I have decided to create a mailing list for sending future articles that I
write in the Wall Street Journal, Financial Times, and elsewhere. Probably
about two or three things a month. Let me know if you would prefer not to
be on this list
My latest WSJ and FT pieces follows:
Originally published in The Wall Street Journal July 2, 2013
The Fed Should Start to 'Taper' Now
By MARTIN FELDSTEIN
The Federal Reserve should begin now to end its program of long-term asset
purchases. It should not wait for the improved labor market that it
predicts will come later this year, an improvement that is unlikely to
occur. Instead, the Fed should emphasize that the pace of quantitative
easing must adjust to the likely effectiveness of the program itself, and
to the costs and risks of continuing to buy large quantities of bonds.
Although the economy is weak, experience shows that further bond-buying
will have little effect on economic growth and employment. Meanwhile, low
interest rates are generating excessive risk-taking by banks and other
financial investors. These risks could have serious adverse effects on bank
capital and the value of pension funds. In Fed Chairman Ben Bernanke's
terms, the efficacy of quantitative easing is low and the costs and risks
are substantial.
At his June 19 press conference, Mr. Bernanke described the Fed's plan to
start reducing the pace of bond-buying later this year and to end purchases
by the middle of 2014. He stressed that those actions are conditional on a
substantial improvement in the labor market, leading to an unemployment
rate of about 7% by mid-2014 with solid economic growth supporting further
job gains. He emphasized that the "substantial improvement" would be judged
by more than the unemployment rate.
Over the past year, unemployment has declined to 7.6% from 8.2%. However,
there has been no increase in the ratio of employment to population, no
decline in the teenage unemployment rate, and virtually no increase in the
real average weekly earnings of those who are employed. The decline in the
number of people in the labor force in the past 12 months actually exceeded
the decline in the number of unemployed.
These poor labor-market conditions are unlikely to improve in the coming
months. The Fed's forecast of substantial employment gains rests on the
assumption that real GDP will grow by about 2.5% during the four quarters
of 2013 and by more than 3% in 2014. That would represent a substantial
rise from the growth rates of less than 2% in 2012, 1.8% in the first
quarter of 2013, and a likely 1.7% in the second quarter. Reaching the
Fed's GDP forecast for this year requires the growth rate to jump to more
than 3% in the third and fourth quarters.
It is difficult to see how this can happen. U.S. exports are declining in
response to weaker growth in other countries and a stronger dollar. The
sequester and the higher tax rates that took effect on Jan. 1 will continue
to reduce aggregate demand. These forces will more than offset the
favorable but small effect on GDP from increased residential investment.
Corporate profits and nonfarm inventory investment declined in the first
quarter, and nonresidential fixed investment was essentially unchanged.
Spending by state, local and federal governments fell. Personal income
declined and after-tax personal income declined even faster. The growth of
GDP was sustained primarily by a faster pace of consumer spending that will
be hard to maintain with stagnant earnings and a household saving rate that
has dropped to only 3.2%.
The higher interest rates that followed the Fed's announced plans for
tapering its bond-buying will further weaken GDP and employment. This will
make it even more difficult for the Fed to achieve the robust labor market
it says is necessary to scale back the bond purchases.
The Fed is also understating the impact of its tapering plan on interest
rates. Mr. Bernanke has made it clear that he believes the level of
long-term interest rates depends on the total stock of bonds held by the
Federal Reserve, and not on the monthly rate of purchases.
But the planned shift from the current monthly bond purchases of $85
billion to zero over the next 12 months clearly had a large impact on
long-term rates, pushing them to levels not seen since July 2011. This
impact is hard to explain by any effect the tapering might have on the
ultimate size of the Fed's bond portfolio. Mr. Bernanke admitted in his
June 19 press conference that the very large jump in rates that has
occurred was therefore a "puzzle."
The sudden jump in rates suggests that the Fed's statements acted as a
"trigger" indicating that the low- rate equilibrium was coming to an end.
Market participants have recognized that the interest rate on long-term
Treasury bonds is unsustainably low. The real level of 10-year rates was
negative until a few months ago and is now only slightly positive.
That real rate would normally be at least 2%. Given the size of the fiscal
deficit, the relative size of the national debt, and the low rate of
household saving, the real rate should now be significantly higher.
Investors nevertheless continued to hold long-term bonds to gain a bit more
yield, hoping they would be able to exit quickly before higher interest
rates caused asset prices to fall.
Mr. Bernanke's congressional testimony at the end of May and again in June
may have been the trigger that caused portfolio investors to start selling
bonds, just as the observed problems with subprime mortgage securities
triggered a much wider selloff in 2007. If so, long-term interest rates are
likely to go higher.
Although interest rates have increased, they are still abnormally low.
Investors and financial institutions are still accepting significant risks
in order to enhance the yield on their portfolios by buying low-quality
corporate bonds, holding longer-term bonds, making covenant-light loans
that increase the risk to lenders by imposing fewer restrictions on
borrowers. They are also bidding up prices of agricultural land and other
assets.
The danger of mispricing risk is that there is no way out without investors
taking losses. And the longer the process continues, the bigger those
losses could be. That's why the Fed should start tapering this summer
before financial market distortions become even more damaging.
Mr. Feldstein, chairman of the Council of Economic Advisers under President
Reagan, is a professor at Harvard and a member of The Wall Street Journal's
board of contributors.
July 9, 2013
Originally published in The Financial Times
An end to austerity will not boost Europe
By MARTIN FELDSTEIN
The eurozone periphery is on a risky path to end fiscal austerity and
accept larger budget deficits. Portugal is the most recent dramatic shift
in that direction; Italy, Spain and even France are also abandoning plans
to cut spending and raise taxes.
This move away from budget discipline reflects a combination of popular
political pressure, more accommodating bond markets and encouragement from
the International Monetary Fund.
But ending fiscal austerity is not a strategy for achieving growth. It will
reduce downward pressure on aggregate spending but will not lift growth and
employment. Instead, it will raise interest rates and threaten a new fiscal
crisis.
Europe needs three things: structural changes to boost long-run potential
gross domestic product, a short-term stimulus to increase employment, and a
commitment to longer-term spending reductions to shrink the national debt.
The political pressure to end austerity is widespread. Italian voters
demanded relief from the higher taxes and the reduced pension benefits
previously introduced by the Monti government. In France, President
François Hollande won his election with a promise to end austerity
and recently
rejected the European Commission’s demands for specific budget cuts. Spain
and Portugal reacted to public riots by negotiating with Brussels to delay
deficit targets.
The high interest rates on sovereign bonds that put pressure on governments
to cut fiscal deficits fell sharply with the announcement last August by
Mario Draghi, president of the European Central Bank, of a central bank
Outright Monetary Transaction bond-buying facility. The pressure was
further reduced when IMF officials encouraged the shift away from budget
tightening.
The IMF staff responded by raising estimates of the fiscal deficits of
France and the peripheral countries. The increase in current budget
deficits and the expectation of higher future deficits have caused
long-term interest rates to begin rising in all of these countries. As
investors see fiscal deficits increase during the coming year, interest
rates are likely to rise further and faster.
The relatively moderate pace of the recent increase in sovereign interest
rates suggests that markets have forgotten the conditional nature of Mr
Draghi’s promise. The ECB’s willingness to limit interest rates on
peripheral country bonds depends on each country having an approved fiscal
programme. With the countries shifting away from sound budgets, the ECB is
no longer committed to act and would be unwise to do so.
Rising interest rates could bring back the fiscal crisis of a mutually
reinforcing spiral of increasing national debts and rising borrowing costs.
That could revive the risk that some countries would be unable to borrow
and might therefore choose to leave the euro. If the ECB tried to prevent
that despite the lack of fiscal discipline, the result would be escalating
rates of inflation.
To prevent this, governments must combine long-run deficit reductions with
short-run fiscal stimulus. Slowing the growth of pensions and other
transfers would reduce future debt and prevent near-term increases in
interest rates. To make these changes politically acceptable, governments
should combine them with an immediate programme of infrastructure
investment and manpower training. This would not only raise current GDP but
would also strengthen long- run productivity and real incomes.
The slower growth of transfer programmes would also permit lower payroll
tax rates, cutting the cost of labour and increasing employment. Lower
labour cost would also raise the competitiveness of European products in
international markets.
A lower value of the euro could provide a further boost, making it possible
to lift employment while shrinking the short-term fiscal deficits. Although
a lower euro would not change the exchange rate within the eurozone,
countries outside the eurozone account for roughly 50 per cent of the
peripheral countries’ trade.
Policies to allow budget deficits to rise are a dangerous mistake. Italy,
France, Spain and Portugal should instead combine longer-term debt
reduction with short-term fiscal stimulus. Together with a slowing in the
growth in pensions and other transfers, this would boost productivity and
lower deficits and payroll taxes to the benefit of all Europeans. The
eurozone needs to adopt such policies.
The writer is professor of economics at Harvard University and president of
the US National Bureau of Economic Research.
Received on Tue Jul 16 2013 - 08:35:10 EDT
