Signals from the Depths.

Democratically-elected governments have been responding to the “Great Recession” by trying to cut public spending.[1] This is a throw-back to the initial—and disastrous—response to the “Great Depression” after 1929. It is a rejection of the subsequent Keynesian deficit-spending policies that eventually got countries out of the Depression. The “sequester” in place of more stimulus has dragged on American economic recovery since 2011; the Germans insist upon austerity in the European Union, and Japan’s parliament recently passed a higher consumption tax that short-circuited an attempt to stimulate growth there.

In the absence of spending programs, central banks have used, are using, or may be about to use purchases of long-term debt (called “quantitative easing”) to pump money into the economy. This is better than nothing.[2] The Federal Reserve Bank has just ended its buying of long-term bonds and has hinted at higher interest rates in 2015. Thus, it is signaling its belief that economic recovery is well underway in the United States.

Still, amidst all the talk about an improving American economy, there have been signs of new troubles ahead in the world economy.[3] By early October 2014, world prices for bonds, currency, and commodities were being read to suggest the possibility of a new global slowdown. It isn’t clear that there are any policy tools that could check this descent.

Economic growth should reduce un-employment. Over time, lower unemployment should lead to a rise in wages and to higher prices. However, all the major advanced economies seem headed toward low long-term interest rates. There appears to be a widely-shared belief among knowledgeable people that inflation is not going to fire up any time soon. Why would people believe this?

First, the value of the dollar has been rising against the currencies of Europe, Japan, South Korea, and Japan. You could read this as investors taking flight from those currencies to the security of currently stable dollars. This may reflect a belief that by investors that the world economy is headed downhill and that there aren’t any policy tools to control the descent.

Second, stocks and bonds usually move in opposite directions. In an expanding economy, money will flow toward stocks as investors try to share in profits and rising share prices. In a shrinking economy, money will flow to bonds as people try to avoid being stuck with stocks whose price is falling. Monetary policy usually seeks to keep interest rates low when the economy needs to be propped-up. Until that is shown to be working, investors will accept even low yields from bonds. The interest rate on 10-Year US bonds has fallen over the course of the year from 3.0 percent to 2.2 percent. Purchasers are bidding-down the interest on these bonds out of their eagerness to have them in their portfolio.

Third, the price of commodities has been falling. The price of crude oil is down 22 percent since the end of June. The price of corn futures has fallen by 31 percent since late April. Abundant production is forcing down prices. It comes at an awkward time for confidence in the world economy.

What do you do when unelected experts and private investors disagree with elected representatives on the best policy? What if the experts and investors are right?

[1] Neil Irwin, “What the Bank of Japan’s Surprise Move Means for the Global Economy,” NYT, 31 October 2014.

[2] Moreover, it pushes up the prices of assets, which are owned by upper income groups, better than it stimulates employment or raises wages. So, many voters find themselves preoccupied by inequality.

[3] Neil Irwin, “The Depressing Signals the Markets Are Sending About the Global Economy,” NYT, 15 October 2014.

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