Posts by "macrosam"

I don't dispute what you are saying but what my point is that sometimes, regardless of fiscal and monetary policy, it will take time to emerge from a recession. It may take 5 years, it may take 10 years, and that is what the case is when there is a balance sheet recession in place. Poor policy will prolong that recovery or turn it into a Depression. Effective fiscal and monetary policy - policy that prevents further balance sheet destruction while creating an environment where balance sheet repair and restoration are allowed to occur - still may require a good deal of time. What most critics of policy don't seem to accept is that even with effective policy, a recovery may require a decade to emerge from the collapse of years and decades of excess. That is why when immediate results are not seen, governments move towards fiscal consolidation, and monetary policy tightening, the same flaws of impatience and desire for immediate gratification that fuels assets bubbles.

When we don't see explosive GDP growth resulting from policy, well, we're not supposed to. Frankly, just keeping GDP flat via policy is a triumph.

(continued yet again)

Economists and market pundits are missing the point when they criticize the effectiveness of fiscal and monetary policy in a balance sheet recession (as academia, the IMF, OECD, Fed, etc, misguidedly criticized Japan's policies) for not fostering more GDP growth. The Keynesian role of governments during these recessions is not to borrow and spend in order to GROW, rather to borrow and spend to BRIDGE the gap, restore the money supply, and buy individuals and corporations enough time and to provide a conducive environment in which they are allowed to restore their balance sheets using the free cash flow they are able to still generate during this time. Not much different that backstopping a bank to prevent bank runs as all financial institutions are technically insolvent at any one point in time should all depositors demand their loans back in a simultaneous fashion.

One area I disagree with Koo on is the effectiveness of monetary policy. Koo seems to think it is almost entirely ineffective, but I see it as preventing further balance sheet destruction by propping up the asset values, the asset side of the balance sheet so that less repair and restoration is needed, presumably leading to a faster recovery. If your home value falls from $500,000 to $250,000 but would have fallent o $175,000 if not for Fed programs (MBS, treasury purchases, low rate environment), that is $75,000 less of deleveraging/recapitalization that individuals and financial institutions will need to endure.

On the contrary, I believe Bernanke has progressively gained a better understanding of the nature of this recession and why certain monetary policy implementation is ineffective (the pushing on a string). The world, for the most part, is in what Richard Koo refers to as a balance sheet recession, one in which the animal spirits and economic goal of profit maximation are overshadowed by the need to deleverage and re-capitalize, making low interest rate policy ineffective in terms of stimulating economic growth. Japan was in one and emerged from it (after a some policy missteps which made the recovery take 2-3 years longer), Germany emerged from it post-Telecom bubble (thanks to the Euro and the ability to export unemployment to other EU member nations), but the problem is that these two are export driven, so as they emerged from their recessions, their main sources of revenue entered their own recessions, depleting the customer base of Japan and Germany. Likewise, the Great Depression was a balance sheet recession.

In a balance sheet recession, individuals, corporations, financial institutions, individually or collectively, are in some form underwater on their balance sheets. The commonality is the destruction of asset values (due to bubbles bursting) yet maintaining an unchanged balance of debt. At this point, these entities and individuals are insolvent. The fact that they are still generating cash flow allows them to opportunity (not assured) to emerge from their balance sheet recessions, but it will take years, maybe decades, for the restoration of balance sheets to occur. In Japan, it impacted corporations as businesses in Japan were far more leveraged than their U.S. counterparts (as they should be with lower interest rates in Japan). That is why corporate debt issuance was few in number as prospective corporate borrowers feared having their balance sheets scrutinized by credit analysts and credit agencies who would discover the insolvency. So despite low interest rates, the demand for borrowing just wasn't there, nor would lenders be willing to lend upon examination of these balance sheets. In terms of the general public, well, they are savers, not borrowers. This is in contrast with the U.S. where corporations are cash rich and for the most part have healthy balance sheets. U.S. corporations still tap the bond markets taking advantage of lower interest rates to roll over their existing debt at more favorable servicing levels. It is the individuals, the consumers, who are insolvent from a balance sheet perspective. Here is where the combination of demand destruction (no demand for loans) and the shortage of supply (no lenders will to lend to these people) converge. Financial institutions, while not necessarily burdened with debt as they too have been rolling over debt at more favorable levels, have to restore the capital portion of their balance sheets (Assets = Liabilities + Equity/Capital). As capital is being restored, lenders will either not lend or only lend to the highest quality of borrowers, most of whom have no real demand for loans in this environment. Regulatory uncertainty (more capital required to be held, certain assets no longer qualifying as capital) combined with legacy loans (high unemployment = more loan loss provisions) makes lenders unsure of how much capital will be needed, so they are being extra caution in their balance sheet restoration.

After debt is reduced (U.S. consumer) and capital is adequately restored (U.S. financial institutions), these participants will then look to acquire assets on their balance sheet (assets like the ones whose value plummetted, but higher quality). Only after the repair of balance sheets and the restoration of satisfactory asset levels will consumers and concurrently financial institutions resume their normal or(as El-Erian calls for) "new normal" levels of consumption and lending.

So what policy is effective? Fiscal policy must take place, i.e. Keynesian policy, to maintain GDP levels by stepping in and restoring the money supply to prevent or slow down deflation. Markets generally provide a conducive environment (i.e. low rate) for government borrowing in these types of recessions, so it is imperative that effective leadership borrow and spend wisely (i.e. invest in infrastructure, structural reform, etc.) in order to take advantage of this low-rate environment. GDP is really a measure that gauges spending, it is more of a standard of living measure. Economists and market pundits are missing the point when they criticize the effectiveness of fiscal and monetary policy in a balance sheet recession (as academia, the IMF, OECD, Fed, etc, misguidedly criticized Japan's policies) for not fostering more GDP growth. The Keynesian role of governments during these recessions is not to borrow and spend in order

Ashraf, out of curiousity, do you see yourself more as an Austrian, Keynesian, Monetarist, or a combination?

Yep, watching it now.

But they are being faded!