Krugman Sees the Light and Calls on the Fed to Print $2 Trillion
Posted by Michael A. Kamperman on December 11, 2009
In this morning’s New York Times Paul Krugman called on Ben Bernanke to ratchet up the Federal Reserve’s efforts to create jobs by printing $2 trillion. Krugman says the economy needs to create 300,000 jobs per month for the next five years in order to create the 18 million jobs necessary to return to full employment. The Keynesian econonomist ruefully acknowledges the appetite for a full scale fiscal assault on the economic crisis doesn’t exist in Washington and he is turning to Bernanke and monetary policy as the nation’s best option to create jobs. Krugman states “the most specific, persuasive case I’ve seen for more Fed action comes from Joseph Gagnon, a former Fed staffer now at the Peterson Institute for International Economics. Basing his analysis on the prior work of none other than Mr. Bernanke himself, in his previous incarnation as an economic researcher, Mr. Gagnon urges the Fed to expand credit by buying a further $2 trillion in assets. Such a program could do a lot to promote faster growth, while having hardly any downside.” While Joseph Gagnon is on the right track he underestimates the size and scale of quantitative easing necessary to end the credit crisis. Consider that Goldman Sach’s estimates that every $1.4 trillion worth of government securities the Fed purchases is equivalent to lowering the Fed Funds rate by 1%. Goldman further estimated the Fed Funds rate needs to be lowered another 6% in order for monetary policy to have enough teeth to get the economy moving again. The Goldman study estimates the Fed needs to print $8.4 trillion.
While I think Mr. Gagnon’s estimate is way too low and that Goldman’s estimates are also too low I am thrilled that Professor Krugman has kick-started the debate about why isn’t the Fed printing more money and just how much money does the Fed need to print. My own estimate is we should start with $10 trillion, though it will probably take $20 trillion, and virtually eliminate all of the outstanding U.S. Treasuries. This shock and awe strategy would restore confidence because the federal government would be almost debt free. It would also mean our President wouldn’t have to go to Asia and bow down before his bankers. And, it would free the Congress from concerns about the deficit allowing them to send the states the estimated $350 billion they will need over the next two years to close their budget deficits.
Imagine a world where the too-big-to-fail-too-yet-too-broke-to-lend-banks have no risk free Treasuries to invest in and are forced out on the risk curve with no option but to lend again? It is up to the Fed to take the “hide the money under the mattress” Treasury bonds away from the institutions. We have seen several Treasury auctions this month where the winning bidders accepted zero interest just to know their money was safe. One auction had demand for over five times the amount of Treasuries auctioned even though there was no interest to be earned. If I ran an institution I wouldn’t want my money in a maybe too big to fail bank, or in Dubai or Greece either. For those worried about the dollar if the Fed takes the plunge you can bet the Japanese and the Brits will be quick to follow. We are in a global debt-induced deflationary depression and it is up to the U.S. to lead the way out. Mr. Bernanke, to whom much is given, much is required.
Lawrence Bagshaw said,
Do you not think that creating more money will only lead to another market distorting episode whereby false price signals arising from printed money will lead to further malinvestment and eventual collapse? The sub-prime fiasco seen in the US, the collapse of the property markets in Spain and Irish and the resulting unemployment are all a result of similar false price signals arising from an over-supply of credit. Many other examples exist. By printing more money and holding down interest rates we merely create new market distortions of the type which caused the crisis originally. Would this not eventually lead to a bigger bust, high unemployment and economic pain greater than we are now experiencing?
Would it not be best simply to liquidate malinvestments, pay off debts and let the market decide which companies and individuals are to prosper ? This would be short-term painful but would risk neither the currency, inflation nor our standing with world creditors and the currency markets.
Michael A. Kamperman said,
The reason we need to print more money is to restore balance to the credit markets so that fair price signals can be found for most assets. I agree the pendulum swung too far in the direction of easy credit when unemployed people with bad credit were given no money down loans to move into $500,000 homes. But the bursting of that bubble has caused credit to contract too tightly whereby normally qualified consumers and small businesses cannot access credit on reasonable terms. This is causing a false price signal on the downside. Prior to the summer of 2007 it would never have been appropriate for the U.S. to print money in the post World War II inflationary era. But those days are over.
Consider that after almost 20 years Japan has yet to escape the “short term” pain of liquidating malinvestments. The weight of the debt will only lead to more and more defaults or Zombie banks that extend and pretend but don’t lend, ala Japan.
Finance Considered said,
I note the first comment mentions Ireland, my home. The state here is moving towards a gradual balancing of the books. One of the things that has been done here is a plan called NAMA, basically the state is buying distressed assets off the banks, and paying them with bonds, that can be redeemed at the ECB. The only problem is that house prices are still on the way down. The governing party is very close to the construction industry and the banks, so they are trying to set a floor under prices. In a deflationary depression, it is impossible for a small open economy to insert floors in the market.