Re: [A-List] znet/weisbrot on deflation - critique?

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

>-----Original Message-----
>> From: Canova, Timothy
>> To: 'Mark Weisbrot '; 'weisbrot-columns@xxxxxxxxxxxxxxx '
>> Sent: 7/10/03 4:57 PM
>> Subject: RE: [weisbrot-columns] Threat of Deflation Is Exaggerated
>>
>> "Let's Not Exaggerate the Federal Reserve's Capabilities", by Tim Canova
>>
>> I was quite surprised to read Mark Weisbrot's recent column ("Threat
of Deflation is Exaggerated", July 3, 2003) in which he downplays the
threat of deflation.  First, as he points out, even disinflation has its
down side (and as the Boskin Commission from a few years back notes,
even the offical Consumer Price Index (CPI) overstates actual
inflation).  Arguably, we're already there, and if not, there are plenty
of factors pushing the global economy in that direction (only some of
which you acknowledge), from deflation in Japan, recession in Germany,
falling oil prices, weak consumer confidence, weaker business
investment, austere fiscal policies in almost every state, and the
possibility of a bursting housing bubble (and maybe also a bearish
government bond market).
>>
>> Weisbrot places far too much hope on the Federal Reserve being able
to get the U.S. out of any deflationary cycle.  He states that the Fed
"can create all the money that it wants to create, and thereby drive
prices back up."  Just what does that mean?  That the Fed can purchase
long-term government bonds, at any price, to push long-term yields to
zero.  Yes, the Fed has that power (as in "the pegged period" of
1941-1951), but driving long-term bond yields to near zero won't get a
deflationary economy back up on its legs (recall the dirty 1930's and
present day Japan).  Hence, the Keynesian description ("pushing on a
string") of the futility of monetary policy during a liquidity trap.  As
every deflationary episode suggests, the central bank can make cheap
money available; but it cannot force anyone to actually borrow or spend
the money, and that is exactly the problem when business and consumer
confidence collapses.
>>
>> Over the past six months, several Fed officials have attempted to
quiet fears in the financial markets by referring to the Fed's power to
>> purchase long-term bonds (one Fed official even referred to the
pegged period).  I was therefore quite surprised to see Weisbrot buy
into the Fed's own public relations campaign.  It is a sign of the Fed's
fears of deflation that Fed officials have engaged in such heresy as
speaking well of the pegged period (previously only a shining moment in
monetary history for New Deal progressives like me).  But when the
consumer and business sectors are demoralized, pegging interest rates at
near zero will only be effective if it's to accomodate massive
government spending.
>>
>> Of course there's another impediment to the Fed creating lots of
money through long-term government bond purchases -- namely, the
precarious value of the dollar on international exchanges.  The dollar
has already fallen more than ten percent against the euro in the past
year, and hopefully such an orderly decline will give U.S. manufacturing
a lift.  But a full-blown run against the dollar would be a disaster.
That could swamp Fed policy, collapse the bond market, push up long-term
yields (against the Fed's wishes), and utterly destroy the housing
bubble.  No one knows for sure, because we are in such unchartered
territory.  But to be cavalier about such risks is not responsible
behavior by Fed officials or by progressive economists.
>>
>> Downplaying deflationary risks (at a time when it's knocking on the
CPI doorstep) plays into the hands of the do-nothings:  no need for a
federal jobs or spending program, no need for a federal revenue sharing
program for state and local governments, no need for much of anything
but tax cuts and hollow optimism of the Fed's ability to push money on
investors and consumers, even when they refuse to invest or borrow at
near zero percent. >
>>
>> Weisbrot's analysis is far too optimistic that the Fed's policy
tools are sufficient, and that the only question is political (i.e.,
getting the
>> Fed to dig into its policy bag of tricks).  The problem and the
solution is political, however, in another sense:  the only way out of a
>> liquidity trap is a massive fiscal stimulus, such as the U.S.
spending on the Second World War.  Tax cuts are not necessarily a very
effective way to restore growth in output and prices.  History suggests
that only significant increases in government spending will do in a time
of deflation.  And there will always be great political impetus for
balancing budgets during times of fiscal crisis (resulting from a
recession in tax revenues).
>>
>> Maybe we will dodge the deflation bullet.  But making light of it is
akin to saying that the threat of nuclear weapons is exagerrated.  All
>> it takes is one nuke in the wrong hands (an Islamicized Pakistan or
the Ayatollahs of Iran) and we'll have a day far worse than September
11th.  And all it would take is a genuine U.S. deflation for this world
to get much more dangerous quickly and for the economic pain to spread
exponentially.
>>
>> Weisbrot's column was surprising and hopefully he will re-think such
naive optimism about Federal Reserve capabilities.  For Fed officials,
it's a thin mask covering a cynical game of talking up the financial
markets while accepting income tax cuts targeted for the top percentiles
of households.
>>
>>
>> Tim Canova
>> Professor of Law
>> University of New Mexico
>> (still the 1st university to formally join the World Bank Bonds boycott)
>> Tel:  (505) 277-5654
>>
>> Visiting Professor of Law
>> University of Arizona, James E. Rogers College of Law

e-mail:  tim.canova@xxxxxxxxxxxxxxx

>> Tel:  (520) 626-6451

Xenon Zi-Neng Yuan wrote:
> a request to folks on the list, as i am still learning the economics -
> is there anything fundamentally wrong with the assessment here?
>
> http://www.zmag.org/content/showarticle.cfm?SectionID=10&ItemID=3857