On Aug. 21, the National Press Club hosted a panel of three experts to discuss the state of the U.S. economy, moderated by Jennifer Schonberger of The Wall Street Report.
The three panelists were Mohamed El-Erian, head of the $2 trillion bond fund at Pimco; John Taylor, a professor of economics at the Stanford University Business School and the foremost authority on the Taylor rule to limit the monetary policy discretion of the Federal Reserve; and Sheila Bair, former chairman of the FDIC, now at the Pew Charitable Trusts in Washington.
This article will discuss the views of El-Erian and Taylor on the economy, while the remarks of Bair on the state of the banking system require such careful parsing that they will be analyzed in two subsequent articles.
Schonberger set the stage for the discussion by describing the current circumstance. Four years after the 2008 episode, the economy is still in second gear, stuck at less than 2 percent growth for three consecutive quarters, which is below the average growth rate of 2 percent for the duration of the current recovery and well below the 3 percent rate at which the economy has historically grown.
Incomes are stagnant, and unemployment is high, at 7.4 percent. Adding workers who have left the work force because they are discouraged would raise the unemployment rate to 14 percent.
While the housing market is improving, home prices remain at levels last seen in May 2004. She asked the panel how much longer the economy will remain stuck in the mud and what can be done to pull this economy out of this tepid period of growth. She put the question first to El-Erian, who coined the term "new normal" back in 2009.
El-Erian responded that the slow pace of growth is no longer cyclical. It will remain lower than historical norms unless the mindset in Washington changes. He warned in 2009 that this was the situation, and in the meantime it has materialized. Not only is the economy stuck in second gear, but it is also trying to navigate a foggy road, although the United States is doing better than Europe and Japan.
He asserted that there is no reason why the economy has to remain in second gear. Appropriate solutions are technically feasible, but they have proven to be politically unfeasible. Any proposals to kick the economy into higher gear have been DOA in Congress, and the Fed's actions are limited by the nature of monetary policy. Now that the Fed has maintained accommodative policy for an extended period and plans to continue to do so, Fed Chairman Ben Bernanke himself has expressed concern over the potential for collateral damage.
What is needed, according to El-Erian, is a "Sputnik Moment," in which policymakers resolve to take the following four steps:
1. Structural reforms, to improve the competitiveness of the economy.
2. More balanced aggregate demand.
3. Resolving the debt overhand that acts as an impediment to growth.
4. Address long-dated issues, such as education and retooling and retraining labor.
El-Erian contended that these measures would not be hard to implement if there were a political consensus to act. Otherwise, there is a risk that even 2.5 percent growth will not be achieved, because skills will erode, and the competitive position of the United States will continue to decline.
When Schonberger asked whether higher interest rates might choke growth even more, El-Erian offered a chilling observation. He drew a contrast between the ways economists and investors looks at the economy. He said economists tend to look at the journey, whereas investors look at the destination.
He warned that the Fed's quantitative easing (QE) policy is experimental and has not been tested, but the Fed has responded to evidence that the effect of QE might be diminishing by applying even more easing. When Bernanke floated the prospect of tapering on May 22, interest rates rose, and since then, the Fed has been walking back this idea.
I raised a similar question a couple years ago at a monetary conference sponsored by the Philadelphia Fed, asking an economist whether the market would not calculate how much rates would have to increase upon the withdrawal of QE, say 400 basis points, then once the Fed made its first move, go quickly to the destination, shocking the markets, and the economist agreed this is likely to happen.
Taylor pointed out that the 10-year Treasury rate had been about 1.7 percent during the fourth quarter of 2012, but it got to 2.9 percent last week. He declared, "I really see no positive effect on rates from this QE; forward guidance, perhaps, but it is just not there."
He agreed with El-Erian that the policy is experimental, and the impact is unknown. He predicted that the impact would be "basically negative" on the economy, although it would ultimately boost asset prices.
I have predicted that the effect of the post-2008 interventions would be another bout of stagflation and that repeated episodes of the financial crisis are in store, because nothing has ever been done to contain the excesses built into the flawed business model of the banking industry.
These themes will be further developed in the next two articles.
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