Roubini: Why monetary policy easing is warranted in the current insolvency crisis

[quigleydoor]

Is Nouriel Roubini correct?

http://www.rgemonitor.com/blog/roubini/232729

The whole essay is worth reading but here are the major arguments.

While aggressive monetary policy easing will not prevent a hard landing – as it did not prevent one in 2001 – the length and depth of an economic downturn is affected by monetary policy. And it is both the duty and responsibility of central banks to reduce partly avoidable severe economic downturn that lead to massive losses of jobs, welfare and incomes. The job of a central bank is not to bail out the financial system and/or investors but that of bailing out the real economy. Having millions of workers lose their jobs only to teach a lesson to reckless investors and lenders on Wall Street and the City does not make sense.

At this point the financial losses from the reckless credit bubble of the last few years are mostly unavoidable and will not be avoided by easier monetary policy. . . . And the broader financial losses – that will be close to 1,000 billion dollars once you add sub-prime, near prime, prime, auto loans, credit cards, student loans, commercial real estate, leveraged loans and lending to the distressed parts of the corporate sector – will be massive regardless of what the Fed does. And once the unavoidable hard landing becomes clear to market participants the current delusional hope of the stock market investors that the Fed can prevent such hard landing will fizzle out and stock price will sharply fall as well. . . . So to those who are worried about moral hazard: don’t worry as reckless lenders, borrowers and investors will be severely punished as they are already.

a US hard landing followed by a global slowdown will seriously reduce those inflationary force and would – like in 2001-2003 – rather induce serious deflationary risks. Inflationary pressures may be elevated now but they will fizzle away in short order once the US hard landing is in full swing. Thus, the central banks current concerns with a rise in inflation are misplaced as a US recession will lead to global disinflation (and concerns about deflation as in 2002-2003). There are at least four reasons why these global inflationary forces will abate once this US hard landing occurs:

a) a fall in US aggregate demand relative to supply;

b) a slack in labor market conditions and slowdown in wage growth as the unemployment rates sharply increases;

c) a fall in global aggregate demand as the glut of output from overinvestment in China and some other emerging market economie will face a fall in global demand as the world re-couples with the US hard landing;

d) a sharp fall in oil, energy, food and other commodities prices as a global slowdown emerges.

We are thus set for the repeat of the 2000-2003 cycle when the Fed and other central banks underestimated the downside risks to growth and overestimated the upward risks to inflation and ended up having to aggressively cut rates to deal with the fall in economic activity and the deflation risks that such a US and global recession triggered.

[jk]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

sounds to me like ka unfolding.

[Tulpen]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

I think he has a point but only if the easing is not going to be used to create yet another asset bubble to avoid any kind of landing.

And I am all but convinced that the US government, federal reserve and US banking system is not going to think of another bag of tricks in trying to avoid it for now.

[EJ]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

Is Nouriel Roubini correct?

http://www.rgemonitor.com/blog/roubini/232729

The whole essay is worth reading but here are the major arguments.

I agree in part.

While aggressive monetary policy easing will not prevent a hard landing – as it did not prevent one in 2001 – the length and depth of an economic downturn is affected by monetary policy. And it is both the duty and responsibility of central banks to reduce partly avoidable severe economic downturn that lead to massive losses of jobs, welfare and incomes. The job of a central bank is not to bail out the financial system and/or investors but that of bailing out the real economy. Having millions of workers lose their jobs only to teach a lesson to reckless investors and lenders on Wall Street and the City does not make sense.

Agree entirely that this is no time for moralism. Households have less than 19 days of liquidity vs 30 Jan. 2000. There will be plenty of time and opportunity for political responses later. That said, I disagree that the Fed is behind the curve. The Fed has let inflation rip to save this economy. The Fed has been neither slow nor ineffective in its response. It has managed the yield curve as intended and as explained years in advance. Unfortunately, this has resulted in undesirably high rates of inflation. For a solid analysis of the process, see:

Consumer Crush, December 2007
http://www.piscataquaresearch.com/research/economic/
(Requires free registration.)

At this point the financial losses from the reckless credit bubble of the last few years are mostly unavoidable and will not be avoided by easier monetary policy. . . . And the broader financial losses – that will be close to 1,000 billion dollars once you add sub-prime, near prime, prime, auto loans, credit cards, student loans, commercial real estate, leveraged loans and lending to the distressed parts of the corporate sector – will be massive regardless of what the Fed does. And once the unavoidable hard landing becomes clear to market participants the current delusional hope of the stock market investors that the Fed can prevent such hard landing will fizzle out and stock price will sharply fall as well. . . . So to those who are worried about moral hazard: don’t worry as reckless lenders, borrowers and investors will be severely punished as they are already.

- Approximately $11 trillion in fictitious value from 2002 - 2005 real estate inflation will be lost to a combination of defaults and the loss of purchasing power of housing values.

a US hard landing followed by a global slowdown will seriously reduce those inflationary force and would – like in 2001-2003 – rather induce serious deflationary risks. Inflationary pressures may be elevated now but they will fizzle away in short order once the US hard landing is in full swing. Thus, the central banks current concerns with a rise in inflation are misplaced as a US recession will lead to global disinflation (and concerns about deflation as in 2002-2003). There are at least four reasons why these global inflationary forces will abate once this US hard landing occurs: a) a fall in US aggregate demand relative to supply; b) a slack in labor market conditions and slowdown in wage growth as the unemployment rates sharply increases; c) a fall in global aggregate demand as the glut of output from overinvestment in China and some other emerging market economie will face a fall in global demand as the world re-couples with the US hard landing; d) a sharp fall in oil, energy, food and other commodities prices as a global slowdown emerges. We are thus set for the repeat of the 2000-2003 cycle when the Fed and other central banks underestimated the downside risks to growth and overestimated the upward risks to inflation and ended up having to aggressively cut rates to deal with the fall in economic activity and the deflation risks that such a US and global recession triggered.

No. Supply will decline even faster than demand as occurred during two recessions in the 1970s. Wages may be allowed to inflate if rising nominal incomes are the last bullet left for US households to use to cope with a decline in credit to fund cash flow.

As I've explained before, the post housing bubble collapse process is entirely different than the post stock market collapse. No repeat of the 2002-2003 cycle. This is a completely different animal. This is a debt deflation.

- More gradual but more profound and broad-based negative wealth effects
- Broad impact in consumer spending, unlike the 2002 - 2003 business recession
- Requires both P/C Economy and FIRE economy reflation measures
- P/C Economy reflation is problematic due to weak dollar, relatively low Fed Funds base, high commodity price inflation.

Global central banks not allow zero bound to be approached as in Japan in the 1990s or the US in the 1930s. The Fed is inflating away debt as I write.

[Mega]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

"Global central banks not allow zero bound to be approached as in Japan in the 1990s or the US in the 1930s. The Fed is inflating away debt as I write."

If i understand right you mean that unlike Japan the FED will NOT allow rates to hit the floor & stay there. They allow inflation to rip for 12-20 months, then "Volker it"?
Mike

[jk]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

"Global central banks not allow zero bound to be approached as in Japan in the 1990s or the US in the 1930s. The Fed is inflating away debt as I write."

If i understand right you mean that unlike Japan the FED will NOT allow rates to hit the floor & stay there. They allow inflation to rip for 12-20 months, then "Volker it"?
Mike

inflation is viewed as the less serious threat than deflation. if you read the prior discussions, and look at the graphs/charts of future hypothetical inflation and interest rates, the expectation is for YEARS of varying but sluggish growth and varying degrees of inflation. during this period the fed will be viewed as behind the curve with respect to inflation, but that will be because it wants to be sure to be ahead the curve with respect to deflation. it will take years for there to be adequate inflation to dissipate the fictitious value in the housing, debt, and equity markets. once this is accomplished, we will be able to survive the reign of volker's future reincarnation.

[Guest]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

Miker -

The situation requires long-term negative real interest rates. Which investment class is that supposed to be good for? Bondholders will take it on the chin. And all those loopy goldbugs and stopped clocks collecting that shiny blingy stuff will (finally - after proclaiming imminent Armageddon for 27 years to no avail) finally have their reward.

I was at my gym yesterday evening and got talking to a guy about ways and means to semi-retire. I asked him what he thought he'd need to accomplish that. His answer? Have a million USD and put it in a money market CD and live off the 4% interest. I almost flinched at the idea of someone working for 30-40 years, then taking those savings and putting them in a US money market CD and going off to enjoy their retirement.

At present inflation rates the poor SOB's money is toast in 5-10 years.

I always ask such questions to people I meet to get a sense of where Americans are in the 'self-defense' category. I hate to admit it because I really don't like calling everyone around me stupid for fear of indulging a conceit. But the vast, vast majority of people over here have not got a solitary clue what's happening to their money.

So the 'low inflation' snow-job being perpetrated by the Fed is showing every potential for effectively 'anchoring people's inflation expectations' for a good while longer. If ever a term were a fig-leaf for criminal misrepresentation, 'anchored inflation expectations' is it.

The FED's 'job' now is to maintain inflation at all costs. They will probably err on the side of caution in maintaining that bias. Sooner or later you have to climb off the fence and take either an inflationist or deflationist position to some extent. I'm betting that except for the short ugly deflationary scares, it's going to be inflation as far out as the weary eye can see.

[dbarberic]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

I believe EJ is spot on and it still amazes me when I read editorials that basically characterize the current situation as a debt deflation, the central banks are out of "tools", pushing on a string, and then end result will be massive crash/deflation.

There are no bounds to the creativity that the Fed will come up with to monetize the debt and inflate away and prevent hitting the zero bound.

I always come back to this slide:


We already have the Central Banks loaning out money on CDOs marked-to-fiction using early 2007 data. There is nothing to stop the Fed from other extreme tactics to move currently restricted instruments to unrestricted instruments.

A blast from the past...
No Deflation! Disinflation then Lots of Inflation
http://www.itulip.com/forums/showthread.php?t=417

[grapejelly]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

Miker -

The situation requires long-term negative real interest rates. Which investment class is that supposed to be good for? Bondholders will take it on the chin. And all those loopy goldbugs and stopped clocks collecting that shiny blingy stuff will (finally - after proclaiming imminent Armageddon for 27 years to no avail) finally have their reward.

I was at my gym yesterday evening and got talking to a guy about ways and means to semi-retire. I asked him what he thought he'd need to accomplish that. His answer? Have a million USD and put it in a money market CD and live off the 4% interest. I almost flinched at the idea of someone working for 30-40 years, then taking those savings and putting them in a US money market CD and going off to enjoy their retirement.

At present inflation rates the poor SOB's money is toast in 5-10 years.

I always ask such questions to people I meet to get a sense of where Americans are in the 'self-defense' category. I hate to admit it because I really don't like calling everyone around me stupid for fear of indulging a conceit. But the vast, vast majority of people over here have not got a solitary clue what's happening to their money.

So the 'low inflation' snow-job being perpetrated by the Fed is showing every potential for effectively 'anchoring people's inflation expectations' for a good while longer. If ever a term were a fig-leaf for criminal misrepresentation, 'anchored inflation expectations' is it.

The FED's 'job' now is to maintain inflation at all costs. They will probably err on the side of caution in maintaining that bias. Sooner or later you have to climb off the fence and take either an inflationist or deflationist position to some extent. I'm betting that except for the short ugly deflationary scares, it's going to be inflation as far out as the weary eye can see.

My best friend put much of his savings into an annuity after losing a ton of money in the tech crash. Sigh. 4% guaranteed. So sad. People do not understand what is happening.

[raja]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

I asked him what he thought he'd need to accomplish that. His answer? Have a million USD and put it in a money market CD and live off the 4% interest. I almost flinched at the idea of someone working for 30-40 years, then taking those savings and putting them in a US money market CD and going off to enjoy their retirement.
At present inflation rates the poor SOB's money is toast in 5-10 years.

Lukester,

If inflation goes up, then CD rates should go up, right?

If he's in short-term CDs, he can just reinvest and follow the rates up. When the rates are high, he can lock in a long-term CD at a high rate, or buy a 30-year Treasury, and retire on 10%, 15% or 20% (depending on how close he gets to the top).

Seems like a great idea . . . so what am I missing here?

[Guest]

Re: Roubini: Why monetary policy easing is warranted in the current insolvency crisis

Raja -

Maybe Grapejelly can answer this better than I - or Finster or Bart, or lots of others here. The term "CPI + Lies" gives a hint of what the problem may be if you are parked in anything where the Government is doing the "inflation indexing" for you. Talk about letting a fox loose in the henhouse!

Maybe if used in conjunction wth a decent percentage of gold and a bit of some commodities index as inflation compensators it could work.

But Raja, there are others here a great deal more qualified than I to answer this question.