Paul McCulley — Our nation can't afford past-its-sell-date economic orthodoxy

Paul McCulley unloads.

I've had it with my profession, macroeconomics. More specifically, I've had it with the consensus of practitioners in my profession.

My disgust reached new heights Friday a week ago, when the U.S. reported "shockingly weak" or alternatively, simply "dismal" employment growth during the month of May: only 38,000 job gains, in contrast to a monthly average increase well over 200,000 over the last two years.

Rather than focus on the existential macroeconomic cause of the disappointing data, my profession's town barkers immediately jumped to the conclusion that the Federal Reserve had "egg on its face" in the wake of its forward guidance in the weeks prior to the data's release, rhetorically "preparing the markets" for a hike in its policy rate this summer.

It must be noted that the hike putatively being "put in play" was lifting the Fed's policy rate by one-quarter of a percentage point, to a level still far south of even 1 percentage point. Most ordinary people would submit that as long as we're talking about interest rates in terms of zero-point-something, we're talking about the moral equivalent of zero.
Yet the Fed is somehow responsible for the U.S. labor market's sudden slowdown? And should have egg on its face?

No, the egg belongs on the face of my profession, which refuses to openly acknowledge that the economy's existential woe is a deficiency of aggregate spending, for which fiscal policy expansion — read dramatically larger fiscal deficits — is the solution, not near-zero Fed policy rates.

To be sure, many in my profession will mouth these words in private. But in public, they demur, citing the lack of brains or courage, or both, of political leaders charged with fiscal policy to do the right thing.

Meantime, the very same pundits religiously sing praises to the Federal Reserve's independence from politics, hailing it as the only responsible "game in town," even if the institution's face is momentarily egg-smacked.

These macro mavens assured the world that notwithstanding May's soggy jobs data, all would continue to be right with Wall Street, because the Fed would surely forget about any nearby hike further away from zero for its policy rate, supporting current lofty valuations for stocks and bonds.

Exactly how that outcome would reinvigorate job creation, or generate a more just distribution of wealth and income growth in our country, was not discussed.
What mattered to the natters was that release of data saying no such thing was happening in the economy was, ironically, good news for Wall Street, because the Fed would "have no choice" but to keep on keeping on, acting as bartender for a hope-it-trickles-down party, tickets reserved for the rich.

Enough is enough.

Not that the Fed has done the wrong thing since the financial crisis of 2008. Quite to the contrary, the Fed has performed brilliantly, and I have been, proudly, a much-maligned cheerleader of the Fed, under both Chairs Ben Bernanke and Janet Yellen.

But it is also true that after a financial crisis, itself spawned by bursting of a bubble in private-sector debt creation, the power of monetary policy to generate robust aggregate spending growth is severely truncated: The private sector is in a de-leveraging state of mind, which is inherently anathema to strong credit-generated aggregate demand growth.

In such circumstances, the economy needs a spender and borrower of last resort: the public sector.

To be sure, monetary policy accommodation can ease the burden of the private sector's existing excessive debt. And by lifting the ceiling of fair valuation for long-dated assets, monetary accommodation can also create bull markets in those assets, owned primarily by the rich.

And, yes, some of those winnings for the rich will be spent, trickling down to jobs and income for the non-rich.

But there is a large slip between the champagne crystal of the rich and the mouths of the non-rich. Put differently, fattening the wallets of the rich generates far less aggregate demand bang for the buck than generating jobs and wage increases for the non-rich.
While the rich spend a lot in absolute terms, their spending is miserly as a share of their income, in contrast to the budget constrained non-rich, especially those who live, literally, paycheck to paycheck (assuming they have a job, of course).

At the macroeconomic level, one entity's spending is another entry's income.

Thus, if there is a deficiency of aggregate spending in the economy, there will be a deficiency of aggregate jobs and income.

This is not a dirty secret, but rather the essence of macroeconomics, in contrast to individual household economics: Spending drives jobs and income, not the other way around.

Thus, it should be self-evident that the public sector needs to spend more, and not "pay for it." This was the right blue-book exam answer when we macroeconomists were in graduate school. (And still is.)

Yes, fiscal deficits need to be dramatically bigger, so as to lift economy-wide spending, with the Federal Reserve at the ready to thwart any fear-mongering by Wall Street about the "evil" risk of associated upward pressure on inflation and thus, interest rates.

The only way that interest rates would "need" to go up in the wake of debt-fueled fiscal expansion would be if such fiscal action were to "work," generating robust aggregate demand and fostering an "overheated" economy, most importantly in jobs.

Please throw our country into the briar patch!

It is beyond me that our political leaders don't recognize the latitude they have to spend money they putatively don't have. They do have it!

The Federal Reserve, which is a creature of Congress, can and does create money out of thin air. The moral question — which is the foundation of politics in a democracy — is: for whom and for what?

It is time for my profession to say this publicly, owning the egg on its own face: We can't enable the world in the cruel belief that fiscal austerity is somehow always and everywhere a good thing.

It is only always good for the moneyed class.…

McCulley goes on to explain what needs to be done.

Strong stuff.
 
The Hill
Our nation can't afford past-its-sell-date economic orthodoxy

Paul McCulley, a senior fellow with the Jack G. Clarke Program on the Law and Regulation of Financial Institutions and Markets at the Cornell University Law School. He retired last year as chief economist and managing director of PIMCO.
ht Michael Stephens at Multiplier Effect