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Global Perspectives
リチャード・クラリダ | 2009年3月
A Lot of Bucks, But How Much Bang?
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“We have involved ourselves in a colossal muddle, having blundered in control
of a delicate machine, the working of which we do not understand.”

– John Maynard Keynes, “The Great Slump of 1930,” published December 1930

I recently had the privilege of participating on a panel that was part of the Russia Forum, an annual conference held in Moscow that brings together market makers, policymakers, and academic experts to discuss the state of global markets, geopolitics, and the many and varied ways that Russia factors into these complex domains. The topic assigned to our panel, not surprisingly, was the global financial crisis – causes, consequences and policy responses. Among those on the panel were Nassim Taleb and Rughuram Rajan (both speakers at last year’s PIMCO Secular Forum), Nouriel Roubini, Hernando de Soto (none of us a Russia expert per se) and Sergei Shuvalov, first deputy prime minister of Russia (someone who certainly is!). Although there is little advance coordination among the speakers (par for the course at such events), there was, it seemed to me, a cohesive, urgent theme that emerged from the two-and-a-half-hour session that included probing questions from a number of the 1,000 audience members assembled for the event. That theme suggests the title I’ve chosen for this installment of Global Perspectives: there are, at last, a “lot of bucks” now committed by policymakers to address the global recession and the global financial crisis, but there is real doubt about how much “bang” we can expect from these bucks.

In the U.S., President Obama has just signed a nearly 800 billion dollar stimulus package and the Fed has cut the federal funds rate to zero. Monetary policy in the rest of the G7, while lagging behind the U.S., will follow the U.S. lead and cut rates to, or close to, zero. (In the case of the European Central Bank (ECB), the policy rate may end up at 1%, but the effective interbank rate has been trading well below the official policy rate in recent weeks, so a policy rate of 1% could translate into an effective interbank rate of nearly 0%). Likewise for fiscal deficits – they are rising globally and headed higher, propelled by a combination of discretionary actions and automatic stabilizers.

However, to date, these traditional policies have been found to be insufficient to the scale and scope of the task. Recall that the Obama stimulus package is actually the second such U.S. effort in the last 12 months. The 2008 D.C. edition was deemed to be a failure because a big chunk of the rebate checks were saved or used to pay down debt and not spent. The Obama package includes tax cuts and credits that will provide a boost to disposable income, but doubt remains over how much of these will be spent versus how much will be saved or used to pay down debt. The package also includes a substantial increase in infrastructure spending, as well as transfers to the states, but the infrastructure spending is back-loaded to 2010 and later, and the transfers to states will most likely just enable states to maintain public employment, not expand it appreciably.

What is the source of this concern that the U.S. fiscal package will not deliver a lot of “bang” for the “bucks” committed? Because of the financial crisis and the severe damage caused to the system of credit intermediation through banks and securitization, policy multipliers are likely to be disappointingly small compared with historical estimates of their importance. Many of you will remember from Econ 101 the idea of the Keynesian multiplier, which is that the impact of traditional macro policies is “multiplied” by boosting private consumption by households and capital investment by firms as they receive income from the initial round of stimulus. It is important to remember why and how policy multipliers actually work. Policy multipliers are greater than 1 to the extent the direct impact of a policy on GDP is multiplied as households and companies increase their spending due to the increased income flow they earn from the debt-financed purchase of goods and services sold to meet the demand generated by the initial round of stimulus. Historically, multipliers on government spending are estimated to be in the range of 1.5 to 2, while multipliers for tax cuts can be much smaller, say 0.5 to 1. But these estimates are from periods when households could – and did – use tax cuts as a down payment on a car or to cover the closing costs on a mortgage refinance. For example, in 2001 the economy was in recession, but households took advantage of zero rate financing promotions – as well as ready access to home equity withdrawals from mortgage refinancings – to lever up their tax cut checks to buy cars and boost overall consumption. With the credit markets impaired, tax cuts, as well as income earned from government spending on goods and services, will not be leveraged by the financial system to nearly the same extent, resulting in (much) smaller multipliers. 

There is a second reason why the bang of the fiscal package will likely lag behind the bucks. Even if some semblance of order and function can be reestablished soon in the global financial system, the collapse in global equity and housing market values has so impaired household wealth that private consumption (which after all represents 60%–70% of GDP in G7 countries) is likely to lag, not lead, economic growth for some time as households rebuild their balance sheets the old-fashioned way, by boosting their saving rates. In 2008 alone, I estimate that the net worth of  U.S. households fell by some 10 trillion dollars, with much of this concentrated in older demographic groups who, in our defined contribution world, must now be focused on building back up their wealth to finance their retirement, which is not that far away. This means more saving, less consumption, and smaller multipliers.

Outside of the G7, many of the major countries (certainly including Russia) are commodity exporters. The global recession has triggered a collapse in commodity prices, turning 2007 fiscal surpluses into 2008, 2009, …? fiscal deficits, and turning property and capital spending booms into busts in a matter of months. For example, as I am writing this, a headline has just popped up confirming that Dubai has received a “10 billion dollar bailout” from the United Arab Emirates (UAE) central bank to help provide financing for the rollover of debt backed by thousands of unfinished and unsold houses and apartment projects. Immense reserve stockpiles, which only months ago were criticized by some as excessive and without any purpose other than to manipulate national currencies so as to prevent appreciation are now, in Russia and some other prominent countries, being drawn down rapidly in a futile attempt to slow speculative depreciation of their currencies. In Russia’s case, Deputy Prime Minister Shuvalov made very clear that 2009 will be a year of hard choices for the Russian government. Most importantly, Shuvalov made clear that Russia is unwilling to spend more than the 200 billion (a third) of the reserves they have already spent in what has turned out to be a futile attempt to support the ruble. This will mean that companies and some banks will be allowed to fail, and that fiscal outlays will be scaled back and not funded at previous levels through a further drawdown of reserves. So in Russia’s case, and I suspect some others, a lot of “bucks” remain in reserve coffers, but they will be mostly saved, not spent to finance a major discretionary expansion in fiscal policy.

So where does this leave us? A LOT is riding on the efforts of the Fed and other central banks to stabilize the financial system and restore the flow of credit. Officials are coming to recognize these challenges and are now committed to or are seriously considering “non-traditional” policies that combine monetary and fiscal elements. When monetary policy has reached the zero lower bound and deflation risk dominates the probability distribution, monetary and fiscal policy effectively become one. Cutting rates to, or close to, zero has not been a mistake, but it has been ineffective; it is the most striking example of “pushing on a string” I  have witnessed in my lifetime. The reason, again, is the impaired credit intermediation system. The private securitization channel, which at its peak was intermediating nearly 50% of household credit in the U.S., has been destroyed. Banks are hunkering down in the bunker, hoarding capital as a cushion against massive losses yet to be recognized on the trillions of dollars of “legacy” assets that they have been unable to sell, or unwilling to sell at the deep discount required to attract private investors. For this reason, the Fed and Bank of England (BOE) – with many other central banks likely to follow suit in some form or fashion – are filling the vacuum by directly lending to the private sector. The Fed aims to purchase 600 billion dollars’ worth of Agency mortgage-backed securities (MBS) this year and, via the soon-to-be-launched Term Asset-Backed Securities Loan Facility (TALF) program, to finance without recourse up to one trillion dollars’ worth of private purchases of credit cards, auto loans and student loans. Since last fall, the Fed has also been supporting the commercial paper market via the Commercial Paper Funding Facility (CPFF) program, which had average holdings of around 250 billion dollars in February.

Altogether, between the MBS, CPFF and TALF programs, the Fed is committing  nearly two trillion dollars of financing to  the private sector. While these sums may be necessary to prevent an outright economic  collapse that extends and deepens into 2010, 2011,…?, it is not clear to me that they are sufficient to turn the economy around to the extent that it will return to robust growth. Moreover, based on the Fed’s just-released economic forecast and Chairman Bernanke’s recent testimony to the Senate Banking Committee, the Fed is not convinced that these policies are sufficient to turn the economy around so that it returns to robust growth. Speaking on Tuesday, February 24, and knowing that an 800 billion dollar stimulus program has been passed, that the Fed is  committing nearly two trillion dollars of lending to the private sector, and that the Treasury’s Public Private Investment Fund will aim to support up to one trillion dollars of private purchases of bank legacy assets, the Fed chair said:

“If actions taken by the administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability – and only if that is the case, in my view – there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery.”

As I said in my remarks at the conference, my mother Edith Ann raised me to be an optimist, and that outlook on life has served me well. However, the last nine months have severely tested that mindset, at least as it pertains to my professional endeavors. But old habits are hard to break, so I am casting aside the contrary evidence and putting my “bucks” on the Fed. But it is a close call.

Richard H. Clarida
Global Strategic Advisor
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