The Wall Street Journal-20080128-Best of Real-Time Economics - A selection of recent items from WSJ-com-s Real-Time Economics blog

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Best of Real-Time Economics / A selection of recent items from WSJ.com's Real-Time Economics blog

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Too Much or Not Enough?

Takes on Fixing Economy

Are the Federal Reserve, the White House and Congress doing too much in reaction to available evidence about a weakening economy -- or are they not doing enough? Depends on your diagnosis and prognosis.

"Right now there are a lot of very negative signals [on the economy]," says Harvard University economist Martin Feldstein, an early advocate of interest-rate cuts and fiscal stimulus. "In response to that risk level, it's appropriate for the Fed to be rather aggressive and for Congress to be doing what they're doing."

It isn't clear that the economy is tumbling into recession, he says. "My own preference was for the fiscal policy to be conditional," he says. "But if you have to choose between doing nothing and doing the kind of package they put together, the package was better than doing nothing."

Mr. Feldstein's bigger worry is that the monetary policy won't have the kind of traction it traditionally has had. Byron Wien, chief investment strategist at hedge fund Pequot Capital Management, shares that concern. "You have some real structural problems," he says. "This needs an operation, not a Band-Aid."

In retrospect, both the rate cuts and the stimulus package are "going to look smart," says Doug Elmendorf, a Brookings Institution economist. The fiscal-stimulus package will help buoy spending in the second half of the year, he says. Then, as the effects of that stimulus wear off, the rate cuts, which have a lagging effect on the economy, will be felt.

The real test for the Fed may be how fast it raises rates once the economy regains its footing. "They have to be very flexible and make sure what they've done isn't in place too long," says Joseph Carson, chief economist at investment management firm Alliance Bernstein.

-- Justin Lahart

Mexico's Ortiz Sees

Regulation Risks

Asked about the global credit crunch, Guillermo Ortiz, former finance minister and now central-bank governor of Mexico, says without missing a beat: "Well, I can say: This time, it wasn't us."

Mr. Ortiz, who helped to guide Mexico during the crises of the 1990s, finds himself safely in the bleachers this time. "Regulators have been talking for many years about the mispricing of risk," he said at the Davos gathering of global elites in Switzerland. "But there hasn't been a lot done about it. Maybe because they didn't know where to begin."

"The U.S. is an innovator" in the financial markets. "You didn't want to choke innovation. But on the other hand, the market was getting ahead of the regulators."

The regulators, he says, "didn't understand" the complexity of some financial instruments -- bundled and rebundled, and blessed by ratings agencies -- that now appear illiquid, and so haunt the global economy.

One solution, he says, is stronger self-regulation. Another, tying executive compensation to longer-term corporate results, could help banks avoid excessive risk-taking. Perhaps originators of some of the complex securities should be required to retain a portion of the risks, he says, rather than freely selling them off.

But regulators should beware the pendulum of public opinion: "The risk of over-regulating" in response to the current problems "would have negative consequences for the essential role of finance," he says. And a big part of that essential role: to efficiently transfer capital to where it's needed, and to hedge risks.

-- John Bussey

Bernanke Revisits

'Financial Accelerator'

Fed Chairman Ben Bernanke's urgency in addressing the risk of recession can be traced in part to the insights from his research on the financial system and the Great Depression. In June, Mr. Bernanke delivered a speech on the "financial accelerator," which describes how weakness in the financial system can compound an economic downturn. He developed the theory in the 1980s to explain the depth and duration of the Great Depression, and later expanded on it in collaboration with Mark Gertler of New York University.

Rereading that speech helps explain last week's 0.75-percentage- point rate cut, a likely cut this week, and Mr. Bernanke's advocacy of fiscal stimulus. Fed commentary these days contains a lot of references to "feedback loops" and self-reinforcing spirals of declining confidence and asset prices. Those are the hallmark of the financial accelerator in action. They give the current economic cycle a different cast from the typical post-World War II cycle, which was driven largely by trends in inventories, employment and -- in 2001 -- capital investment.

"Economic or financial news has the potential to increase financial strains and to lead to further constraints on the supply of credit to households and businesses," Mr. Bernanke observed in a speech Jan. 10. Note the reference to "news": it's not just economic and financial developments, but how market confidence is affected by news of those developments, that can aggravate the downward spiral.That may explain why just the threat of a steep stock decline last Tuesday played a part in Mr. Bernanke's decision to cut rates: allowing the drop to play out may have had confidence-damaging consequences beyond the lost stock-market wealth.

-- Greg Ip