Citigroup’s Orszag: Fix the Government’s Economic Models!

Most of the villains of the global financial crisis are familiar by now. We’ve read volumes about reckless home-buyers and property-flippers, unscrupulous mortgage lenders, Wall Street bond desks, and credit-rating agencies. There’s also the lazy regulators and Federal Reserve policy makers who thought they had figured out the world economy. Other folks also blame yield-hungry global investors, especially China, whose gigantic savings account makes it stash cash in the U.S. and inadvertently distort the interest rates of the world’s biggest economy.

But one culprit in this rogue’s gallery that tends not to get as much attention is the computer, or rather computer modeling, says Peter R. Orszag, President Barack Obama’s former budget chief and now vice chairman of global banking at Citigroup Inc.

In their first comments since last week’s monetary policy-setting Federal Open Market Committee meeting, central bankers appeared in strong agreement that expanding the balance sheet with more bond buying is pretty unlikely.

The policy makers made their remarks in the wake of the FOMC meeting last Tuesday and Wednesday and left in place its current policy regime. Officials reaffirmed their collective view that rock-bottom rates will stay in place until late 2014, and continued forward with a $400 billion effort that sells short-dated bonds from the central bank’s $2.9 trillion balance sheet, to buy a like amount of long-dated securities.

The U.S. economy’s gradual recovery still warrants the Federal Reserve‘s supportive policy stance, but potential inflationary pressures may well call for a withdrawal of accommodation sooner than expected, a top Fed official said Tuesday.

“While I believe monetary accommodation is still called for, in the absence of some shock that derails the recovery, we may well need to begin to gradually scale back the level of accommodation well before the end of 2014,” Federal Reserve Bank of Philadelphia President Charles Plosser said before the CFA Society in San Diego.

Fed’s Lacker: Higher Interest Rates Could Be Needed Even If Jobless Rate Doesn’t Fall

The Federal Reserve may need to start raising interest rates even as unemployment rates remain historically high, a senior Fed official said Tuesday.

The unemployment rate “could well be above 7%. I think we have to prepare for that,” Federal Reserve Bank of Richmond President Jeffrey Lacker said at a Bloomberg Washington Summit. “I think it’s a misconception to think we’ve got to get unemployment all the way down to 5[%] or some number like that…before we raise rates.”

Lacker was the only one of the 10 voting members of the Fed’s policy-making committee last week to oppose the group’s decision to reaffirm its plans to keep short-term interest rates near zero until late 2014. The central bank will likely need to start raising interest rates in the middle of next year to keep inflation in check, he said.

ISM to Regional Factory Reports: Drop Dead

What factory slowdown?

Bucking expectations, the Institute for Supply Management reported nationwide factory activity accelerated in April. Its purchasing managers’ index rose to an 11-month high of 54.8, with new orders, production and employment picking up speed.

The ISM report was a refutation of several regional Federal Reserve surveys that showed factory activity slowing sharply or even contracting last month. Since manufacturing has been leading the recovery, a nationwide stumble by the sector would have raised questions about the total U.S. recovery’s health.

One reason manufacturing is doing well, said Daniel Meckstroth, chief economist at the Manufacturers Alliance for Productivity and Innovation, is pent-up demand. Consumers are buying goods like cars that are wearing out. Firms are replacing equipment.

Good factory news should calm slowdown worries, but the ISM report isn’t a sign economic growth is about to soar. Headwinds including housing and debt still loom large.

Moreover, with uncertainty still hanging over U.S. fiscal matters and the euro-zone debt crisis, the Fed will keep further stimulus as an option. Indeed, policy makers probably won’t move accommodation off the table until job growth is on a sustainable solid trend.

On that front, the ISM report agrees with the dour regional surveys in an upbeat assessment of April labor markets on top of the 120,000 factory jobs added in the first quarter.

The New York and Philadelphia Feds reported declines in their respective top-line indexes but accelerations in their employment indexes. The Kansas City Fed showed production grinding into neutral but employment still in expansion mode last month.

Greenspan: Obama Should Have Embraced Simpson-Bowles

Former Federal Reserve Chairman Alan Greenspan on Tuesday said President Barack Obama should have immediately embraced the 2010 Simpson-Bowles deficit-reduction proposal.

“The worst mistake the president made was not embracing that vehicle right away,” Greenspan said at the Bloomberg Washington Summit.

The plan, designed by former Republican Sen. Alan Simpson of Wyoming and former Clinton White House Chief of Staff Erskine Bowles, would reduce the growth of the deficit by roughly $4 trillion over 10 years through a combination of spending cuts and tax increases.

“It’s the ideal vehicle, which won’t get us fully out of this” fiscal situation, Greenspan said. He said the plan is ideal because it allows political compromise even if it wouldn’t now completely resolve the deep fiscal problems the country faces.

Greenspan served as Fed chairman from 1987 to 2006.

Breaking Down ISM Report Showing Strong Factory Expansion

Chief Economist Robert Brusca of Fact & Opinion Economics talks with Jim Chesko about the ISM report showing that the U.S. manufacturing sector’s expansion picked up in April.

Secondary Sources: Moral Case for Capitalism, Job Sharing, Taxmageddon Chart

A roundup of economic news from around the Web.

–Moral Case for Capitalism: James R. Otteson makes a moral argument for capitalism. “What the free-enterprise system — Smith’s “obvious and simple system of natural liberty” — proposes, then, is the adoption of those political and economic institutions that manage to combine not one but two great moral imperatives: allowing people the opportunity to rise from the impoverished existence that seems to be humanity’s miserable, if equal, status quo; and respecting people as the irreplaceable and precious individuals that they are. That is a sublime conjunction of material prosperity and moral agency, the likes of which no other system of political economy has ever contemplated, let alone achieved. Capitalism is not perfect. But no system created by human beings is, or ever will be, perfect. The most we can hope for is continuing gradual improvement. To this end, we must honestly examine the prospects of the available systems of political economy. The benefits of the free-enterprise society are enormous and unprecedented; they have meant the difference between life and death for hundreds of millions of people and have afforded a dignity to populations that are otherwise forgotten. We should wish to extend these benefits rather than to curtail them.”

–Job Sharing: Betsey Stevenson and Justin Wolfers note the benefit of work-sharing programs. “If you cut 10 percent of your workers, they qualify for unemployment insurance, but if you keep all your workers and cut their hours by 10 percent, there’s no parallel insurance. By treating the two actions differently, the government tilts the playing field toward cutting people rather than hours. A little-noticed provision in the Middle Class Tax Relief and Job Creation Act, which President Barack Obama signed into law in February, aims to change the situation. The idea, known as work sharing, is that you can get partial benefits when your company cuts part of your job. Because the prorated compensation will make workers less reluctant to accept shorter hours, economists reason that it is likely to shift the incentive from firing people to cutting hours. It’s one of those rare win-win reforms. For workers, it means avoiding the despair of joblessness. For employers, it means that when weak demand next hits, it will be easier to hang on to the investments they have made in finding, hiring and training the right people.”

–Taxmageddon Chart: Joe Weisenthal reposts a chart from Citigroup’s Steven Wieting illustrating how taxes are set to surge in 2013 under current policy. “Historically, the change in total personal taxes as a percent of GDP moves roughly in line with the year-over-year change in GDP. But in 2012, all that will change. As you can see, the expected surge in taxes as a percentage of GDP will almost certainly blow past any growth we’ll see at the same time.”

Vital Signs: Saving Rate Trending Lower

The saving rate inched up recently after trending down. The Personal Saving Rate — what consumers have left after spending and taxes — inched up to 3.8% in March from 3.7% a month earlier. That is still below 2011’s readings in the high-4% range. A declining saving rate is one factor behind strong consumer spending but many economists expect saving ultimately to creep back up.

North Carolina Sen. Kay Haganis taking the side of the nation’s biggest banks on a proposed Federal Reserve rule to limit the firms’ exposure to one another.

Ms. Hagan, a Democrat and a member of the Senate Banking Committee, said the Fed has taken “a blunt approach” to trying to reduce the interconnectedness of major financial firms in a draft rule implementing provisions of the Dodd-Frank financial law, in a letter sent to Fed Chairman Ben Bernanke Monday.