The Fed’s decision to pump $600 billion into the banking system may seem like a bold move, but it’s not likely to be adequate to the task. And if Congress fails to extend the expiring Bush tax cuts, the negative fiscal impact would overwhelm the stimulative effect of the Fed’s recent move – by a factor of roughly eight to one.
That’s the warning delivered by Princeton University economist Alan Blinder, who has particular standing when it comes to the art of fiscal and monetary policy.
Blinder served on President Clinton’s Council of Economic Advisers from 1993 to 1994, and was vice chairman of the Fed from 1994 to 1996 – a period of falling deficits, low inflation and strong growth. Of late, he has been arguing for a mix of short-term fiscal stimulus (though he is dubious that the new Congress can deliver) and long-term fiscal discipline, with a focus on health care cost-containment and Social Security reform.
In a far-ranging interview with The Fiscal Times, Blinder highlights his provocative views on how to avoid a “slow-motion train wreck” on the economy, why the Fed will need to do more, and what it all means for the dollar and inflation. The long-time Washington insider also dishes on why he thinks Republican leaders have been “irresponsible in the extreme,” and how the president can get back on track.
The Fiscal Times (TFT): What impact will the Republican takeover of the House have on fiscal policy for the remainder of President Obama’s term?
Alan Blinder (AB): I think that rational fiscal policy is now virtually unthinkable for the rest of his term. I’m frankly worried that we’ll actually get a perverse fiscal policy that nobody wants, simply because the two sides can’t agree on what to do about the Bush tax cuts. In the case of a stalemate, when the clock strikes midnight on Dec. 31st, we get the Cinderella scenario — it all turns into a pumpkin with the expiring of the Bush tax cuts. That would be the supreme irony because there’s not one of the 535 members of the Congress who wants that outcome.
TFT: What would letting the tax cuts expire mean for the economy?
AB: A contractionary fiscal policy on the order of 2 percent of GDP. That is a completely crazy thing to do with an economy in the kind of shape that ours is.
TFT: What can keep this from happening?
AB: A little bit of amity on both sides. There is plenty of room for compromise. I would like to see the Obama policy of preserving the tax cuts for households below $250,000 and ending them for incomes above. There are compromises, such as extending the cuts indefinitely below $250,000 but only for two years above $250,000. There are probably 50 other compromises that can be thought of, all of which would be better than letting it all expire.
who prescribes medicine to a sick person
knowing that the medicine has side effects.
TFT: Turning to the Federal Reserve’s new round of monetary easing, how do you critique the plan to buy $600 billion of government bonds to stimulate the economy?
AB: I’m glad the Fed did it. I think they needed to do more and probably will do more. Realistically, you should expect only a quite small stimulus coming out of this easing.
TFT: How small?
AB: Maybe a reduction of 30 basis points on Treasurys and 15 basis points on corporates. That’s not based on any careful analysis — it’s just trying to put numbers in the ballpark.
TFT: How much would this help the overall economy?
AB: The honest answer is nobody knows, but you’re talking about a fraction of a percentage of GDP growth. I would think in a range of about a quarter of a percentage point of growth.
TFT: Some critics worry that the new round of easing will weaken the dollar, jack up inflation and create a speculative bubble in bonds and other assets. How do you view these risks?
AB: I think there’s very little doubt that the Fed is creating an asset bubble in Treasury debt and probably a smaller asset bubble in non-Treasury debt. I think the Fed understands that very well and has the attitude of a doctor who prescribes medicine to a sick person knowing that the medicine has side effects. This may give you a headache. And you’d rather not give the patient a headache, but if he’s really ill with something else, you give the medicine.
Look, what I’m telling you about the likely effect of this stimulus being small is the consensus view. If that’s right, then there’s no reason to think of a big effect on the exchange rate or that inflation will rise a lot in the United States.
I’d be pushing for a new jobs credit … and
more direct hiring by the federal government.
TFT: You sat next to Bill Clinton in 1993 when the country was coming out of a recession and the byword was, “It’s the Economy, Stupid!” If you were sitting next to President Obama now, how would you advise him to restart growth and reignite the country’s job engine?
AB: I’d tell the president what I told him in 2009: jobs, jobs, jobs. And to be more concrete, I’d be pushing for a new jobs tax credit, which the administration did push for and didn’t get except in minute form. And I would be doing and pushing for more direct hiring by the federal government. But in the American system most government jobs are not on the federal payroll, so they would mostly be on the state and local payrolls, but they would still be financed by the federal government.
TFT: What are the chances of such moves being enacted?
AB: You asked me what I would say to the president. Would I expect the Congress to do those things? No, absolutely not. With the second of those two things, I can just hear the right wing of the American political system yelling socialism, which in some literal sense it is. It’s putting people to work for the government, but temporarily and for a reason.
But the first of those things, the new-jobs tax credit, is to me a source of unending frustration. Because if you ask yourself what the Republican Party always wants, the answer is business tax cuts, and this is a business tax cut. And yet they opposed it. Why did they oppose it? I think the answer is simple ─ because Barack Obama proposed it. They followed the strategy of opposing everything that Obama wanted to do more or less 100 percent, and they were richly rewarded at the polls. So why should they change?
TFT: How would you characterize that Republican strategy?
AB: I would say that it is irresponsible in the extreme. It’s one thing if they just want to play games with Barack Obama and other elected Democrats. But they’re playing with the well-being of 310 million Americans. That’s very high stakes.
costs … The old image of a slow-motion train wreck is appropriate.
TFT: You have said that the real deficit problems the country faces amount to a whopper that lies in the future. What are the real problems and what should be done about them?
AB: It’s surprisingly simple to get the answer 85 percent right, and then it takes a long answer to get to the other 15 percent. But if you get the 85 percent, you’re doing well enough. Solving our deficit problems comes down to controlling health care costs. When you look out 10, 20, 40 years from now and see projections of completely horrendous budget deficit numbers, they’re almost entirely driven by health care expenditures. I’m talking about deficit numbers that run 30 percent, 40 percent, 50 percent of GDP, and that can never happen. Things will crack up before you get that. The old image of a slow-motion train wreck is appropriate because it is slow motion and there sure as hell is a train wreck out there.
TFT: What can prevent this train wreck from happening?
AB: The much-maligned health care bill took more or less the right approach to this. It put in, on either a pilot or an experimental or a small-scale basis, almost every idea that’s been advanced for controlling health care costs. The tricky part will be to ride the winners and throw away the losers. That’s what a business would do. You launch eight products and say goodbye to the ones that aren’t selling and put your efforts into the others. But I don’t know which health care ideas are going to be the ones that work. I just hope that some of them do.
Let me add one more thing to that. It’s slightly more than a hope because we know that no other country in the world spends anywhere near as much as we do on health care, and the other rich countries get as good or better outcomes as we Americans do. So it seems to me that implies that we can do it for less.
TFT: What would you say to the president’s bipartisan National Commission on Fiscal Responsibility and Reform that is soon to recommend ways to balance the budget by 2015 and improve the long-run fiscal outlook?
AB: Good luck. I’m extremely sympathetic to its leaders, [Erskine] Bowles and [Alan] Simpson, and to its nonpolitician members. But you ought to remember that 12 of the 18 members are sitting politicians — that’s why I say good luck.
Blinder, Zandi Say Bailouts Likely Averted Depression (Bloomberg)
Return of the Bond Market Vigilantes (Wall Street Journal)
Blinder: Bank profits 'Collateral Damage in a War to Save the Economy' (Washington Post)