Baum on Money: Popcorn Topples Dominoes
Happy Friday. Here are some of the stories I'm reading on the U.S. economy this morning.
U.S. deficit is falling at the fastest pace in 60 years.
That's what President Barack Obama has been telling us, ad nauseam. With one month left to go in fiscal 2013, the deficit is down 35 percent from a year ago, according to the Treasury's August budget statement. Tax receipts are up, outlays are down, and the deficit is expected on track to shrink to 3.9 percent of gross domestic product -- the lowest since 2008 -- from 6.8 percent last year, according to the Congressional Budget Office. I can already hear the Keynesians clamoring for more spending.
Think popcorn, not dominoes.
Economists Ed Lazear and Keith Hennessey, both of whom worked in the George W. Bush administration, offer their insights in a terse, 41-page essay, "Observations on the Financial Crisis." Too much emphasis has been placed on contagion following the collapse of Lehman Brothers, they say. Popcorn, not dominoes, is the better analogy. Each institution, like each kernel of corn popping in oil, "feels the same heat" from prior actions, such as loading up on risky, asset-backed securities. "When those securities lost value, the solvency of the institutions was threatened and it did not matter much whether other institutions had survived or failed," they write. "The fundamental cause of the problem for other institutions cannot be alleviated by treating the first institution that fails."
A clearly communicated muddled message.
The Federal Reserve is expected to do two things when it meets next week: announce a tapering of its asset purchases and lower its growth forecasts. On the surface these would appear contradictory, write Craig Torres and Ilan Kolet of Bloomberg News. Even below the surface, it's not clear why the Fed wants to reduce stimulus when unemployment is high, growth is slow and inflation below target. Ben Bernanke is going to have to do a lot of fancy footwork, via forward guidance, to explain the inconsistencies. Even then, it's doubtful he can reverse the rising trend in long-term rates.
From secrecy to transparency in two decades.
Before 1994, the Fed's policy was one of silence. Changes in policy were a form of guesswork left to a species known as "Fed watcher." (Former Fed chief Alan Greenspan introduced his own unofficial modification to official policy, which involved leaks to chosen members of the press.) Less than 20 years later, talk -- formally known as "forward guidance" -- has been elevated to a policy tool. The Dallas Fed reviews the evolution of the Fed's communication policy for us. The idea is that the central bank can guide expectations about the future overnight rate and hence influence long-term rates today. The problem is that the market has its own expectations, and sometimes the two are different.
Dylan Matthews of the Washington Post's Wonkblog explains in a clever chart how to dismiss research that challenges your beliefs.
(Caroline Baum is a Bloomberg View columnist. Follow her on Twitter.)