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Has Fed Done All It Can to Prop Up U.S. Economy?

August 27, 2010 at 5:36 PM EDT
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Federal Reserve Chairman Ben Bernanke said Friday that the central bank is prepared to take new action to help the sagging economy if needed. Jeffrey Brown talks to economists Paul Krugman and Douglas Holtz-Eakin about whether the Fed is doing enough to lift the economy.
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JEFFREY BROWN: There were new signs today of a continuing and prolonged economic slowdown, even as Federal Reserve Chairman Ben Bernanke said the Central Bank was prepared to take further measures.

Under increasing pressure to respond to fears about the economy’s fragile state, Chairman Bernanke delivered a much-anticipated speech today at the fed’s annual conference in Jackson Hole, Wyoming. He said he continues to believe there will be — quote — “some pickup in growth next year,” but that “growth recently appears somewhat less vigorous than expected.”

Bernanke stopped short of committing to any immediate moves, but raised the possibility that the Fed would make substantial purchases of securities and government bonds to lower long-term rates and boost lending. His remarks this morning came shortly after more bad economic news, as the Commerce Department announced that the gross domestic product expanded at a 1.6 percent annual rate last quarter, less than the 2.4 percent pace it had previously estimated.

And that followed evidence this week that housing could be falling into a second slump, as new home sales fell 12.4 percent in July to the lowest level in nearly a half-century. Chairmen Bernanke also referred today to the high unemployment rate, saying it “poses risks to the sustainability of the recovery itself through its effects on households’ incomes and confidence.”

Despite the gloom, Wall Street today seemed to focus on the Fed’s willingness to act. The Dow Jones industrial average gained 165 points to close at 10151. The Nasdaq rose just under 35 points to close above 2153. For the week, though, the Dow lost six-tenths-of-a-percent; the Nasdaq fell 1.2 percent.

And we get two assessments now of the economy and the Fed’s response to it. Paul Krugman is an economist at Princeton University and a columnist for The New York Times. Douglas Holtz-Eakin is a former director of the Congressional Budget Office. He’s now president of the American Action Forum, a policy think tank.

Paul Krugman, I will start with you. You wrote in your column today, this isn’t a recovery in any way that matters. So, did you sense today that Ben Bernanke agrees and is taking the right steps?

PAUL KRUGMAN, columnist, The New York Times: Well, he may agree, but he’s not taking the right steps. I mean, there was no sense of urgency in his talk. Yes, he said we will do something if the situation warrants. But here we are. You know, this is — we’re now 32 months into this slump. Unemployment is disastrously high. Growth, we — the economy needs to grow about 2.5 percent annual rate just to keep unemployment from rising. It’s not doing that.

What would it take to justify action? So, you know, it was a good signal that he is saying, you know, the Fed is kind of, sort of willing to do something, maybe, which is better than previous statements. But, if this isn’t a situation that warrants action now, what would be that kind of situation? Do we have to have a whole Great Depression to get the Fed moving?

JEFFREY BROWN: Douglas Holtz-Eakin, what did you hear from the Fed today?

DOUGLAS HOLTZ-EAKIN, former Congressional Budget Office director: Well, there was a little bit in there for everybody. He said, we recognize the economy’s struggling, and thus tried to make sure people didn’t think the Fed was out of touch. He told those who were worried about the economy going down into double dip that they had things they could do, and he outlined them.

And then, at the end, he told the people worried about inflation, believe it or not, look, we’re not promising higher inflation in the United States. We’re not going on record for that. So, I thought it was a talk carefully designed to appeal to lots of audiences.

JEFFREY BROWN: All right, carefully designed, but what about the state of the economy that Paul Krugman sees as in dire straits, needing more?

DOUGLAS HOLTZ-EAKIN: The economy is not in good shape. And I think, about that, there ought to be great agreement. But the key is that the Fed has done all it can do. It did a tremendous job in propping up the economy during the crisis. It is now badly extended. The keys now are that we have an economy that is growing. It’s been growing for about a year, but it is growing too slowly. We ought to rethink this, not as a crisis, sort of stimulus issue, but one where we have got to concentrate on long-term growth and do all the things to make the economy grow faster.

JEFFREY BROWN: All right, well, that gets to the nub of the argument here, Paul Krugman. What should the Fed do now? What do you want to see it do?

PAUL KRUGMAN: I think it should be throwing everything, including the kitchen sink, at the problem. I mean, Doug is saying that there’s — the Fed has done all it can do. That’s not what the Fed says. The Fed says it has ammunition; it continues to have the ability to act. So, we should take them at their word and see them actually act. They can do purchases of long-term bonds. They can raise their inflation target, which, you know, Ben Bernanke, when he was a Princeton economics professor, advocated for Japan when it was in a similar situation.

JEFFREY BROWN: Explain — explain for the — I’m sorry, but just explain to the audience what that means and what an impact it would have.

PAUL KRUGMAN: Sure. The — the Fed has — it has in its mind and more or less publicly an idea of what it wants the inflation rate to be over the next five years. It’s — that’s believed to be about 2 percent. If the Fed were to make it known that, look, we actually think it should be 3 percent, that would at least give some incentive for people, corporations that are sitting on piles of cash to say, you know, that cash is going to be worth a little bit less. We should spend more, give it a — make it a little bit more attractive for people who are deciding that they have a good investment project, but they’re not really sure whether they should borrow for it.

It will make them think, well, it will be a little easier to service that debt. It’s something that can move decisions at the margin. There is a whole list of things that the Fed can do. They are all uncertain, because we are in uncharted territory. We haven’t been in this kind of situation, where short-term interest rates, which the Fed really controls directly, are basically zero. We haven’t been in this situation since the 1930s.

But that’s not a reason not to act. And yet the Fed is sort of saying well, you know, it’s — things are uncertain. Maybe things will improve. And this may not look like a crisis to the Fed, but to the very large number of people who are unemployed, to the near-record number of people who have been unemployed for more than six months and more than a year, this is a crisis. I’m amazed that there is no greater sense of urgency here.

JEFFREY BROWN: Well, Douglas Holtz-Eakin, well, respond to that. I mean, he…

DOUGLAS HOLTZ-EAKIN: The first thing the Fed is going to say — and I think properly — is, look, we are going to hold on to some things in reserve if — in case the economy actually begins to go down again, and then we will act.

I think that is appropriate. Now, let’s look at this economy. We’re not in uncharted territory. Lots of economies have gone through financial crises. And what is characteristic of them? They grow slowly coming out of them. You don’t get a V-shaped recovery. You grind out over a long period.

The U.S. is doing that. It has got a household sector that is very weak, had a lot of debt going in. Houses aren’t worth what they used to be, portfolios aren’t worth what they used to be. It is not going to spend its way out. They are not going to power us out.

Governments are in about the same shape, right? There’s a lot of problems with long-term federal budget. States are in bad shape. There is one healthy part of the economy. It’s the business sector. They have got cash. They have got the capacity. And instead of scaring them into spending it, as raising an inflation target might do, we ought to give them some positive incentives. And the business community has been very vocal about how they feel this administration has been anti-business. And it’s hurting them.

JEFFREY BROWN: But you were — earlier said that you didn’t think the Fed even had much — much in the way that it could do. Now, is that the argument, or is it that they can do certain things, as they suggested today, but those might pose new risks?

DOUGLAS HOLTZ-EAKIN: I think they can do more things. They said it clearly in the speech. Paul is right about that.

But we ought to hold on to those in case the economy actually begins to go into a recession again.

PAUL KRUGMAN: It — it doesn’t work that way.

DOUGLAS HOLTZ-EAKIN: We’re growing. We have been growing for a year. And it’s important to think about this problem correctly. And I think the administration has misdiagnosed it. This is a growth problem. The United States has been growing for a year. It’s growing too slowly. So, we need to throw everything at taking the long-term budget deficit off the table, control spending, so that businesses aren’t worried about higher taxes, high interest rates, or both.

Get some trade agreements. Don’t just talk about it. Do it, so we can sell to other customers. Keep taxes low on, you know, savings and investment. These are important issues for business. And they have a long list of gripes about the policy agenda with this administration that is not imaginary. It’s real. And it’s hurting their ability to drive this economy.

JEFFREY BROWN: All right, Paul Krugman, come back. I know you want to jump in.

PAUL KRUGMAN: No, it’s imaginary. Doug, this is something that is made up. It is their lobbyists who have that long list of problems. But when you actually look at surveys of businesses who are asked why are you not investing, why are you not hiring, they say it’s lack of demand. The economy is not strong enough for them to start hiring.

We need to do something to make this economy stronger, not five years from now, not 10 years from now, but now. We need to prop this up. Yes, it’s true that the aftermath of financial crises is usually a long period of poor economic performance. But that’s not something to just accept.

We’re supposed to do something different. When Japan had a somewhat similar situation in the 1990s, after its bubble burst, American economists, American officials were caustic about the unwillingness of the Japanese to take strong action to deal with their problem, the way they were just sitting there. And now we’re doing the same thing.

We are turning Japanese in our economic policy. This is not something we should be accepting. This is — it’s very easy for comfortable people, like all of us, right, in this discussion to say, well, you know, these things take time. Not necessarily. And — and we should be trying to do better, not just sitting and accepting this prolonged period, when — when productive workers, men and women who want to work, can’t find jobs.

JEFFREY BROWN: And you don’t see the…

PAUL KRUGMAN: That is not acceptable.

JEFFREY BROWN: Excuse me. But you also wrote today about the politics, I mean, the other thing that one could look to and often have in the past with the stimulus from the government. You see the politics as taking that off the table right now?

PAUL KRUGMAN: Unfortunately, I think so. I think that the economic case for doing more fiscal stimulus is very, very strong. The markets are not worried about U.S. debt. They are willing to lend at very low interest rates to the federal government.

But, you know, realistically, given the way the U.S. political system works, your chance of getting 60 senators for another major stimulus is something less than zero. So, I’m — you know, I would be all for it, but I

don’t think it can happen.

JEFFREY BROWN: What do you see on that…

DOUGLAS HOLTZ-EAKIN: I do not think anyone should be complacent. I absolutely agree about this. This a situation where we need to do things differently and actually grow faster. Stimulus will not be the solution. This is no longer an economy that’s falling and needs the government to step in and prop it up. It’s growing. It’s just not growing very well. And we have to think of it as a growth problem.

And to do what Japan did, which is spend a lot and raise taxes, exactly the mix that you are hearing the administration talk about, is to become Japan. And we can’t go that route.

So, take the tax increases off the table. Don’t rely on government spending. Let the private sector drive this thing. And it’s not imaginary to — to look at things the administration wants credit for, increased emphasis on clean technologies, increased health I.T. Those aren’t stimulus. Those are costly changes in the American economy they’re trying to do in the name of stimulus. That’s not helpful.

JEFFREY BROWN: All right, debate to continue. Douglas Holtz-Eakin and Paul Krugman, thank you both very much.

PAUL KRUGMAN: Thanks a lot.