Following is an excerpt from Bernanke's Jan 13 speech at the London School of Economics:
Although the federal funds rate is now close to zero, the Federal Reserve retains a number of policy tools that can be deployed against the crisis.
One important tool is policy communication. Even if the overnight rate is close to zero, the Committee should be able to influence longer-term interest rates by informing the public's expectations about the future course of monetary policy. To illustrate, in its statement after its December meeting, the Committee expressed the view that economic conditions are likely to warrant an unusually low federal funds rate for some time. To the extent that such statements cause the public to lengthen the horizon over which they expect short-term rates to be held at very low levels, they will exert downward pressure on longer-term rates, stimulating aggregate demand. It is important, however, that statements of this sort be expressed in conditional fashion--that is, that they link policy expectations to the evolving economic outlook. If the public were to perceive a statement about future policy to be unconditional, then long-term rates might fail to respond in the desired fashion should the economic outlook change materially.
The entire speech was equally as nonsensical and can be filed appropriately under the heading of "you just can't make this stuff up!"
This is the man who was once considered to be the foremost expert on the Great Depression, which apparently was caused by a miscalculation by the Fed. If ever a similar situation were to come along, "it wouldn't happen again," he promised Milton Friedman and Anna Schwarz. The correct tools were in place to ensure that much.
Now that his toolbox is essentially empty, he has resorted to claiming some sort of godlike ability to jawbone the market back to "normal." He has officially lost his mind.
So now that we know (or are at least reasonably certain) that Bernanke and his ideologically similar minions (Krugman, Stiglitz, among many others) have been proven wrong, we need to focus on why in order to ensure the same thing isn't perpetuated all over again.
What made these people believe that pumping trillions of dollars into failing financial institutions would solve the problem? What made them think that by buying worthless assets, the financial system would revert back to it's old ways? And what makes them think that giving shovels to mortgage brokers and subsequently instructing them "dig," will cause any meaningful rise in production or employment?
All signs point in the same direction. And that is in the direction of an underlying principle from which all their other principles are derived: The General Equilibrium Theory.
According to this band of geniuses, an economy with relative full employment and low inflation is said to be "in equilibrium." But every once in a while, something strange happens and the economy goes into disequilibrium. Therefore, the central bank and the government need to step in and "fix" it. In order to decide how best this is done, the economists in question create complex mathematical "models" that tell them which policy action is more desirable, and precisely what effect those actions will have.
Starting from the beginning, this equilibrium theory is bogus. There is no equilibrium. The "normal" state of an economy is disequilibrium. It is always in a state of either oversupply or excessive demand. Prices are always either too high, or too low. Therefore, the models being created based on this false equilibrium are fatally flawed from the outset. [note: Joerg Guido Huelsmann gave a lecture on this topic, explaining that a paradigm of equilibrium is indeed useful, but not for what it is commonly applied to.]
This is important because when we are listening to our apparent "smartest people" on how to fix our problems, we automatically assume that they have a sound understanding of the problem and why it occurred. They don't.
As a function of their belief in this magical equilibrium, they are disinclined to consider the possibility of a multi-decade decrease in risk aversion. Nor do they consider the blowing of speculative bubbles because of too low interest rates. Nor do they consider changes in social attitudes toward debt, consumption or saving. They instead brush it off as some sort of statistical anomaly. If it can't be modeled, it's not worth considering. Hence, any unintended consequences of their current actions are not thought of. All that matters is getting the economy back to equilibrium. Once it is "there" they can worry about the problems that arise.
To them, the credit and consumption binge was "normal." It was the hallmark of an economy in equilibrium and a byproduct of what Bernanke termed "The Great Moderation." From his 2004 speech of the same name:
Few disagree that monetary policy has played a large part in stabilizing inflation, and so the fact that output volatility has declined in parallel with inflation volatility, both in the United States and abroad, suggests that monetary policy may have helped moderate the variability of output as well.
To suggest that the last 20 years was in any way "moderate" is absolutely asinine.
Nowhere was there a mention that risk premiums had been unnaturally influenced by these policies. Nowhere was there mention of an increased willingness of foreigners to lend the US money based on implicit government guarantees for Fannie and Freddie paper. And nowhere was there a mention of the possibility that previous bank and hedge fund bailouts were encouraging financial institutions to take more risk than they would otherwise. No, it was because the Fed and other central banks had become "enlightened." The amount of arrogance it takes to draw this kind of conclusion makes professional athletes sound modest.
Next, we shall consider a recent post from Nobel Prize winning economist Paul Krugman:
... Anyway, it’s true: the cost of an effective fiscal stimulus, in terms of adding to the government’s debt, can (and should) be much less than the headline cost.
Consider an increase in government spending; assume that the interest rate is fixed (a good assumption right now, because interest rates are up against the zero lower bound). Then textbook analysis says that if the stimulus is dG, the increase in GDP is 1/(1 - c(1-t)) where c is the marginal propensity to consume out of income and t is the marginal tax rate. Suppose c is 0.5 and t is 1/3; then the multiplier is 1.5, which is more or less the conventional wisdom right now.
But if $100 billion in spending raises GDP by $150 billion, and the marginal tax rate is 1/3, $50 billion of the spending comes back in additional revenue. So bang for the buck — increase in GDP per dollar of added debt — is 3, not 1.5. Since the main concern about stimulus is that it will add to government debt, it’s this bang for the buck measure, rather than the multiplier, that’s relevant. And 3 sounds a lot better than 1.5.
Take this a bit further: $150 billion is about 1 percent of GDP, which Romer and Bernstein say means a million jobs; so this says $50,000 per job, which is a much better number than the critics have been throwing around (plus many more workers with full-time rather than part-time jobs).
Bang for the buck also heightens the contrast between effective and ineffective stimulus policies. Stay with c = 0.5, t = 1/3, and look at the effects of a tax cut; the multiplier is 0.75, half that for public investment, but bang for the buck is 1, only 1/3 that for investment.
So thinking about how stimulus comes back via revenues is important.
Even though the crisis continues to grow, and the theories used to explain it come under increasing suspicion, our smartest economists are proclaiming that even MORE of their failed solutions need to be attempted, lest we go back to living in caves. They demand that massive projects need to be undertaken in order to "create employment." This is an idea that sounds good at face value. But unfortunately, it too fails to hold up to scrutiny. These economists see a correlation between productivity and employment. So they naturally go on to conclude that higher productivity causes higher employment. Unfortunately, correlation does not imply causation. Simply pumping money into make-work projects does not create employment. It just takes money out of the real economy (via taxation) and redeploys it somewhere else. In the hands of it's rightful owners, this money would create employment by itself (via spending or investing). So by taking it away from them, the government reduces employment somewhere else. Even if that money were saved or used to pay back debt, those savings represent future legitimate employment that will no longer be created once expropriated and used for ditch-digging.
What actually occurs in a healthy economy is higher levels of employment creating higher productivity based on doing a task that provides value to someone else. By seeing the equation backward, Krugman and the others prove that they have very little understanding of what labour is. And what they do understand is wrong.
People who were gainfully employed based on a fictitious economy are now being laid off. That is and always was guaranteed to happen. The laid off workers of auto companies, retailers and banks lost their jobs because the companies couldn't make a profit. Not because of some temporary drop in "aggregate demand" like the experts prefer to say.
The mainstream economists all agree that the way out of this depression is to get "aggregate demand" back to bubble levels. And why has aggregate demand really fallen? Not because of some temporary "loss of confidence." No. Demand has fallen because social mood is subliminally dictating to people that living beyond our means is no longer an acceptable social practice.
If Bernanke understood the changes in social mood, he would know that trying to prop up prices with 8 letter acronym programs will not work. He would know that wage controls would likely only lead to more unemployment. And he would know that no level of stimulus can induce people to spend like it was 2005. He would also know that precisely what he is trying to prevent (falling prices, falling wages, bankruptcies, etc) is what is needed to heal the economy. Demand will come back - when prices have fallen to their legitimate levels (and will likely be in new areas of the economy). Employment will return along with it.
Again, the suggestions of the mainstream economists, led by Bernanke, have absolutely no bearing on reality. The assumptions used to create their suggestions are methodologically flawed. And their results that will actually occur are not even close to what is promised.
We can only conclude that Bernanke, Krugman and the rest of them are intellectually bankrupt. The sooner they are removed the better. They would preferably be replaced by nobody. But if someone need be their surrogate, here is a list of capable suitors.