Pushing on a String

At this stage of the business cycle pundits usually talk about the Fed pushing on a string. They mean that the Fed can’t actually make people start to borrow. All the Fed can do is print money and hope that economic activity starts to revive.

The usual response is that, of course, economic activity will revive; it always does. But until it does, who knows how long it will be before greed takes over from fear.

The worry is that the Fed is reaching the zone of “quantitative easing.” That was what the Bank of Japan used to do during the lost decade of the Japanese economy, after its big real estate boom left many of its banks insolvent and unwilling to lend.

Well, we solved that problem, didn’t we? We bailed out the banks by recapitalizing them. But do we know that the banks are out of the wood? After all, the banks depend on the quality of their assets, and that depends, in many cases, on the value of commercial and residential mortgages, and they depend on housing prices.

The Fed is working on that, according to the Wall Street Journal, and its action is already leading to a reduction in mortgage rates which will help to advance a revival in real-estate prices. But what’s really needed is not an increase in liquidity, but an increase in confidence.

Meanwhile, according to Larry Kudlow, the Obama team is planning a massive purchase of mortgage paper.

Team Obama is also drawing up plans for a massive purchase of mortgages in order to get long-term borrowing rates down to 4.5 percent — a full percentage-point drop.

But is that the prescription for recovery? What nobody seems to be suggesting is a tax rate cut, worries Kudlow.

But I still believe the best economic stimulus would be a move to cut tax rates across-the-board for individuals and businesses. No matter how much money the Fed prints, or how many roads or mortgages Uncle Sam buys, none of it creates new incentives for private enterprise, risk-taking, and investment.

Yes. It took Bush two years to get Congress to agree to tax rate cuts. And it looks like the same could happen with the firm of Obama, Reid, and Pelosi.