrect a Frankenstein economy. We have to let the US economy die so that a real one can be born to takes its place. We can’t try to preserve an economy by just spending borrowed money. That’s what the Fed is trying to do and it won’t work. Meanwhile, the banks that were bailed out before are all going to fail. So what’s the Fed going to do? Is the Fed going to let them fail this time?

RL: Well, you’ve covered a lot of ground there. I would say that Ben Bernanke knows more than most people on the globe about both the Great Depression and, I would say, the lost decade in Japan. And I think the common threads he draws from those experiences is that it is worth trying something even if in retrospect they didn’t do much good as opposed to doing nothing. And history is going to have to be the judge about which specific initiatives made a difference. But I do want to go back a little bit because there is a tendency to look at what’s happened in the United States over the last few years as akin to a normal recession. The way we talk to our students about it is the economy catches a cold or maybe even the flu. When to my mind what the economy suffered was more like a stroke and we know that the recovery from stroke can be long and it’s going to take a lot patience and attention to long run therapies. But unfortunately our political system is not very patient.

PS: I think the problem is that every time we actually caught a cold in the past, the way the government cured it was just to cover up the symptoms and let us get sicker. And now we’re so sick from all these prior government stimuluses that this last one is actually the one that’s going to kill us. And that’s why the economy is dying because the government continues to administer the toxic medicine that prevents the free market from healing itself.

RL: Well, I certainly agree that, if we took the stance that policymakers are kind of out of short run remedies, this may be a good thing. The question is whether the longer run adjustments in taxes and expenditures and regulations, in particular, on the fiscal policy side can create a more stable environment for businesses and consumers to make good decisions. And there’s really not much hope that any of that is going to happen in the next fourteen months unless the economy slides a lot more than most consensus forecasters see it at the moment.

PS: Listen, I think we’re in a recession already because I think we’re in a depression. So I don’t think it ever ended and I don’t think it’s going to end. I think it’s going to be with us probably for the balance of this decade because I don’t know that the government is ever going to do the right thing. I think they are going to keep on stimulating and we’re never going to get out of this and we’re just going to dig the hole deeper.

RL: Part of it is maybe instant analysis and the 24/7 discussions and the way politicians can get trapped sometime by saying things that maybe in the more full reflection they don’t really believe. But it seems to me that we’re in an environment where, just to take one example, this discussion about “should we or shouldn’t we raise taxes on the rich”. If we stopped the average person on the street – I’m guessing, I think it’s true – that the President and most of the Democrats understand that the wackiest thing you could do between now and when the economy were to regain its feet would be to raise taxes. But that nuance, it gets to be a discussion about raising taxes now and cutting Social Security benefits and Medicare. That would be crazy. I think what the markets are looking for – and I’m guessing what you’re imagining the economy needs – is a path to a more sustainable fiscal environment. And the path would have to be sensitive to where we’re starting from. The great mistakes that were made in the Depression were that we allowed aggregate demand to contract even as it needed to be boosted. We need to avoid that.

PS: Well, I would disagree with that. I think we’ve had too much demand. We bought things we couldn’t afford. That’s the problem. We need more savings. We need to produce more. But the whole thing on taxes and the problem with our economy is not that the rich aren’t taxed enough. The rich are paying plenty of taxes. But when people object to raising taxes in a recession, they do that because it takes money away from individuals. Well so does government spending. The problem is that when you run a deficit as opposed to raising taxes, this damages the economy even more than the taxes. So if politicians are worried about draining the economy of resources from taxes, they really need to be worried about draining the resources from government spending. So what we really need right now is massive cuts in government spending. That’s the only stimulus that going to help: massive cuts in government spending!

RL: Yeah, I would disagree that that is the route out of this – where we are right now today. I think that over the longer run, there’s no question that government spending is too large. You know, Milton Friedman certainly understood that actually the route to long run prosperity was to cut spending for reasons... (inaudible).

PS: Then, how do you think we get out of this? We run big deficits? Let the government spend a bunch of money? I mean, how does the economy recover?

RL: I don’t know any economist – well, I shouldn’t say that. Most economists, rational economists, believe that we need a lot more fiscal discipline over the longer run than we’ve seen.

PS: But we don’t need any now?

RL: The question is how you get there.

PS: But what about right now? What do we need to do right now? What should the fiscal policy be right now? What should the monetary policy be right now?

RL: I don’t think the Fed could or should do much more than it’s done already. We got plenty of liquidity in the system and a little tick down in interest rates isn’t going to make any difference. As you know, it’s small businesses and consumers that can’t get access to credit for a lot of reasons, including the aftermath of the 2007 recession.

PS: Right, but the last thing we want is more consumer credit because we don’t want more spending on borrowed money. We want that credit available for investment and production. So, that would be a bad thing is consumers got more credit.

RL: Well, consumers are rebuilding their balance sheets and what you’re suggesting is that the government needs to rebuild its.

PS: Absolutely.

RL: And I agree with that over the longer run. But I think cutting aggregate demand right now would be exactly the wrong policy. On the other hand, laying out a path, and I’ve seen a lot of different plans. And certainly the deficit reduction committee – the earlier one and the one that is operating now – understand both the need for a path and the general outline of what it’s going to involve. The question is: “Is the political will there to do it?”

PS: But what you’re suggesting is to make that path more difficult. You’re saying we have to run bigger deficits now so that we can tackle the deficits later. But the bigger we make them now, the more difficult it is and the less likely we’re ever going to tackle them.

RL: Well, I don’t think you asked me what I would do on fiscal policy today.

PS: I did ask you. What would you do?

RL: My first order of business would be to lay out the path to fiscal balance over the next five to ten years. That would be the first thing I would do.

PS: We’re going to have to hold that thought until after the break. But I would like to know what we’re going to do about the deficit this year, next year, right away, not the path of the future because we can’t force Congress to follow that path. What counts is what we actually do right now. Think about that and we’ll be right back.


PS: So not about a plan for the future, what do we do right now. What does Congress do for this current fiscal year, if anything to make the economy grow?

RL: Well, I would say “damn little” that they can do to improve the economic performance over the next year. I would say that because a lot of the momentum – or lack thereof – is already set in place, I think that we are going to be given a lot of false hope by some. I would have thought we already learned the lesson that there aren’t really such things as shovel-ready projects. So we’re hearing more about infrastructure – I guess the President today was going to be at some bridge in Kentucky saying that this is what we can fix up. But what we’ve learned is that by the time Congress enacts something until a job gets created is a very long time and it has much smaller impact than were envisioned at the time that the policies were pushed. I think that is not the route forward for the next fourteen months. I think extending the payroll tax cut won’t hurt and could help. But I think the most important thing that Congress can do is get together on a longer run framework for cutting spending and, I think, adjusting tax revenues. We can debate whether it should be closing loopholes and lowering rates but we need to be able to adjust the revenue.

PS: But how do they do anything long term when whatever they pass today is not binding on any future Congress? Whatever they do can be undone.

RL: That’s a really good question and I’ve thought about that. You know, political scientists have looked at whether term limits would make a difference. I remember when I was back in Washington for quite a while the Gramm-Rudman-Hollings budget rule that was put in place did have some significant impact on retaining spending. And looking back on that kind of approach might make some sense.

PS: It couldn’t have worked too well because we got rid of it. That was part of the problem, right? We got rid of it.

RL: I think it did restrain spending relative to what it otherwise would have been and then it got abandoned so let’s learn from that. This time around the committee that is meeting knows that if some agreement on deficit reduction isn’t made there will be very large cuts to the military. And some of them are not too happy about that. So there may be a lever that’s been uncovered here that helps bring some discipline over and above what rule they agree to. There are institutional arrangements that have to be adjusted here. There isn’t an argument that you’re going to make or that I’m going to make that by itself is going to change the path to fiscal stability.

PS: I think big cuts in military spending would be a good thing. So I just assume let them go through. I don’t think that would jeopardize our security. I think what is jeopardizing our security is all the money we’re wasting on excess military spending, among other things. But here’s the problem. See, if I’m right and the economy never recovers then how are they ever going to deal with these deficits? They are always going to say “we can’t raise taxes in a recession and we can’t cut spending in a recession”. And eventually, interest rates are going to go up because inflation is going to be such a problem that they are not going to able to stay down. And then what do we do? What do we do with all of this debt that is financed with T-bills when interest rates are going up? Is the government going to spend all of its money on interest and nothing on anything else or are we just going to turn the money presses full steam?

RL: Well, I think that’s a little extreme but I’m thinking that’s one of the reasons you recommend people be in precious metals. But I’m not as pessimistic as you are at the moment, I think.

PS: About what? You don’t think interest rates can go up?

RL: Look, as we’re speaking, the Dow is down (inaudible) points...(inaudible)

PS: You don’t think interest rates are even going to go up? No, I’m not talking about today...(inaudible)

RL: It’s floating though. It’s floating every day.

PS: Right, but I’m saying, let’s say over the five to ten years. Do you think interest rates are going to stay at these ridiculously low levels?

RL: No, of course not.

PS: Alright, so what happens when they go up to a normal level? The government can’t afford to service the national debt with normal interest rates, let alone high interest rates.

RL: Well, not if you hold everything constant. But everything else is hardly ever constant.

PS: What do you think is going to happen? Are we going to have enormous economic growth that’s going to make these huge deficits financeable at higher levels of interest?

RL: Not with the current set of policies we have in place.

PS: Right. But we could have higher interest rates. We could certainly have a big pick-up in inflation. What if the Chinese decide to...(inaudible)?

RL: I wouldn’t expect that to happen until aggregate demand strengthens considerably.

PS: What about aggregate demand in China? What if the Chinese come to their senses and let the dollar drop against the RMB and the Chinese currency were to sky-rocket in value and China was to go on a global buying spree?

RL: Well, that would be one thing that didn’t stay equal. We could list all sorts of things which would change the economic outlook and that would certainly be a significant one. And policy would need to be adjusted in light of that. And we’d have to hope and expect the Federal Reserve would extract a lot of the liquidity that’s in the system to deal with the inflation that was beginning to emerge.

PS: You keep focusing on this aggregate demand that we need the government to supply. All that government does supply is inflation. All they do is buy what’s been produced. They don’t increase supply. They just increase demand so prices have to go up, or prices are prevented from falling, which might be something that would help the economy. But just having government spend money isn’t going to grow the economy.

RL: Well, I think it’s a component of aggregate demand. It’s not the only source. We also have the consumer...(inaudible)

PS: But where does the government get the money? I mean, if the government spends it somebody else doesn’t have it.

RL: The consumer is the most important part of the economy, proportionally. The consumer is rebuilding its...(inaudible)

PS: Well, I would disagree because if nothing is produced what is he going to consume? Where is the consumer if there is no producer?

RL: Well, producers will produce when demand picks up.

PS: But there’s always demand. I mean, everybody “wants” things. The question is you have to be able to supply it. You have to be able to create it. There are all sorts of things that I’m sure you would like to have but don’t have because you can’t afford it. It’s not because you don’t have demand. You just don’t have the means.

RL: You’re trying to push me into a debate. This is an old debate: does demand create supply or does supply create demand? And the fact is that markets reflect both supply and demand. So that’s my position. I’m saying that, right now, the economy is operating well below its potential. Firms have less employees. Their plants are more idle than they would be in the face of a pickup in their orders. That’s just going to have to work its way out of the system.

PS: Yes, I think what is preventing them from producing is that they lack the capital. They can’t do it at a low enough price to produce goods that propose can afford.

RL: What capital? Firms are sitting on an enormous amount of funds right now.

PS: Well, funds...but that’s not a factory. Just because they have paper doesn’t mean they have a machine.

RL: Oh, there are very few firms today that will tell you they are not hiring because they don’t have more factories to put them to work in. There are a few but there aren’t many.

PS: But they can’t produce things at a competitive price that people can afford to buy. That is the problem. We have to restructure the economy. Hey, this is an interesting discussion. Maybe we can continue it on another program. Thanks for stopping by.