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The Fed Cannot Allow Another Lost Decade

Scott Sumner profile picture
Scott Sumner


  • CBO has updated forecasts for real and nominal GDP growth during the 2020s.
  • You might argue that there's nothing the Fed can do to prevent a big drop in RGDP.
  • I agree, but the decline in NGDP, especially in the out years, is totally unacceptable.
  • And this will make the fall in RGDP even worse than it needs to be.

The CBO has a new report where they update their forecasts for real and nominal GDP growth during the 2020s:

Of course this is just one projection, but it's in line with what I see elsewhere, both among forecasters and in the financial markets. The Fed should not allow this to happen.

You might argue that there's nothing the Fed can do to prevent a big drop in RGDP. I agree, but the decline in NGDP, especially in the out years, is totally unacceptable. And this will make the fall in RGDP even worse than it needs to be.

It looks to me like they've lowered their forecast for 2030 prices by roughly 2.5%. There's no reason why the Fed should allow the current pandemic to reduce inflation by 0.25%/year for the next 10 years. Yes, almost all of that shortfall is expected to occur in 2020 and 2021, but in that case the Fed needs to make up the shortfall with above 2% inflation in future years. The CBO does not expect this, nor do private forecasters (as far as I know), nor do the TIPS markets, nor do I.

I was appalled when in 2008 and 2009 the economics profession as a whole seemed complacent about Fed policy. It was obvious that NGDP would remained depressed for many years, and very few people were calling for a much more expansionary Fed policy. That's why I got into blogging.

Now it's widely expected that the Fed will again allow a lost decade, and I see no sense of urgency in the Fed, in the economics profession, in the government, in the media, or anywhere else to do anything about it. Where are the calls for level targeting?

Where's the outrage?

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Scott Sumner profile picture
Bio My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.

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Comments (55)

Where's the outrage over the wealth inequality which the Fed has created? Capital is moving higher at the expense of Labor. Easy money policies have negative consequences.
David de los Ángeles Buendía profile picture
Hello @atowildcat ,

1) You wrote: "Where's the outrage over the wealth inequality which the Fed has created?"

Wealth inequality existed long before the Federal Reserve Bank (FRB) existed and if it ever ceases to exist, wealth inequality will exist long afterwards. The FRB is simply a large, complicated bank. It does not and cannot create or eliminate wealth inequality.

2) You wrote: "Capital is moving higher at the expense of Labor." That may well be so but the FRB has little or nothing to do with that. That is largely the result of the export of manufacturing capital from the United States to countries will significantly lower labour costs. Labour arbitrage is the problem in this matter over which the FRB has no control.

3) You wrote: "Easy money policies have negative consequences." What do you mean by "easy money policies and how do they create negative consequences?
Soothsayerman profile picture
It's not about the Fed, the fed is doing what we have enabled them to do. It's about policy. Fed officials are appointed, not elected. You want to change the Fed, change who you elect to office. We have free market capitalism in good times and let banks have zero liabilities to reserve ratios then we have corporate socialism in bad times and let the taxpayer foot the bill. The Fed instituted emergency loan procedures in September before a single case of COVID19 appeared. I'm not going to get into the economics of why, but that should tell you something.

As long as we privilege private commercial banks to issue money de novo in order to charge interest on it, we will be at their mercy because of the positive feedback inherent in the debt money system. They will always blow asset bubbles by issuing too much debt money in pursuit of unearned interest income, then when the bubble bursts, hold the economy to ransom by threatening a deflationary collapse if they aren't bailed out. Modern mainstream neoclassical economics is blind (and deaf and dumb) to this fact because of its assumption that money, banking and debt are zero-sum phenomena, and thus irrelevant to the "real" economy.

Elect people that will reinstate Glass-Steagall and put hard limits in realistic amounts on what banks must maintain as liabilities to reserve ratios.
David de los Ángeles Buendía profile picture
Hello @Soothsayerman ,

You wrote: "It's not about the Fed, the fed is doing what we have enabled them to do. It's about policy."

What policy has the Federal Reserve Bank implemented that you disagree with and what policy should they implement?
Soothsayerman profile picture
Doing things outside of their charter like buying junk bonds, setting up offshore SPV's, appointing private companies to administer relief programs and many other things. What the Fed is chartered to do and what it is doing are two completely different things.
David de los Ángeles Buendía profile picture
Hello @Soothsayerman ,

1) The Federal Reserve Bank (FRB) does not do any of those things.

2) Even if the FRB did do those things, that would only be the mechanism by which the FRB tries to achieve it's monetary policy, not what that policy is. My question was what monetary policy should the FRB have adopted instead of it's current policy.

You keep harping about NGDP targeting as if it's a self-contained concept. As David has articulated below, this falls flat purely on the basis of real life mechanics. Being able to prevent tight money depressions is far removed from being able to substitute for real life economic activity.

Repeating of the NGDP targeting tactic, without actually breaking down why this would work is nothing but intellectual masturbation. Especially when on the face of it, it's already apparently failing in numerous ways insofar done (if only because of it unintended side effects). Ironically, coming from academics, why wouldn't you back this up instead of being married to the notion in an ivory tower way.
The outrage should be directed at the Fed for gross mismanagement. If only street protesters would wake up and change the focus from burning down their own house to ending the Fed.
Soothsayerman profile picture
It is not the Feds fault at all. They are providing the function to the market that we, the voter, have set up. There are no elected officials in the Fed. They are appointed. We have put politicians in place that refuse to reinstate Glass-Steagall, have lowered the reserves to liabilities ratios that banks must meet to zero (Trump/Mnuchin), and support a policy of not requiring insolvent financial institutions to declare bankruptcy.

Instead we have freemarkets in good times and corporate/bank socialism in bad times with the tax payer footing the bill. The entire US economy and markets are beholden to 5 banks.
David de los Ángeles Buendía profile picture
Hello @dougkitchen ,

If the Federal Reserve Bank is guilty of mismanagement, what specifically did they do wrong? Monetary policy is not especially complicated. Any central bank can increase the supply of narrow money or restrict it. This will necessarily impact short term interest rates and create inflationary or deflationary pressures. What specific policies should they have implemented and how would those policies have produced better results?
Soothsayerman profile picture
They do a lot more than just monetary policy.
Salmo trutta profile picture
re: "the Fed needs to make up the shortfall with above 2% inflation in future years"

Standing alone, lending/investing by the Reserve and commercial banks is inflationary. Lending/investing by the nonbanks is noninflationary (other things equal, e.g., the maldistribution or misallocation of credit).

From the standpoint of the commercial banking system (not an individual bank), the banks collectively create bank deposits, they don’t lend existing bank deposits. The nonbanks transmit bank deposits, lend existing bank deposits (bank deposits that have been saved outside of these intermediaries, indeed outside of the entire the intermediary group). I.e., all monetary savings (income not spent) originate within the payment’s system.

The NBFIs, e.g., hedge funds, insurance companies, pension funds and shadow banks are the DFI’s (regulated member banks), customers. The DFIs process all of the NBFI’s underlying payment transactions, both clearings, and settlements.

So, to increase R-gDp relative to N-gDp, the nonbanks need to activate otherwise idle monetary savings. I.e., all bank-held savings are un-used and un-spent, lost to both investment and consumption as the banks always pay for their earning assets with new money, not existing deposits.

That means driving the commercial banks out of the savings business, e.g., reducing the FDIC’s $250,000 insurance limit on individual accounts. The 2013 “Taper Tantrum” is prima facie evidence.

This would increase the supply of loan funds, but not the supply of money, a noninflationary velocity relationship.

Sumner’s prescription has already been denigrated. To wit, N-gDp LPT was denigrated in 2019. How do you think we got this slowdown? It was the stagflationists fault, the perverse monetary policy mix:

"Rethink 2%"

Prima Facie Evidence. The 2018 pivot:

As Dr. Philip George says: “When interest rates go up, flows into savings and time deposits increase.” (thereby destroying money velocity)

The interest-bearing character of the DFI’s deposits which result in any sudden larger proportion of commercial bank deposits in the interest-bearing category destroys money velocity.

2018-11-05 0.49
2018-11-12 0.49
2018-11-19 0.56 [spike]
2018-11-26 0.57

This is also an excellent device for the banking system to reduce its aggregate profits (as all savings originate within the confines of the payment's system, and an individual bank's primary deposit is a derivative deposit - from a system's perspective).

It is hard for the average person to believe that banks do not loan out savings or existing deposits – demand or time. But the DFIs always create money by making loans to, or buying securities from, the non-bank public.

This results in a double-bind for the Fed (FOMC schizophrenia: Do I stop because inflation is increasing? Or do I go because R-gDp is falling?). If it pursues a rather restrictive monetary policy, e.g., QT, interest rates tend to rise.

This places a damper on the creation of new money but, paradoxically drives existing money (savings) out of circulation into frozen deposits (un-used and un-spent, lost to both consumption and investment). In a twinkling, the economy begins to suffer.

% Deposits vs. large CDs on "Assets and Liabilities of Commercial Banks in the United States - H.8"

Jul ,,,,, 12227 ,,,,, 1638.6 ,,,,, 7.46
Aug ,,,,, 12236 ,,,,, 1629.4 ,,,,, 7.51
Sep ,,,,, 12268 ,,,,, 1662.4 ,,,,, 7.38
Oct ,,,,, 12318 ,,,,, 1685.8 ,,,,, 7.31 (twinkling)
Nov ,,,,, 12313 ,,,,, 1680.1 ,,,,, 7.33
Dec ,,,,, 12425 ,,,,, 1698.6 ,,,,, 7.31
Jan ,,,,, 12465 ,,,,, 1732.9 ,,,,, 7.19
Feb ,,,,, 12494 ,,,,, 1744.6 ,,,,, 7.16

See: Dr. Philip George - October 9, 2018: “At the moment, one can safely say that the Fed's plan for three more rate hikes in 2019 will not materialise. The US economy will go into a tailspin much before that.”

Or you could look at the Calafia Beach Pundit: “money demand fell from mid-2017 to mid-2018 as confidence soared and the economy strengthened”

Link: September 25, 2018: “An Emerging And Important Secular Trend”
Link: “Demand for money; what went up will soon come down”
Link: scottgrannis.blogspot.com/...
Salmo trutta profile picture
Danielle Dimartino Booth’s in her book gets it backwards too: “Fed Up”, pg. 218

“Before the financial crisis, accounts were insured up to the first $100,000 by the FDIC. That limit kept enormous sums *in the shadow banking system* [sic].
hoyt15 profile picture
@Salmo trutta

could you help explain your comment on savings in respect of banks vs. non-banks:

" I.e., all bank-held savings are un-used and un-spent, lost to both investment and consumption as the banks always pay for their earning assets with new money, not existing deposits."

I received my stimulus, which to me is excess income not currently spent. I have 3 choices (for simplicity sake)...put in a bank savings account, in a money market fund or a whole life policy. When the recipient gets my "money", they will buy a security with it, lets say again for simplicity, a gov't agency note. None of these transactions results in new money being created, and in each case the same security is purchased from the same dealer. I am struggling to understand why, when a bank buys a security with my deposit, it is different than when a non- bank buys the same security, in gross economic effects. I am not meaning the effect on velocity, but on the economy.

Thanks for your usual helpful response.
Salmo trutta profile picture
@hoyt15 re: "None of these transactions results in new money being created" Your stimulus check is new money. But you are double counting to say that you will "put the remittance in a bank savings account". It's already in the payment's system (and idled).

re: "when a bank buys a security with my deposit, it is different than when a non- bank buys the same security"

You‘re the owner of the funds, not the bank. If the bank bought the same security for itself, then it would be creating new money and credit. It would be adding assets and liabilities to its balance sheet, and not your pocket.

It is incumbent upon the saver-holder, the owner of funds not spent, to invest/spend directly (e.g., automatic reinvestment of shareholder dividends in more shares of a company's stock), or indirectly via an intermediary (e.g., broker-dealer), outside of the banks in order to activate savings products.

This simply results in an exchange in pre-existing commercial bank deposits, DFI liabilities, within the payment’s System (where all monetary savings originate). This is the source of secular stagnation since 1981.
End the Fed
David de los Ángeles Buendía profile picture
Pr. Sumner @MoneyIllusion ,

You asked: "Where's the outrage?" about the decline in Nominal Gross Domestic Product (NGDP) and parallel decline in Real Gross Domestic Product (RGDP).

You answered your own question when you wrote: "You might argue that there's nothing the Fed can do to prevent a big drop in RGDP...I agree...". If the Federal Reserve Bank can do nothing to address RGDP, how can it do anything to address NGDP?

What drives an economy is the creation of goods and services and the exchange of those commodities for other goods and services, mediated through money. Economic growth is principally about capital creation and the production of goods and services and the exchange of goods and services. There is little that the FRB can do to impact that process.

Dr. Ben Bernanke said in 2011 in Jackson Hole that : "Most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.”. Right he was.
U studied Mises and the Austrian school and I totally agree. This article states the fed not done enough? Look at how much m2 has grown. When we end up with stagflation they will complain fed eased too much. Ppl should be careful what they wish for.
David de los Ángeles Buendía profile picture
Hello @mfanelli ,

It is widely believed, including the Austrian School of Thought but not limited to them, that interest rates are crucial to economic growth. The idea is that capitalists will create more capital when interest rates are low and create less capital when interest rates are high, or put a different way, rates of investment (or capital creation) or interest rate sensitive. However it would appear that rates of investment are largely interest rate insensitive [1][2]. It might have been true once that investors access to money needed to create capital was throttled by interest rates but it does not seem to be the case today. Investors invest largely irrespective of interest rates.
Soothsayerman profile picture
Good ole Hayek.
It's going to take Fiscal change.

We have to get wages up.
arthur_bishop1972 profile picture
And (consumer) demand
BullBear Trading profile picture
Metrics such as GDP essentially no longe exist. GDP is only relevant to a market driven, capital-based economy. The old economy has been placed in Fed receivership for reorganization as an Information-based, outcome-driven Technocracy. Information is the new Capital.
I don't understand your concern. First the CPI adjustment for nominal to real is totally phony in that it doesn't represent actual living costs. Second any inflation just reduces the lower 70 percent of the population purchasing power. So yes perhaps the Fed will induce inflation but it won't help anyone except the top 1-10%. I guess that you want to help borrowers instead of savers or help speculators instead of investors.
Debt spiral trap. They'll try to inflate their way out of it. Will it work? The burden is becoming increasingly detached from needed output but to try to shrink it now would be a disaster. If they try to wait for a time when output exceeds the debt burden that time may never come -- how many more nail salons and tattoo parlors do we need? Wages do need to rise but will be constrained by their disparity over developing economies and automation. The best hope for now is that the cheap money does its trick.
David de los Ángeles Buendía profile picture
Hello @PreCambrian ,

Dr. Sumner was writing about Gross Domestic Product, real and nominal, not Consumer Price Index.
David de los Ángeles Buendía profile picture
Hello @connecon88 ,

The Federal Reserve Bank (FRB) is indeed attempting to create inflationary pressures by increasing the supply of narrow money, mainly bank reserves. The FRB hopes that they will be enough to counterbalance the intense deflationary pressures present in the economy of the United States right now. The FRB was created in no small part to combat deflationary spirals. Throughout the 19th and early 20th centuries the economy of the United States was plagued by a long series of deflationary spirals. Many consumer prices are already falling, especially non-food commodities.
Quick note to the author: you live in the U.S. not the Soviet Union. The government does not have complete control of the economy, yet anyway.
Buyandhold 2012 profile picture

11 years ago the S&P 500 was 666. Now it's 3,192.

5 times what it was 11 years ago.

After a wonderful 11 years like that, perhaps 10 years of just treading water wouldn't be so bad.
Maga infinity profile picture
no, 30000 in 10 years
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