Scott Sumner thinks Volcker recession was unintended… really?
Yesterday I wrote that causing a recession to correct policy mistakes would reflect the medical wisdom of re-breaking a bone in order to set it correctly. Yes, there is pain in re-breaking a bone. Yes, the patient screams. But the patient is better off in the long-run. I said people would think I was crazy, and Scott Sumner thinks I am crazy.
“PS. Marcus Nunes has a wonderful new post that directed me to a left wing blog that advocates intentionally driving the economy into a recession as a way to reduce inequality. That’s a wonderful idea. I strongly encourage all progressives to read this Angry Bear post, and adopt the “breaking bones to fix bones” model of the economy. Voters will love it and that will finally convince them to adopt all your other socialist ideas.”
Scott Sumner praises the post by Marcus Nunes who basically said that the Volcker recession was unintended. He cites a book by William Barnett…
“Following the inflationary 1970s, Paul Volcker, as chairman of the Federal Reserve Board, decided to bring inflation under control by decreasing the rate of growth of the money supply…The policy succeeded in ending the escalating inflation of the 1970s. but was followed by a recession. That recession, widely viewed as having been particularly deep, was not intended.”
“The chart reveals the cause of the unintended recession. The rates of growth of the Divisia monetary aggregate was much lower than the rate of growth of the official simple-sum aggregate which was the official target of policy. With the Divisia growth so much lower the result was an unintended negative shock of substantially greater magnitude than intended. A deep recession resulted.”
Was the Volcker recession really unintended? Was it an “oops” moment? Well, let’s listen to Milton Friedman and George Shultz talking about the Volcker recession…
First Milton Friedman…
“There is no other president in the postwar period who would have stood by without trying to interfere, to intervene with the Federal Reserve. The situation was this: The only way you could get the inflation down was by having monetary contraction. There was no way you could do that without having a temporary recession. The great error in the earlier period had been that whenever there was a little contraction there was a tendency to expand the money supply rapidly in order to avoid unemployment. That stop-and-go policy was really what bedeviled the Fed during the ’60s and ’70s. That was the situation in 1980, in ’81 in particular. After Reagan came into office, the Fed did step on the money supply, did hold down its growth, and that did lead to a recession. At that point every other president would have immediately come in and tried to get the Federal Reserve to expand. Reagan knew what was happening. He understood very well that the only way he could get inflation down was by accepting a temporary recession, and he supported Volcker and did not try to intervene.”
Reagan and Volcker did exactly what I called “re-breaking the bone” of the economy in order to set inflation straight.
Now George Shultz…
“When President Reagan took office, he had people like Milton Friedman. I was chairman of the economic policy group, Milton was a member, and there were others who said the essence of the inflation problem is monetary policy, and to deal with it effectively, you’ve got to discipline the money supply. Paul Volcker agreed with that, and President Reagan gave him a green light. Now, people worried about that, and many people warned President Reagan that if he did this, there’s likely to be a recession. And obviously who wants a recession? But I can remember President Reagan using those famous words, “If not now, when? If not us, who?”
“And so when he (Reagan) took actions that he thought were right, knowing that there could be difficulties, he stuck with them, he didn’t run away. He had a stiff backbone.”
Reagan and Volcker both knew there would be a recession. Yet they had the backbone (speaking of bones) to push the economy through the screaming pain of a deep recession. And they knew they were risking a political backlash. Milton Friedman said…
“And I know — I can speak with, I think, authority on this — that he (Reagan) realized what he was doing, and he knew very well that he was risking his political standing in order to achieve a basic economic objective. And, as you know, his poll ratings went way down in 1982, and then, when the inflation seemed to be broken enough, the Fed reversed policy, started to expand the money supply, the economy recovered, and along with it, Reagan’s poll ratings went back up.”
Christina Romer is telling us not to worry about recessions. We can recover quickly with proper policy. We could also have a better economy because of a recession, as is the case of beating down inflation during the Volcker recession.
So when Scott Sumner sarcastically says that pushing the economy into a recession to reduce inequality is a “wonderful idea” that voters will love, he is implying that he would have advised against Reagan and Volcker to cause a recession. He is implying that he would not have had the backbone to do what they did. We do not need economists like him. We need economists with backbone.
Voters did not like inflation back then, and they certainly don’t like inequality now. So it follows from the Volcker-Reagan example that a plan to reduce inequality, even if it involves provoking a recession would eventually be appreciated by the voters.
Here is how I see the next recession… (taken from my comments at Mr. Sumner’s post)
To start, there is a growing problem of inequality that is getting more entrenched everyday. Monetary policy is feeding the inequality. We can see who is benefiting and who is not. Just as inflation adversely affected economic decision-making back in the 1970′s, inequality is distorting decisions now to the point that financial stability is again a primary concern. Asset prices are once again becoming distorted. International markets are sensitive to Fed policy. The central bankers are talking seriously about financial stability again.
Yet, the Fed is in a trap. If they tighten to stop this growing financial instability related to inequality, they really do risk a recession. Profit rates have peaked. So what do they do? They choose to push on keeping a hopeful face that a far off full employment will rectify the problems, including inequality and low inflation. That is the only way out of this trap. Basically they underestimated weak demand. They did not understand what a falling labor share meant. They expected the economy would have recovered by now.
The economy healed incorrectly after the crisis, considering the fall in labor share. Then profits increased to great levels with the blessing of monetary policy, while inequality increased. Inflation is staying low globally. There is weak demand from low labor share. The transmission mechanisms of liquidity to middle and low income households is not good enough. Christian Romer acknowledged this in her talk. During the crisis, she didn’t think it proper to help middle incomes. She would help middle incomes in the next crisis. That somehow makes me want a new crisis right away.
The economy is proceeding with a permanent limp related to policies that increase inequality. I foresee progressive mechanisms being engineered in the next recession.
My view is that a recession will happen anyway before their full employment level is reached due to weak effective demand, which monetary policy could not resolve. And the recession will easily be blamed on a monetary policy that benefited the rich at the expense of everyone else. Then as the economy recovers, there will be pressure to make policy more progressive to help the 99%. The new policy will have mechanisms directing liquidity at middle and low incomes.
Larry Summers has already pointed to weak demand causing low production. He has said that policy in the future must be directed at demand. That means labor income in my book. The words of Larry Summers and Christina Romer have influence. So the stage is already set. When the next recession happens, we will see more progressive policies.
So my backbone is ready for the next recession… go ahead and break my bone. Let me scream. I see good economically progressive doctors ready to make the economy better.
To wrap up, Volcker knew what he was doing by re-breaking the economy to correct inflation. Reagan had the backbone to stand by him. We need progressive economists with backbone to correct inequality.
Define “Effective Demand: for me please. I tend to agree with this:
“effective demand is a limit to employment and capacity utilization against which aggregate demand stimulus is totally ineffective.
The Fed is independent in the government not independent of the government.
In 1980 public opinion was more than willing to accept the trade-off of a recession or high unemployment to end double digit inflation.
Frank Morris, the President of the Boston Fed at that time, was a strong advocate of targeting money supply as a way to get high interest rates without having to take the blame said that the Fed pretended to be targeting the money supply and Congress pretended to believe them so they could both avoid the blame for the recession.
Frank was known in Boston for having a few drinks before speaking to private groups like the Boston Economic Club where he would talk bluntly about Fed policy and inside deliberations.
“public opinion was more than willing to accept the trade-off of a recession or high unemployment to end double digit inflation” True. I also remember Nixon’s price and wage controls being accepted by the public. What a roller coaster the time period from Nixon to Reagan were.
Ultimately that is the message from effective demand. There is a natural limit (natural GDP) that when surpassed leads to destabilizing consequences. The limit acts upon the utilization of labor and capital through aggregate incentives for increased profit. Beyond the limit, profit incentives become sensitive to changes in the economy, which can result in inflation or contractions… as seen through the aggregate supply-aggregate demand model.
There are a number of problems with your analysis Edward IMHO. First, the 70’s stagflation was in my mind a somewhat special time because much of the inflation was due to the OPEC cartel. Now it could well be argued that oil had been too cheap and the U.S. was getting a disproportionate share of it, but to say that there was too much money floating around is only a small part of the story. Second, it was labor’s ability to secure increased wages which prevented the OPEC shocks from simply stopping the economy dead in its tracks. That ability simply does not exist today. I do not know how often Bernie Sanders gets fact checked but he indicated that the average worker in in either 1987 or 1978 made as much in real terms as the average worker today. As a young adult with debt, I did okay during the inflation of the late 1970’s. I got a raise every year and paid off my loans in cheaper dollars. Young people today are lucky to have a job and if they do are often asked to take pay cuts. If their is deflation my 401K will be worth more but all those college loans, credit card balances and mortgages will be that much harder to pay off. In any event despite pumping something like $4 trillion into the economy there are no signs of inflation and as long as workers can not demand wage increases there will not be. Third, I do not see how you can equate growing inequality with Fed policy. While the inequality has increased since 2008 and at a startling rate, that inequality has more to do with stagnating real wage growth coupled with Reagan and Bush era tax cuts for the wealthy and the growth in financial assets than low interest rates. While it would be nice for me to make more interest on my savings, most people–particularly young people do not care about interest rates except on the payback of loans. They also do not care about lower tax rates on capital gains and dividend income because they do not have either. Fourth, do you really think that Summers and Romer did not know what they were doing when they had positions of influence in the Obama administration? Either they are as bad as Republicans who like Lucy promise Charlie Brown they will not take the football away next time or there simply was not a political climate to do the right thing. I simply do not believe that if the political will is lacking to do right by the 99% that anything short of economic collapse will provide that will. And by economic collapse I mean where there are bread lines and riots. I for one think that is way too strong a medicine and the fact is that the wealthy will still come out on top–the rest of us will be that much poorer. Now if you want to make the case that we would have been much better off if Greenspan had not propped up the Bush economy with bubbles, I can agree but that was done more for Bush’ political fortunes and Greenspan’s in retrospect ignorance. Remember that was a time when the vice president of the United States could say “deficits don’t matter”. Even Reagan could not make that case stick in 1986.
yet final demand has been good(and revised upwards) since Q2 2013.
Wages have been replaced by debt. pure and simple. because of the favoritism toward debt, financial institutions can give out a lot and be patient about repayment………until they give out to much.
This keeps wage inflation down and thus inflation down. saying there are “no signs of inflation” is embarrasing.
There was a post about the Volcker recession that might answer some of your questions about oil prices and wage contracts…
The easy monetary policy provides liquidity as is needed or wanted. Much of that liquidity has been channeled through international markets, as opposed to domestic productive investment. Weak effective demand gives less incentive for domestic productive investment. So the liquidity of monetary policy equates with inequality by being used for non-productive investments, assets, which concentrate capital ownership in the hands of rich people. Inequality is becoming more and more entrenched for the future as the Fed’s liquidity is being used for grabbing capital ownership.
Romer and Summers did not think the recession was going to be so deep. They expected a recovery fairly quickly. They underestimated the fall in labor share. Mrs. Romer now admits that she would have done more for middle incomes. Mr. Summers too I think would now do more for middle and lower incomes. They thought that just fixing the banking and financial sector would be enough. Well, now they understand that the 99% needed support too.
Now when you say that a recession is too strong a medicine… Realize one thing… we got the New Deal because of the Great Depression, and then we had decades of prosperity until weak Fed policy allowed inflation to creep in. Did you read what M. Friedman wrote above about the stop-n-go policies? I highlighted it… So a recession is a time when things can be set straight. Policy is implemented and away we go. If the policy falls short, then it is hard to correct near the end of the business cycle. Then you have to have another recession and try to fine-tune your policy, hoping it will have better results than before.
Bottom line, there should have been more policies to support labor share. It is hard to do that now without triggering a reaction from business since profit rates are peaking. It would have been better to support wages right after the crisis, as FDR did my implementing the minimum wage towards the end of the 1937 recession. Unemployment came down nicely after he did that.
Perpetual QE is starting to have another predicted effect – the rise of a new Ponzi economy :
Subprime auto loans , evergreening of zombie company loans – it’s deja vu all over again.
Well, that is not what Greider said. and as between William Greider and George Schultz, I know who I’d trust if I had to trust anyone.
And it’s not “the economy” that get the screaming pain. It’s people who are not George Schultz.
And the thing about calling for a recession… it is certainly not something you want to have said in public so Scott Summer can blame the left.
Maybe a little fiscal “stimulus” directed toward workers, and maybe a little regulation directed against criminal banks would do some good without a recession.
NO return to Glass-Steagall, NO win for the country or the economy.
@Mike Meyer, considering Bear Stearns, Lehman Brothers, Countrywide, New Century, Washington Mutual, Fannie, Freddie, AIG, Goldman Sachs, Morgan Stanley, and one could even argue Merrill Lynch would have been compliant in a Glass-Steagall regulatory framework, can you please expound on your comment?
@Terry: “While the inequality has increased since 2008 and at a startling rate, that inequality has more to do with stagnating real wage growth coupled with Reagan and Bush era tax cuts for the wealthy ”
Income inequality is usually quoted in pre-tax terms. While tax cuts for the wealthy benefited after-tax income, and may have resulted in an increased proclivity to recognize rather than defer gains (which benefits Treasury from a present value standpoint), aside from gains, can you help me understand how tax cuts are a factor in pre-tax income inequality?
I believe you misread Terry. He admits to stagnating real wage growth. The other factors just minimized or maintained the growth during recession. Hopefully, you can do better than this?
i’d also suggest that tax cuts lead to more money in the pocket which can be reinvested if you insist that since income is counted pre-tax then tax cuts don’t make the rich richer
i get a feeling that everyone has a few “words” on the subject they can cherish so they don’t have to think about reality.
In its most basic form: Glass-Steagall divided investment banks from savings banks. All savings in a savings bank (accounts that perhaps U&I might place there to protect OUR lifetime’s labor) are protected and INSURED by the FDIC. Investment banks take investors’ monies and invest them in the hope of a return at interest (various loans, stock portfolios, hedge funds, various financial paper products, etc.)
Glass-Steagall separated the two. Its removal (Dec. 24, 1999, signed into law by Bill “Big Dawg” Clinton and as I call it Y2k) allowed the two to combine. Should investment office of the combined bank take OUR savings, without OUR knowledge or approval, out of the savings office of the combined bank, (its OK those accounts are FDIC INSURED) and invest them in a sure winner, say ENRON, (roulette just the way ya like it) and sadly lose, well then THE TAXPAYER covers the loss.
Fun for the combined bankers, U&I won’t feel a thing unless the bank goes belly up and WE get a letter telling US what’s what. and, AS ALWAYS, THE TAXPAYERS are left holding the bag, yet again.
From now on this game will continue on in a “Groundhog’s Day” fashion until Glass-Steagall is reinstated
You are even more clueless than I thought. You claim I think the Volcker recession was unintended, but then the body of your post quotes Nunes making that claim. Bizarre, even by Angry Bear standards.
Of course there is much, much more to Glass-Steagall than above. Lets look at loan retention. Before removal, a bank making a mortgage loan would have to hold on to 70% of the loan for the loan life(say 20 years). The rest could be sold off at auction(bailed) to garner a quick though smaller return on that 30%. After removal, the whole loan/s could be immediately sold off at auction(bailed) for that quick buck.
Of course this lead to the CORRUPTION in how loans are evaluated, to FRAUD in how the loans are sold, and criminal accounting practices in the everyday paperwork in registering those mortgaged properties.
That’s JUST two examples concerning Glass-Steagall. I could go on&on, but why???
Let say removal of Glass Steagall lead to efficiency in banking since APPARENTLY its more efficient to steal than to deal honestly.
You said… “And the thing about calling for a recession… it is certainly not something you want to have said in public so Scott Summer can blame the left.”
Yet my post points out that is what Reagan and Volcker did. They caused a recession. So they can’t blame the left for something that Reagan did.
I know this may sound like blasphemy, but “saving the rich” isn’t always what’s good for the majority of the nation. Sometimes, much like Reagan’s policies, it only helps the rich.
Then there is no hope, no way to rectify the situation. As long as there is no recession, policy will keep pushing forward feeding wealth into the hands of the wealthy.
Yet a recession will come at some point. It is only natural. What would you do then?
“Edward Lambert…Then there is no hope, no way to rectify the situation.”
End debt created money. E. Brown in The Web of Debt administrated how simple and would force capitalism to return to productive activities, and the numbers showed the national debt could be paid off in a year (?) plus have tax relief.
IF anyone has a copy I think the formula was around page 444.
run – I’ll concede stagnating real wage growth, which is why I didn’t ask him about it. But if you make a statement that z happened because of x *and* y, I assume it’s okay to ask about y without asking about x, am I wrong?
coberly – good point. But for investment returns to be reflected as “income” they have to be realized through dividends, interest, or sale. There’s an argument to be made that faster realization of investment returns could be worsening income inequality but improving wealth inequality, because not realizing investment income causes investments to compound tax-deferred. I’m aware that wealth inequality has been growing at a faster rate than income inequality, but that doesn’t disprove the former argument, the rate could have been even worse with greater incentive to defer gains.
Thanks Mike, but I’m pretty sure there are only 4 banks that wouldn’t be compliant in a Glass-Steagall regime right now – Citi, B of A, JP Morgan, and Wells Fargo. Now they have huge market share of deposits – off the top of my head, I’d guess mid-30’s percent.
As for portfolio versus securitized loans, I think mortgage pass thrus started in the early 1970’s. Lehman and Bear Stearns, the two big investment banks that went under during the crisis, were not deposit taking institutions and were the biggest packagers of securitized mortgage product. As I mentioned, I’m pretty sure Lehman and Bear in their corporate forms in 2007/2008 would have been compliant in a Glass-Steagall regulatory regime.
if i understood you, “official statistics” count pre tax wages as a measure of “wealth.” you take this to argue that the wealth of the rich did not increase because of tax cuts.
even forgetting about the possibility of investing the money, i think a more real-world understanding of wealth would suggest that the money the wealthy did not spend on taxes was spent on consumption… what most people think of as wealth… while the money not collected in taxes was not spent on things that would have helped not only the poor (welfare) but ordinary workers, perhaps by paying for something so ordinary as road repair, but certainly by paying for honest government… that would have prevented bank fraud and the artificial, non-free market, downward pressure on wages, … etc.
I don’t think it’s a good idea to do what REagan and Voker between them did. But moreover I think you are pretty naive to think the Right can’t blame you for doing exactly what they did, if they can twist the story to make it sound like you are causing a recession …
perhaps I was unclear. “income” is generally considered a flow number and “wealth” is generally considered a stock number. In terms I know you’re familiar with, it’s analogous to the difference between the government budget deficit [flow] and the government debt [stock].
pre-tax wages are a component of income, as are realized investment gains, dividends, and interest received. “consumption” is also generally considered a flow number, though broadly speaking and depending on what’s “consumed” you could argue it has the potential to add to wealth in the future (e.g., buying a house).
my point about tax cuts on income is that if I’m both wealthy, and have sufficient annual wage income to meet my annual consumption needs, I am more likely to avoid realizing investment income in a high tax regime than in a low tax regime. If I’m avoiding realizing investment income, my investments will compound off of a pre-tax base.
mathematically – assume I have $100 in investments. Assume we are choosing between 2 different tax regimes, 15% or 35% on investment gains and a matching deduction for interest expenses if I borrow and that investment returns are 7% in either regime. Under any circumstance, I’m going to consume $4 units after tax above my wage income and can access that $4 through either realizing investment gains, or through borrowing at 5% pre-tax. If I borrow I end up with more wealth after 10 years (just randomly selected) in a high tax regime because I get to deduct my interest expenses in a higher tax regime. If I consume, I end up with more wealth in a low tax regime (as you would expect). But in a higher tax regime, I’m more sensitive to taxes, so I’m more likely to borrow. So let’s assume in a high tax regime, I borrow 1/2 of the $4 and realize the other 1/2. In this case, my “income” looks lower, but my “wealth” ends up higher.
All hypothetical of course, but this is the point I was trying to make. A low tax regime invites greater income inequality, but has the potential of improving wealth inequality. I’m not sure which is a bigger problem for “honest government”, I’d suspect it’s wealth more than income, but not for any particular reason other than the notion that you don’t see politicians kowtowing to athletes and entertainers (high income) in quite the same way as billionaires (high wealth).
I’d plant a garden.
I look at it as a “can’t see the forest for the trees” kind of a proposition. For the 99% the recession hasn’t gone away, hasn’t been solved. Why, the demand for a minimum wage increase is in itself proof of that. Even full employment at less than living wage isn’t really “full employment”. People work to sustain life, not just so they can claim to have a job. If I have to work ALL my waking hours to eat and pay rent and can only get a 5 hour job at McDonalds then I’m not fully employed.
Wall Street, on the other hand, doesn’t see a recession, in fact it sees profits in the range of 2good2btrue. Of course over the last years QE has propped Wall Street up. That’s The Fed’s stated reason, its a FACT.
Had 2big2fail been allowed to follow “Market Forces” instead of being propped up then ALL the big banks would have gone “The Way Of The Buffalo” and many bankers would be living under the overpass like a lot of the 99%.
New banks would have started out of the REAL ASSETS of the old 2big2fails and many of the old board of directors members would get prosecuted. INSURERS OF LAST RESORT such as AIG would be in jail by now for their fraud. Investors would sue but things would settle peaceably for THAT’S what Courts, Law & Justice are about.
But NONE of that happened. The investors got stuck, Wallstreet got welfare, and The 99% are STILL seeing a recession. OUR recession never healed its just hidden from the wealthy by way of QE. Those of Mainstreet, the former Middle class are no longer in their previous financial state and won’t be for a long time, if ever.
Once the Middle Class is back to its former estate, then and only then can that “broken bone” be considered healed correctly or incorrectly.
I can see your point, now that you explain it. But I am always leary of too abstract a level of analysis. I think we have seen a “low tax regime” for quite some time, and it doesn’t seem to be helping anyone very much except for the predatory capitalists.
I don’t have anything against capitalists as such, but I think we have a serious problem with predators, getting worse, and getting very close to being the basis of our morality.
Reply to Scott Sumner,
Scott you praised the article by Marcus…
“Marcus Nunes has a wonderful new post that directed me…”
Now you are distancing yourself from him? How does Marcus feel about that?
Australia saw something similar in the 1990s when our prime minster said that the recession is something we needed to have. Did not work well with the voters but it did great in cleaning out the excess which saw another 20 years of economic growth (thanks China!)
The problem is that our economy still hasn’t recovered from the recession of ’79.