Simplified Monetary and Fiscal activities for Financial Crisis

Discussion of tepid recovery of Economy 

We need to realize that the economic recovery is very slow since 2008.  The Free Market economy is not capable of self starting for full employment.

This article provides a layperson’s view of monetary and fiscal stimulus which are the economic theory options available to improve the economy. Based on the material here we should have some insight to what is happening and form our own opinions of the utility of government and Central Bank (FED)

So – what caused Financial Collapse

Financial dark clouds starting forming in the 2006 – 2007 time frame. In 2008 the US and World Financial System collapsed due to the biggest Investment banks suddenly becoming illiquid because of many high risk fraudulent mortgage activities. In short they could not raise daily cash to run the business. In the depression era this was called a bank run. Despite Wall Streets claims, the Financial Crisis happened because the Financial community paid of congress and the president to deregulate the industry and it came down in 8 years because it was unsustainable. Regarding the  Financial collapse Clinton enabled it, Bush implemented it and Obama maintained it.

Because of the Financial Crisis Federal, State Tax and local receipts dried up, exacerbating the Federal, State local government deficits

. The free market economy has not recovered after 5 years. GDP growth per year has been in the tepid 1 to 2 % ranges, not enough to provide the escape velocity to allow the economy to become self-sustainable. High unemployment exists. The current projections are for slow growth for decades. So let us begin the journey to get a laypersons view of Monetary and Fiscal Policy. At the end, we will summarize how it had limited success and what needs to be done

A simple Model needed to understand concepts of monetary policy

Economics and Business can be extensively described by complex equations but they become understandable by presenting results using simple models which describe specific concepts for  basic understandings. One such model is called the Capital Hill Babysitting Coop information is sourced in Appendix A

Baby Sitting Coop
Baby Sitting Coop

Basically the Model is a closed group of families offering and using babysitting services. The coop emulates a closed society.  Each family interacts with any or all of the other families.

Looking at the model, the following can be observed

1      Coop members were issued one hour script (money) to be traded for babysitting services

2      One families income is another families expenditure-basically a working economy is functioning.

3     Society good is served if income & expenditure is distributed in the population. Result is low unemployment.

4     Lets say that one or several families provide services but do not spend. Eventually wealth is concentrated and not flowing through society, a induced depression / recession. The general liquidity of Script in the coop is drastically diminished. In short the functionality of the coop (society) is not working.

5     The saving people could loan/sell the excess script to people at a premium. Hence people needing babysitting services could get them at a higher cost, diminishing the demand for services.

6      The coop voted to assign more script (printing money ) to individuals and the economy started flowing and the value of the hoarded cash diminished. Kind of equivalent to Inflation. This is the basis of the FED policy

 

Notes on Coop Observations

Item 2

Is very important in that it says all of society needs to be working / participating. We have a simplistic example here in that all make the same wage. People can make different wages  and participate at various levels. But money is the glue that makes things work at different levels. This  is called liquidity

Item 4

This is a characterization of what happens when small groups of people get a disproportionate share of wealth. The society tends to drastically slow down. This is called inequality.

Item 6

The management Issuing script is a good example of what the FED and US government are doing. This takes many forms: TARP, ZIRP,QE and American Recovery Act (Fiscal Stimulus). All injected money into the economy. All had limited effect and the tepid recovery continues.

The net goal has to be making commerce flow.

We now have a model defined, now we will see how it helps us understand our economy.

Tools to fix the economy

The government has two economic tools to use; Fiscal and Monetary Policy. In general, the FED (Federal Reserve System) often called the Central Bank provides Monetary Stimulus. The Congress and President Provide the Fiscal Stimulus packages which will be discussed later.

The Congress established the statutory objectives for FED Monetary Policymaximum employment, stable prices, and moderate long-term interest rates–in the Federal Reserve Act.  

FED Monetary Policy

The FED has other programs but we are going to concentrate on the depiction to the right. The basic function of the programs discussed here create and insert money.  The Zero Interest Rate Policy (SIRP) is the FED directly loaning money to the Banks at a near zero interest rate to be loaned to the people.

FED Monetary Policy

The other technique is Quantitative Easing (QE) which is used when the interest rate is near zero. This entails the FED purchasing Bonds or Securities from Banks and Financial Institutions. Basically they were  purchasing  Mortgage Backed Securities and Treasury Bonds from the Banks to get money into the system. One could ask, why was ZIRP not enough? The perception is that the banks had so many securities (many of them toxic) with high risk. I think some Investor customers forced them to take them back because of poor performance. Their books were simply overloaded. To sell them off, the banks would have to declare a loss. Keeping them on the books allowed them to artificially maintain the value. It is understood that not having to declare losses are good for executive compensation.

Treasury Bonds

Generally speaking Treasury Bonds are purchased by the public through special designated banks. The FED purchases them directly from the Treasury. Individual investors or foreign nationals purchase Treasuries because of their perceived safety. Interest rates are low but safe. Basically Treasuries fun the US government. Inherently, if the Unites States defaults on its debt, the FED can print more money. The value of the dollar will fall but that is good for relative International Trade. Kind of confusing and we will not spend much time on it other than recognizing the FED buying Treasury’s injects money in the system. Article confirms the points made here

No Surprise, Fed Was Biggest Buyer of Treasuries in 2013

http://www.nytimes.com/2014/02/22/business/economy/no-surprise-fed-was-biggest-buyer-of-treasuries-in-2013.html?ref=business&_r=0

How well is it working?

The ZIRP and QE policies have been in place since 2008 along with others. So the recession was pretty deep and one could argue the FED policies are not up to the job. Despite $4.0 Trillion of FED action, The case can be made that it helped the banks but not the population.

This article summarizes the case

What Is Quantitative Easing?

http://useconomy.about.com/od/glossary/g/Quantitative-Easing.htm

This 4 page article is worth printing and reading.

From the Article

Did QE Work?

QE achieved some of its goals, missed others completely, and may have created a bubble. First, QE did remove toxic subprime mortgages from banks’ balance sheets, restoring trust and therefore banking operations. Second, it also helped to stabilize the U.S. economy, providing the funds and the confidence to pull out of the recession. Third, it kept interest rates low enough to revive the housing market. Fourth, it did stimulate economic growth, although probably not as much as the Fed would have liked.

However, it didn’t achieve the Fed’s goal of making more credit available. It gave the money to banks, which basically sat on the funds instead of lending it out. Banks used the funds to triple their stock prices through dividends and stock buy-backs. The large banks also consolidated their holdings, so that the largest .2% of banks control more than 70% of bank assets. Since banks didn’t lend out the money, inflation wasn’t created in consumer goods. As a result, the Fed’s measurement of inflation, the CPI, stayed within the Fed’s target. (Source: WSJ, Confessions of a Quantitative Easer, November 12, 2013)

However, QE did create asset inflation, first in gold and other commodities, and then in stocks, as investors were forced out of bonds.  An ounce of gold more than doubled, rising from $869.75 to $1,895 between 2008 and 2011. After that, investors shifted to stocks. The Dow rose  24% in 2013 as corporations followed the banks’ example and boosted stock prices with buybacks and dividends. Article updated December 30 2013

It helped Wall Street but did not help the economy. Most of all, employment has been very slow to recover.

In Short the Bernanke Legacy will be not as glorious as hoped, however much better than the Greenspan disaster. However the FED has been working with a dysfunctional Congress. Bernanke has publically said, QE cannot do it alone, there needs to be a functional Fiscal Policy.

What Is Fiscal Policy

The President and the US congress are responsible for the Fiscal policy. Fiscal Policy involves the government initiating programs that put people to work. The Eisenhower Interstate and the Kennedy Space program are examples of Fiscal Policy. The depression era of Civilian Conservation Corps and Public Works program basically worked on Infrastructure, bridges and parks. Many of which  served the county well for years in critical functions

We need to be aware of the fact that Federal, State and Local tax revenue dramatically decreased after 2008.  The Bush years war effort was not paid for and drastically increased total Federal Debt. The Bush tax cut did not expand employment as promised. The Bush eviseration of financial regulation enabled Toxic mortgages. Toxic Mortage Backed Securities defaulted and caused the Financial Crisis. So our Federal Deficit and Debt increased dramatically and the country was left with a financial crisis and a badly damaged financial system requiring a bail out given the size of the collapse. There was a lot of pandemonium in the government including the election of Barak Obama as president.

The American Reinvestment Act and Recovery Act was passed February 17, 2009. The single page summary can be read here: http://www.whitehouse.gov/assets/documents/Recovery_Act_Overview_2-17.pdf

The summary is provided in the appendix at the end of this document. This was a halfhearted attempt negotiated by a Timid President. Given the Congress we have and dealing with the financial collapse (Auto Bail Out, bailing out with the banks and others) it was probably all that can be mustered. Furthermore, the Bank Lobby and their surrogates were active within the administration and the banks came first. I am specifically talking about Mary Shapiro (SEC), Tim Geithner (Treasury Secretary) and Larry Summers ( National Economic Council – Direct report to the President) All of these people had a direct hand in diminishing regulation which let the banks run wild, creating the financial collapse in eight years. It was not a once in a hundred years event, it is all traceable to deregulation and not prosecuting fraud, starting in 1999 and collapse in 2008.

The President threw the Stimulus package to congress for development which immediately turned into a jobs saving package versus an economic development packages like Eisenhower Roads. Kennedy space program. Jobs saved were Teachers, Fire and Police and local government workers. These programs had 1.0 job retention. Programs such as infrastructure were limited. Infrastructure programs tend to have over 2  multipliers.  In general, non service jobs tend to spawn requirements for new use of materials, vendor services and new product. In layman’s terms, the economy is not able to generate escape velocity to enable a self sustaining economy. A simple reason is that the public (especially small business) will not go out on the limb to explore new idea’s.

The major exception to this was the Department of Energy Smart Grid project. It is about solar, wind energy and energy storage (like batteries and Pumped Hydro). Like the Space Program, many new technologies were developed. There was matching funding coming from industry vendors, research organizations ( EPRI)  and nationwide Utilities. Pilot programs have been set up at the utilities and will be providing valuable experience for other utilities to use in development of their smart grids. From this experience industry professional organizations (IEEE) are developing standards for vendors and utilities to use. Most of all it was a integrated industry upgrade, centered on efficient development and use of energy, Critical because we waste more energy than we use.

Smart Grid Depiction

The Smart Grid is about modernization all aspects  of the nation’s electrical energy grid. The most evident are development of solar,  wind energy and Advanced Metering . This is a massive program providing research and funding for all aspects of energy delivery.  

The wind farms are in the midwest (Dakota’s to Texas and Michigan).  Solar is in the sun belt ( AZ, NM and CA) with solar panels and concentrated solar sites. Wind and solar are coming into production, producing commercial power in some cases competitive with coal power plants.

It is also about energy storage development such as batteries and pumped hydro. Major pilot programs are installed and collecting results. GE and other companies are providing a specific product combining windmills and batteries. Many companies are developing / providing products to address smart grid needs. This program has major success in the areas of energy efficiency, storage and alternative  sources to coal and oil.

Economic Stimulus for the Smart Grid is detailed here: http://energy.gov/oe/articles/economic-impact-recovery-act-investments-smart-grid-report-now-available

Executive Summary is on page 1. As of 2012, $2.6 Billion resulted in $6.8 Billion spent for economic output. Matching spending came from Utilities, Product vendors and industry research facilities (like EPRI). $6.8/$2.6 is a 2.6 multiplier. This is a true stimulant program.

Things to consider

That said, we have a lot of national infrastructure programs such as roads, bridges, rail, sewer systems need to be addressed. The American Society of Civil Engineers has generated a report card on U.S. Infrastructure. The predominate grade for the different categories is D or D+. http://www.infrastructurereportcard.org/a/#p/home. So the need for a fiscal expenditures is evident.  

What is holding us back?

However the large debt and continued yearly deficits have produced an environment of austerity, which is the worst thing to do from a national perspective during a recession. Austerity at a personal level is valid, but when you have the power of a central bank, national debt can be controlled. For example, if the debt limit is exceeded, we can print money and avoid the catastrophe. The FED has printed $4 Trillion for the banks and have gotten minimal response in terms of employment.

Summary

  1. The Baby Sitting Coop Model provides very basic insight to Monetary Policy as implemented post Financial Crisis. The FED concept of injecting money is easy to understand. The interaction of income and expenditures is demonstrated. A corollary is that when all are participating, we are at Full Employment
  2. Despite $4 Trillion spent by FED on QE the banks were helped but employment tepidly increased. Progress cannot be identified with Zero Interest Rate Policy. One of the problems is the money in the banks does not get out to the public because of lack of demand. Hence the need for Fiscal Stimulus to create a demand.
  3. The Stimulus program was job retention based but not economy expanding. The exception to this is the DOE Smart Grid program. For each $1 million spent
  4. With the Economy in a tepid recovery now, tax revenues are coming back and the annual deficit is falling. Apparently we (banks, government, public ) do not have the will or knowledge to move ahead. Same thing happened in Japan resulting in the lost decade.
  5. Monetary and Fiscal Policy have not been instrumental in providing Full Employment because of Tepid demand. When the Stimulus was initiated, several Economist said it was not enough.

 

FED objectives

http://www.federalreserve.gov/faqs/money_12848.htm

First sentence:

The Congress established the statutory objectives for monetary policy–maximum employment, stable prices, and moderate long-term interest rates–in the Federal Reserve Act.

Are we close – I think not

The FED does not have the tools to do the resolve the problem. Bernanke publicly said, the FED cannot do it alone, congress needs to act on Fiscal Policy. However with the corruption and dysfunctional congress, it will be a long time.

The inability of the public to understand the concepts discussed in this article, will stall any progress.

 

Appendices

 

Appendix A – Baby sitting coop – source material

http://www.pkarchive.org/theory/baby.html  is described in a narrative format. Wikopedia has a more elaborate discussion: http://en.wikipedia.org/wiki/Capitol_Hill_Babysitting_Co-op

 

 

Appendix B What Is Quantitative Easing?

http://useconomy.about.com/od/glossary/g/Quantitative-Easing.htm

 

 

Appendix C

THE WHITE HOUSE

Washington February 17, 2009

The American Reinvestment and Recovery Act

Jumpstarting our Economy and Investing in Our Future

The American economy is in the midst of a crisis unlike any we have seen in our lifetime. The economy lost 3.6 million jobs in the last 13 months, the biggest job loss since the end of World War II. Many experts believe unemployment could reach double digits if no action is taken. In light of this historic economic weakness, President Obama is signing the American Recovery and Reinvestment Act, a nationwide effort to create jobs and transform our economy to compete in the 21st century. The legislation represents the most ambitious effort to stimulate the economy in our nation’s history. It will:

  • Create or save 3.5 million jobs over the next two years. Based on an analysis by the Council of Economic Advisers, the legislation will meet the goal of creating or saving at least 3.5 million jobs over the next two years. Jobs created will be in a range of industries from clean energy to health care, with over 90% in the private sector.
  • Provide nearly 40 percent of the package in direct relief to working and middle class families: The package includes a Making Work Pay tax credit for 95% of workers and their families. In addition, the package provides direct relief for families by expanding unemployment insurance and offering payments to Social Security beneficiaries and veterans. The vast majority of the remainder of the package is provided in state fiscal relief and investments that also benefit working families.
  • Double renewable energy generating capacity over three years. It took 30 years to reach current levels of renewable energy production. This package will double that level over the next three years – enough to power 6 million American homes.
  • Creates a Clean Energy Finance Authority and Renewable Tax Credits that together will leverage an additional $100 billion in private investment in the renewables sector. The finance authority will provide loan guarantees and other financial support to help ease credit constraints for renewable energy investors and catalyze new private sector investment.
  • Make a $150 billion investment in our nation’s infrastructure – the largest investment since the interstate highway system in the 1950s: It includes historic investments in public transit and high speed rail, an unprecedented effort to upgrade or nation’s electricity grid, and a new initiative to expand broadband coverage throughout the nation.
  • Protect health care coverage for millions of Americans during this recession. The legislation provides a temporary increase the Federal Medical Assistance Percentage so that no state has to cut eligibility for Medicaid and SCHIP because of budget shortfalls. This investment will protect roughly 20 million people whose eligibility might otherwise be at risk. It will also generate considerable state economic activity, jobs and wages.

Enact the most significant expansion in tax cuts for low- and moderate-income households ever: Under current law, a family of four earning the minimum wage currently lives below the poverty line. Under the plan, that family will be lifted out of poverty by a combination of an $800 Making Work Pay tax credit and $1,200 from an expanded child tax credit. All told, more than 2 million people would be lifted out of poverty by the plan.

 

Appendix D – FED person charged with implementing QE saying it did not work

 

Andrew Huszar: Confessions of a Quantitative Easer http://online.wsj.com/news/articles/SB10001424052702303763804579183680751473884

 

Radio Interview with Andrew Huszar: Confessions of a Quantitative Easer | McAlvany Commentary

http://www.youtube.com/watch?v=_XAmpkX8g2w

Big problems with QE: Former Fed official

http://www.cnbc.com/id/101192690

 

Fed Should Have Stopped After QE 1, Huszar Says

 www.bloomberg.com/video/fed-should-have-stopped-after-qe-1-huszar-says-ewDl2sFUQdmEyKnp~4hbzw.html

Advertisements

About fiscalliberal

New blogger primarily in financial and government issues. Retired male (71) who has followed lifetime of politics and read extensively on the financial crisis
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s