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Economics Lesson for Charles Lane

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Tuesday, 04 December 2012 08:21

Washington Post columnist Charles Lane is angry with Ben Bernanke and the Federal Reserve Board. He is upset because the Fed is not working to advance his agenda of cutting Social Security and Medicare by raising interest rates and putting more pressure on Congress.

Lane tells readers:

"With the U.S. economy still reeling from the Great Recession, the Fed has been trying to stimulate economic growth by holding down interest rates, and it has pledged to keep doing so through mid-2015. It does this in large part by buying up government debt. Partly as a result, the United States was able to issue $4 trillion in new debt from 2009 through 2011, while keeping net interest costs at or below 1.5 percent of gross domestic product.

"It’s perfectly consistent with the Fed’s mandate. And it sounds like a great deal for the government, too. According to more than a few economists, pundits and politicians, Congress should seize the opportunity to borrow and spend on growth-enhancing investments such as infrastructure.

"However, in a properly functioning economy, rising government borrowing costs can play a useful role: Specifically, they are the market’s way of warning government that its debts are unsustainable.

Muffle that signal, as the Fed’s policy is doing now, and politicians are less able to guess right about how much time they really have to fix fiscal policy and to feel less pressure to do so."

Actually the market is doing exactly what it is supposed to be doing. Interest rates are extraordinarily low now because of the massive amount of excess resources in the economy. The low interest rates are a way to encourage spending. In fact, if anything the goal would be to have lower real interest rates, but this can only be done by having a higher rate of inflation.

Lane is upset that the markets don't seem to accept his view that budget deficits are unsustainable. Of course the only reason that budget deficits are large today is because the economy collapsed. In 2008, before it recognized the hit to the economy caused by the collapse of the housing bubble, the Congressional Budget Office projected that deficits would be less than 2.0 percent of GDP through the middle of the decade even without the expiration of the Bush tax cuts.

deficits-per-GDP-10-2012

Source: Congressional Budget Office.

In short, the real story here is that Charles Lane is unhappy that the financial markets and the Fed won't join in his drive to cut Social Security and Medicare.

Comments (10)Add Comment
...
written by JSeydl, December 04, 2012 10:14
Lane also forgot to mention that the Fed isn't even buying USTs anymore. From the latest FoF survey:

unified budget?
written by Arne, December 04, 2012 10:22
Why use unified budget numbers? We knew in 2003 that the off-budget surplus was diminishing and could not really be included if we wanted to answer the question of whether deficits were/are sustainable.
deficit scolds
written by Peter K., December 04, 2012 10:49
deficit scolds:
"Muffle that signal, as the Fed’s policy is doing now, and politicians are less able to guess right about how much time they really have to fix fiscal policy and to feel less pressure to do so.""

So bond markets determine policy, not the voter? Okay so we'll raise taxes to cut the deficit.

Deficit scolds:
"No that will hurt growth. We need to cut entitlements."

Like in the '90s? Cutting entitlements will hurt growth. Blowing housing bubbles will hurt growth. Having a trillion dollar/year output gap and high unemployment will hurt growth.
...
written by Chris, December 04, 2012 11:06
When the government can borrow all it wants at 1.6 or 1.7% interest for ten years, the last thing one should worry about is the deficit. It would be nice to bring it down when doing so won't damage the economy and raise unemployment, but it is hardly a crisis at the present time.
treasury holdings actually down 21.0B in one year...fed is not buying the debt
written by pete, December 04, 2012 11:41
http://www.federalreserve.gov/...1/current/

There was a bubble in 2008/9, but they really haven't done much since then, certainly not the $6T or so issued by the treasury.

No real deficit anyway, just transfers. Transfers are not real deficit, no macro effect.
An economics lesson for Dean Baker
written by joe, December 04, 2012 1:27
"Actually the market is doing exactly what it is supposed to be doing. Interest rates are extraordinarily low now because of the massive amount of excess resources in the economy." Wrong. Interests rates are only controlled by the market insofar as the Fed lets them be. Interest rates are low because the Fed has let the banking system build up excess reserves. Govt deficits push interests rates down because a deficit adds reserves to the banking system. As the amount of excess reserves increase, banks are willing to lend them to each other at lower and lower rates (banks don't lend reserves to the public). Besides, the govt doesn't truly borrow money. The notion of borrowing is meaningless for the issuer of the currency. Treasuries, reserves, and cash are all different forms of the exact same thing, namely govt liabilities. They differ primarily in their interest rate and maturity.
Does Charlie Know
written by Mcwop, December 04, 2012 3:48
That we issue our own currency, and all our debt is denominated in that currency?

Fed Funds rate is zero, and will stay there so long as Fed keeps it there. There is no inflation right now. So he is wrong on so many levels.
Interest on reserves
written by Scott Supak, December 04, 2012 5:21
What's going on with the fed paying way more on reserves than what they're supposed to?

http://uneasymoney.com/2011/10...g-the-law/
the fiscal cliff is utter nonsense, what is the real problem?
written by mel in oregon, December 04, 2012 5:37
in order to understand what the problem is, you have to read far more than the ny times or wa post. in other words, you have to really cover the foreign press to have a true understanding of the depth of america's problems. the problem is far more than just the collapse of the housing market. in addition to the housing bubble bursting, other just as relevant factors are the tremendous waste of money & lives in iraq & afghanistan. remember our veterans may need to be taken care of for 5 or 6 decades meaning many trillions of dollars they deserve but which all would trade for the chance to be made whole again. the neocons wanted these wars, but wanted the middle class & working class to pay for them, while the wealthy profited from them & got a tax cut so they wouldn't have to pay for them. since at least 5 million jobs have been outsourced to china & other low wage countries, & since our economy is based on consumer spending, there will never be a recovery when half the people in this country can't pay their student loans, their car payments or their mortgages. the fed doesn't care about these people, their only concern is to make sure the too big to fail banks & firms on wallstreet don't pay when there speculation fails. since the fed continues to create more money to lessen the debt of these giant corporations, the question is what does the rest of the world think about their holdings in the united states shrinking as a result of the fed's increasing monetization? well you don't have to be very intelligent to understand what's going on. we all know that gold, silver & oil have really spiked since the the bailout of the banks. china, japan & the saudis among others hold a tremendous amount of our debt. so, japan & china are negoiating to trade without using the dollar. so are russia, india, brazil, china & south africa. of course the american press ignores this most important foreign news which when they enact trade in non-dollar currencies will cause the dollar's exchange value to plummet & hyper-inflation in america will occur, which will be reminiscent of germany after ww1 when a wheelbarrow full of marks were needed for a loaf of bread. needless to say, the future for america isn't bright at all.
Maybe it was a rhetorical question?
written by John Wright, December 04, 2012 10:52
"Interest on reserves
written by Scott Supak, December 04, 2012 5:21
What's going on with the fed paying way more on reserves than what they're supposed to?"

This is a pure handout to the banks and is evidence that the banks are not truly healthy in the eyes of the Fed.

It is easier to hand money to the banks by paying money on excess reserves, than have obvious direct cash payments.

Note, if the Fed wanted to encourage lending, it would pay zero interest on excess reserves, and the loss of bank income would encourage the banks to lend to businesses.

This also may be evidence of the Fed's embarrassment that it completely missed, or did nothing to prevent, the housing bubble and hopes the various handouts to the financial industry (TBTF insurance, handing unnecessary interest payments to banks) won't be noticed.

And the Fed may be correct, as the political class moves to "entitlement reform" which could have a large negative effect on middle/lower class effective net worth, the Fed's actions might be largely missed by the media, as bookeeping transfer entries between the well-connected go unnoticed.



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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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