Thursday, June 10, 2010

The Fed is "Pushing on a String"?

During economic times like these, economists say that the Federal Reserve is “pushing on a string”. That is, the central bank has pumped a large amount of reserves into the banking system, yet banks are not lending, and the money stock is not growing.

Excess reserves in the banking system total more than $1.0 billion. Bank loans on a year-over-year basis show a negative growth rate. And, the M2 measure of the money stock, year-over-year, is growing at a 1.6% annual rate.

The Fed’s actions are not getting transferred through the banking system to the real economy!

As a consequence, economic growth does not seem to be accelerating at the speed economists and governmental policy makers would like.

Yet, if one compares the Great Recession which we have just passed through with the second worst recession in the post-World War II period the recovery does not really look that bad.

What seems to be different is the rate of growth at which the economy was growing in 1978, between 5% and 7%, and the speed it was growing before 2008, around 3%. In addition, the economy rose out of the 1981-1982 recession accelerating into the 8% range. No one seems to be predicting that the United States economy will move into this latter range in the near future. Recovery is occurring, it is just not very robust.

Fed Chairman, Ben Bernanke, testifying before the House Budget Committee yesterday spoke of the economy growing at a 3.5% rate “in the months ahead.” Economists surveyed by the Wall Street Journal expect the economy to grow about 3% in the second half of 2010 and continue that pace into 2011. (See
No one seems to believe that economic growth in 2010-2011 will match the recovery achieved in 1983-1984. The difference? Banks aren’t lending. Underemployment seems to be hanging at post-World War II highs, near 20%, and industry is operating at a capacity near post-World War II lows. On this see my post, The economy was expanding before the Great Recession, but substantially below the post-World War II average of about 3.4%, year-over-year.
Real growth in the period 2005 to 2010.
The American economy has been showing some substantial dislocations and these are expected to persist as the recovery continues! These dislocations are not going to be corrected with short-term fiscal stimulus packages. And, so the economy will just scrape along.

Along with the factors already mentioned as reasons for why the economy has grown so slowly in the 2000s and why it might be expected to continue to grow slowly is the perception that the economy is bifurcating. That is, one side of America seems to be doing very well and another side is not doing so well at all. This may be due to the restructuring of the United States economy and the slow transition that is occurring getting us there.

For example, big banks seem to be doing very well, thank you, while banks smaller than the 25 largest banks seem to be struggling. (See Foreclosures remain high and are expected to remain high as unemployment (and underemployment) remains high. Personal and small business bankruptcies have not dropped off. Legacy industries are still in the process of restructuring and are only modestly turning around while younger industries are growing very nicely. The economy of the early 2000s is different from that of the 1990s and before and we cannot go back. And, government shouldn’t force us to go back.

This restructuring is taking place in balance sheets as well as in the structure of the economy. People and businesses that have built up relatively large debt-burdens are restructuring their balance sheets. Consequently, debt liquidation is exceeding debt creation within the financial system and this is resulting in a contraction of bank loans. This is also contributing to the slow growth in money stock measures. This is why it seems as if the Federal Reserve is pushing on a string in terms of stimulating credit expansion.

Economic recovery is occurring, but it seems as if it will be modest and uneven throughout the economy. It also appears as if the economy is transitioning into something else, the Information Economy and not the Industrial Economy, and this will take time and patience. And, maybe we don’t want the banks to expand their lending too rapidly…given the $1.0 trillion in excess reserves in the banking system. Maybe.