Uncertainty Insurance

June 8th, 2012 at 8:21 am

I’ve avoided adding my voice to the uncertainty chorus—the idea that what’s holding back growth and hiring is uncertainty about the future of health care, tax, or environmental policy.  It’s neither what businesses themselves say nor what economic theory would dictate as the cause of the current slump—that would be weak demand for their goods and services.  Show me a business person who would leave profits on the table because of what might happen to health care reform in 2014 and I’ll show you a business person who will soon be busted.

But I’m coming around.  Reading Fed speeches this week, looking at the upcoming fiscal slope and debt ceiling fights, watching Europe bumble along, and just trying to read the economic tea leaves—“uncertainty” is a pretty good word to describe the way a lot of people are probably thinking and feeling about the current economy right now.

Picture a defense contractor whose short-term future rests on the outcome of the automatic spending cuts, half of which come from defense spending.  Or exporters who sell stuff to Europe.  Or retailers who don’t know whether middle-class paychecks will take a hit on Jan 1 when the payroll tax break ends and middle-class taxes increase (which could show up in wage withholding tables right away).

That’s why the smart thing for policy makers to do is to take out some uncertainty insurance through fiscal and monetary policy.  Federal Reserve governor Janet Yellen said it well:

“It may well be appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest.”

Except for the qualifier “may,” that’s exactly right.  In fact, we should have taken out such insurance a while ago, as it became increasingly clear that it was taking longer than most economists thought to leave the gravitational pull of the Great Recession, as the European crisis was deepening, as federal borrowing costs were falling, and as politics were threatening evermore self-inflicted wounds.

And there, of course, lies the rub.  There will be no smart fiscal policy stimulus—no relief to states to prevent layoffs, no infrastructure, no transportation measures—any time soon.   Federal politics right now is all about whether or not to make things worse, not how to make them better.

That leaves the Fed.  Their messages this week have been generally akin to Yellin’s above, though not so forward leaning.  They apparently need more convincing that the economy is really in slog mode and not getting better before pulling the trigger on another round of liquidity injections (buying more debt, shifting their balance sheet from shorter to longer-term debt).

OK, I’m sure their trigger finger is a lot less quick then mine.  But from where I sit, flames are smoldering and policy makers are arguing whether or not we need fire insurance.

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10 comments in reply to "Uncertainty Insurance"

  1. Chris G says:

    >Picture a defense contractor whose short-term future rests on the outcome of the automatic spending cuts, half of which come from defense spending.

    And I’d be happy to post a picture of myself and my colleagues to illustrate for the audience that that’s not just a thought experiment;-) Our company’s manpower matrix for Q1 of our FY13 (starting 7/1) is going to get worked out next week. The result will be… interesting. Actually, I’m not so concerned about Q1 as I am Q2 and beyond. Suffice it to say we’re not hiring. In fact, I’m pretty sure several people (out of 150) got pink slips last week. Unfortunately, I see no rational basis for believing that the outlook will improve in the foreseeable future.

    At home we’ve probably made 3-4 years worth of capital investments over the past year because we had the savings to do so – had the chimney relined, replaced a couple pieces of old furniture with new, etc. That was quite deliberate – boost our demand to compensate for reduced demand elsewhere. Obviously we can’t keep that up long term but maybe could do it for the rest of this year. We’ll see. If my job goes away though we’ll have to circle the wagons and all non-essential purchases will stop immediately. It’s not complicated: no job = no income = no non-essential spending – and even non-essential spending only lasts until the savings run out.

  2. N. Nyberg says:

    The Fed is filled with people sympathetic to the interests of creditors, not to the interests of borrowers. Thus they will always err on the side of squashing inflation as opposed to stimulating the economy. There is no underwater homeowner or highly indebted college student sitting on the Board of the Fed, but there sure are a lot of former and future banksters there.

  3. perplexed says:

    -”But from where I sit, flames are smoldering and policy makers are arguing whether or not we need fire insurance.”

    The flames are smouldering in the utility room of a house on the other side of tracks. They’re representing those sipping cocktails around the pool out back.

    How was it again that they got the power to make these choices and then stack the deck in their own favor with other bankers?

  4. Scritor says:

    Weirdly, one could look at this from a political perspective. The results aren’t pretty. Once Republicans in the Senate made it clear that they would move heaven and earth to block Obama’s access to the lever of fiscal policy in order to improve the economy and thus improve his chances at re-election, the real battles devolved to the Federal Reserve. The Federal Reserve is a nominally non-partisan institution–above the fray. And yet this hasn’t always been the view of observers. Nixon, for instance, blamed Fed tightening (amongst other things) for his loss in the 1960 election, which was contested in a modest recession. When he finally did become president, he made sure to put pressure on his duly appointed Fed chairman, which helped continue the economic boom and guide him to victory in 1972.

    Obama re-appointed Bernanke. Rick Perry’s denunciation of his monetary policy was instructive. The policy itself has been middle of the road and downright conservative at times. The Fed has done basically nothing when it comes to the unemployment half of its mandate and has targeted a level of “price stability” that would have tanked Reagan’s “Morning in America”. To the extent that Bernanke is politically shielded and tasked with promoting a growing and sound economy, his record–presiding over an economy with growth far below trend and shirking his admitted ability to improve it–suggests that he is indeed promoting the partisan interests served by a poor economy. And the fact that Bernanke was a Republican, originally appointed by a Republican shows that at its core, the notion that important institutions like the Fed and Supreme Court are non-partisan and above reproach is a fallacy too corrosive to bear lying down. The response for Democratic administrations should not be to pretend that meekly returning the favor by appointing balanced slates of nominees and nominating liberals much less liberal than conservative appointees are conservative. We have seen the results of that approach over the last three decades in the Supreme Court. It simply re-inforces the false notion that this is a center-right nation (that curiously can’t stomach letting the chips fall where they may if everyone is allowed to vote, fair and square) and dooms us to the prerogatives of people much less respectful of the norms of bipartisanship and the rigours of non-partisan academic inquiry.

  5. Bob Walling says:

    Great Article! Here is how I see it ….. The President really has no power in a political climate like this (Civics 101). The main goal of the conservative house and senate (60 vote deal!) is to get the black guy out no matter what. You and Dr. Krugman, Dr. Riese etc. have defined the problems and offered common sense solutions to those. People don’t seem to be listening …. This is a sporting contest with whites against people of color (NYT … “Their Last Chance”). The tea party and their friends would rather destroy this country then have a black as president!

    Problems mostly have a simple cause and can be fixed with simple procedures. When a problem becomes complex (“Too Big to Fail”) and the fix for that problem more complex/harder than the initial problem then maybe the problem was intentionally created to fix another problem (Like whites will shortly no longer be the majority) and we got a black as president and he is going to make it happen. If we (whites) are not the majority then lets destroy this country!

    Please …. don’t tell me racism, bigotry, and segregationism have come a long way baby …. NOT. Look at the hysteria over Gays, illegals, unions (communists) , etc. When Bush was in the WH …. No problems (No Blood Libel there?!) Income Inequality …… Which culutres are hurt the most …. People of Color.

    If Mr. Obama is re-elected, and there are no changes in the house and senate, then the pain and suffering will continue. If Romney wins then whites will have their savior and things will be redone for the benefit of whites only. Everybody else are just out there with no one to represent them.

    Whats the fix? The last time we were so divided by race was the Civil War … I at least know how that turned out from reading about it (NYT .. DisUnion). That war did not solve the problem either!

  6. Bert Merder says:

    I, for one, am glad that you’ve avoided the uncertainty chorus for so long. Mostly because it’s populated by jerks and charlatans.

    In fact, I think this post is about certainty. The certainty that nothing much will be done anytime soon.

  7. Luke says:

    I think it is intresting how the Republicans have managed to turn a fairly inaccurate talking point in to a very real issue by (supposedly) trying to deal with it before it became a big issue. I think they are the only people that can turn a non-issue into something big by trying dealing with it.

  8. Misaki says:

    >“It may well be appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest.”

    Will the top 10% who own 75% of wealth in this country stop spending money?

    “Self-reinforcing” is actually pretty rare outside of leveraged financial markets. Cultural attitudes may shift as people become deluded into thinking we need more rich people, but this is more of a “new equilibrium” (or attractor in chaos theory) since it resists downward motion as well as upward.

    Job creation without government spending, inflation, or trade barriers: http://jobcreationplan.blogspot.com/

    • Misaki says:


      >taking longer than most economists thought to leave the gravitational pull of the Great Recession

      Airplanes cannot go into orbit or escape the gravitational well of a planet. The higher up they go, the thinner the atmosphere and the greater velocity needed to have a certain amount of upward lift. Since, iirc, power requirements are the third exponent of velocity (or to think of it another way, less air means that air needs to be displaced with a higher final velocity for constant lift at higher altitudes), this reaches physical limits before escaping the atmosphere. Even ramjets are not even close to orbital velocity.

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