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    Default Nine Questions About the Fed’s New QE Answered

    Anyone interested in monetary policy should like this.

    From Bloomberg:

    Nine Questions About the Fed’s New QE Answered

    The Federal Reserve has announced a third round of quantitative easing, a set of asset purchases designed to increase the money supply. It said it would keep easing until job growth accelerates, and continue a “highly accommodative” monetary policy “for a considerable time after the economic recovery strengthens.”

    Stocks jumped on the news, but conservatives gave it a much more hostile reception. For those trying to make up their minds, here are a few questions one often hears about what the Fed is doing, along with my answers:

    1) What’s the rationale for QE3? One argument for it starts with the two goals that Congress has set for the Fed: to keep unemployment low and prices stable. The Fed defines stable prices as a steady 2 percent inflation rate. Core inflation, headline inflation and market expectations of inflation are all below 2 percent. Right now unemployment is high. Looser Fed policy would bring us closer to both targets.

    2) Hasn’t the Fed already been keeping money extremely loose? It says it has been “highly accommodative,” and it has been if you use interest rates or the size of the monetary base to measure monetary policy. But those are the wrong measures, as the great monetary economist Milton Friedman pointed out. A better measure is provided by the growth rate of total spending in the economy. Before the boom, Fed policy kept that number fairly steady at 5 percent a year. During the crisis of 2008 and 2009, however, the Fed let nominal spending drop at the fastest rate since 1938. The Fed was tight during the crash, and its tightness may even have caused the crash. Nominal spending hasn’t recovered since.

    3) Will looser money hurt savers? The reason Friedman said interest rates are a bad gauge of monetary policy is that tight money can depress the economy and thus lower returns on investment. The weak economy, not excessive money creation, has been keeping interest rates low. If the Fed’s action increases economic growth, then it will help savers. Long-term interest rates rose after its announcement.

    4) Is QE3 a favor to Wall Street? Looser money is boosting stocks because it is raising expectations of economic growth and thus of future profits. That’s a good thing. In the 1970s, when we really did have loose money, easing by the Fed didn’t help stocks because market participants didn’t expect it to strengthen the economy. The market reaction is a sign that this time loosening was warranted.

    5) Won’t QE3 hurt consumers by raising prices, especially for food and gas? There are two ways the Fed’s move might increase consumer prices. The first is by boosting the price level generally. But that effect should raise wages, too, leaving the real price of goods unchanged. The second is by strengthening the economy and thus encouraging people to consume more. One small example: More economic activity leads to more business trips, which leads to higher demand for gas. In that case, the real price of gas would increase, but as a side effect of healthy economic developments.

    6) Is the Fed trying to encourage consumption? Not especially. It is trying to increase the economy’s total level of spending, but it can’t control how that spending gets divided between consumption and investment.

    7) Is the Fed engaged in central planning? No. It isn’t deciding how much of each product the economy should make and at what price each should be sold -- which is what real central planning involves. Instead, it is reducing the drag that tight- money policy has placed on economic growth.

    8) Aren’t our deeper economic problems structural, and beyond the reach of the Fed? Maybe so! We probably need reforms of everything from our patent law to our tax code to raise the economy’s long-term potential growth rate. Fed policy over the past few years, though, has kept the economy under the potential growth rate we could reach even with these structural problems.

    9) Are there any dangers to QE3? Sure. The Fed shouldn’t get into the habit of thinking that it can painlessly boost real economic growth or employment by expanding the money supply. It is only under the unusual circumstances we face today -- spending levels that the Fed has allowed to fall far below trend -- that this policy makes sense. It would have been better for the Fed to say it would purchase assets until those spending levels rose back toward the pre-crisis trend. The more credible its commitment, the fewer purchases it would have to make.

    In this case, though, second-best is not half bad. The stock market got it right, not the critics.
    @Zarathustra @onemoretime your thoughts?

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    Quote Originally Posted by DiscoBiscuit View Post
    Anyone interested in monetary policy should like this.
    Which is to say maybe 4 or 5 people on this site.

    I wish there was a more specific discussion about this sort of stuff in public.

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    Funny that you started this, as last night and this morning I was reading a number of pieces on the Fed's recent decision, and I was considering starting a thread about it. For the moment, I'm just gunna post some stuff I found very worthwhile reading on the matter, and I'll read the article you posted and give my full opinions later. Also, I'm gunna call @reason in here, as I consider him more authoritative on the specifics of monetary policy and theory than myself.

    This piece was by the President of the Dallas Fed, Richard Fisher, a very thoughtful and honorable man, one of our great public servants, and someone whose thoughts I always find extremely illuminating:

    We Are Sailing Deeper Into Uncharted Waters

    By Richard Fisher

    Remarks before the Harvard Club of New York City
    New York, N.Y. · September 19, 2012

    It will come as no surprise to those who know me that I did not argue in favor of additional monetary accommodation during our meetings last week. I have repeatedly made it clear, in internal FOMC deliberations and in public speeches, that I believe that with each program we undertake to venture further in that direction, we are sailing deeper into uncharted waters. We are blessed at the Fed with sophisticated econometric models and superb analysts. We can easily conjure up plausible theories as to what we will do when it comes to our next tack or eventually reversing course. The truth, however, is that nobody on the committee, nor on our staffs at the Board of Governors and the 12 Banks, really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. And nobody—in fact, no central bank anywhere on the planet—has the experience of successfully navigating a return home from the place in which we now find ourselves. No central bank—not, at least, the Federal Reserve—has ever been on this cruise before.

    This much we do know: Our engine room is already flush with $1.6 trillion in excess private bank reserves owned by the banking sector and held by the 12 Federal Reserve Banks. Trillions more are sitting on the sidelines in corporate coffers. On top of all that, a significant amount of underemployed cash—or fuel for investment—is burning a hole in the pockets of money market funds and other nondepository financial operators. This begs the question: Why would the Fed provision to shovel billions in additional liquidity into the economy’s boiler when so much is presently lying fallow?

    Great battles at sea are fought with modern analytical tools and the most sophisticated IT and advanced weaponry available. Fleet commanders, like central bankers, use every bit of the intelligence, technology and theory at their command. But ultimately, just as with great engagements at sea, the decisive factor is judgment. In forming their judgments, fleet commanders rely upon briefings from their senior officer corps on the elements, on the conditions at hand and on their tactical and strategic recommendations before deciding on the proper course of action.

    As you all know, the Federal Reserve’s mission is mandated by the Congress. It calls for us to steer a monetary course according to a dual mandate—we are charged with maintaining price stability while conducting policy so as to best assist in achieving full employment. Most all of the FOMC members—the senior officer corps of the Federal Reserve fleet—have surveyed the horizon from their different watch stations and agree that inflation is not an immediately foreseeable threat. Over the past week, however, there has been a noticeable increase in the longer-term inflation expectations inferred from bond yields. These inferences can be volatile and are not always reliable, but a sustained increase would suggest incipient doubts about our commitment to the Bernanke Doctrine of sailing on a course consistent with 2 percent long-term inflation. I believe that even the slightest deviation from this course could induce some debilitating mal de mer in the markets.

    Charting a Course to Full Employment with Businesses at ‘Sixes and Sevens’

    In the current tumultuous economic sea, facing strong headwinds common in the aftermath of financial crises and balance-sheet recessions, our desired port is increased employment. Certain theories and various hypothetical studies and models tell us that flooding the markets with copious amounts of cheap, plentiful liquidity will lift final demand, both through the “wealth effect” channel and by directly stimulating businesses to expand and hire. And yet from the perspective of my watch station—as I have reported time and again—the very people we wish to stoke consumption and final demand by creating jobs and expanding business fixed investment are not responding to our policy initiatives as well as theory might suggest.

    Surveys of small and medium-size businesses, the wellsprings of job creation, are telling us that nine out of 10 of those businesses are either not interested in borrowing or have no problem accessing cheap financing if they want it. The National Federation of Independent Business (NFIB), for example, makes clear that monetary policy is not on its members’ radar screen of concerns, except that it raises fear among some of future inflationary consequences; the principal concern of the randomly sampled small businesses surveyed by the NFIB is with regulatory and fiscal uncertainty.[3] This is not terribly difficult to understand: If you are a small business, especially, and not only if you operate as an S corporation or as a limited liability company, you are stymied by not knowing what your tax rate will be in future years, or how you should cost out the social overhead of your employees or how you should budget for the proliferation of regulations flowing from Washington.

    With regard to business fixed investment and job-creating capital expenditures (capex), the math is pretty straightforward: Big businesses dominate that theater. Most all of these businesses have abundant cash reserves or access to money, many at negative real interest rates. I have repeatedly reported to the committee that the CEOs I personally survey will simply not be motivated by further interest rate cuts to invest domestically—beyond their maintenance needs—in job-creating capex. In preparing for this last FOMC meeting, I specifically asked my corporate interlocutors the following question: “If your costs of borrowing were to decrease by 25 or more basis points, would this induce you to spend more on job-creating expansion?” The answer from nine out of 10 was “No.”

    The responses of those I surveyed are best summarized by the comments of one of the most highly respected CEOs in the country: “We are in ‘stall mode,’ stuck like Velcro, until the fog of uncertainty surrounding fiscal policy and the debacle in Europe lifts. In the meantime, anything further monetary accommodation induces in the form of cheaper capital will go to buying back our stock.” This is not an insignificant sounding, coming as it did from the CEO of a company that has the capacity to spend upward of $15 billion on capex.

    To be sure, buying in stock will have a positive wealth effect on that company’s shareholders, but putting the equivalent amount of money to work in spending on plant and equipment would put more people back to work more quickly.

    Another CEO of a large corporation provided me with an additional source of uncertainty. In this CEO’s words, China “may be transitioning toward becoming the caboose of the global economy rather than its engine.” This may be a tad bit hyperbolic, but it indicates there is growing uncertainty about the great emerging economy that was once considered an eternal fountain of future demand.

    With the disaster that our nation’s fiscal policy has become and with uncertainty prevailing over the economic condition of both Europe and China and the prospects for final demand growth here at home, it is no small wonder that businesses are at sixes and sevens in committing to expansion of the kind we need to propel job creation.

    The Duke University Survey

    My assessment of the efficacy of further monetary accommodation in encouraging job-creating investment among operating businesses was recently confirmed by a more rigorous analysis in the Global Business Outlook Survey of chief financial officers by the Fuqua School of Business at Duke University—the Harvard of the South—in September.[4]

    Of the 887 CFOs surveyed, only 129, or 14.5 percent, listed “credit markets/interest rates” among the top three concerns facing their corporations. In contrast, 43 percent listed consumer demand and 41 percent cited federal government policies. Ranking third on their list was price pressures from competitors (thus affirming most hawks’ sense that inflationary pressure is presently sedentary); fourth was global financial instability. The analysts at Duke summarized their findings as follows: “CFOs believe that a monetary action would not be particularly effective. Ninety-one percent of firms say that they would not change their investment plans even if interest rates dropped by 1 percent, and 84 percent say that they would not change investment plans if interest rates dropped by 2 percent.”

    Citing the Evidence of the Unsophisticated and the Sophisticates Alike

    Citing these observations, I suggested last week that the committee might consider the efficacy of further monetary accommodation. When I raised this point inside the Fed and in public speeches, some suggested that perhaps my corporate contacts were “not sophisticated” in the workings of monetary policy and could not see the whole picture from their vantage point. True. But final demand does not spring from thin air. “Sophisticated” or not, these business operators are the target of our policy initiatives: You cannot have consumption and growth in final demand without income growth; you cannot grow income without job creation; you cannot create jobs unless those who have the capacity to hire people—private sector employers—go out and hire.

    In the period between the August FOMC meeting and the meeting last week, some very prominent academic and policy sophisticates also questioned the efficacy of large-scale asset purchases. Among them were Michael Woodford of Columbia University—a former colleague of Ben Bernanke’s when they were at Princeton—and Bill White of the Organization for Economic Cooperation and Development and formerly of the Bank for International Settlements, and others.

    Like me, Professor Woodford argues that the economy would not benefit from additional liquidity. Like me, he argues that large-scale asset purchases and maturity-extension programs like Operation Twist are unlikely to appreciably stimulate private borrowing activity through portfolio-balance or term-premium effects.[5] And as for Bill White—a globally respected economist who stood up to convention and predicted in 2003 that policies being pursued at the time would engender the financial crisis of 2008–09—here is what he wrote in a particularly thought-provoking paper a week before the Fed’s annual symposium last month at Jackson Hole, Wyo.:[6]

    “In this paper, an attempt is made to evaluate the desirability of ultra easy monetary policy by weighing up the balance of the desirable short run effects and the undesirable longer run effects—the unintended consequences … It is suggested that there are grounds to believe that monetary stimulus operating through traditional (‘flow’) channels might now be less effective in stimulating aggregate demand than is commonly asserted … It is further contended that cumulative (‘stock’) effects provide negative feedback mechanisms that also weaken growth over time … In the face of such ‘stock’ effects, stimulative policies that have worked in the past eventually lose their effectiveness.

    “It is also argued … that, over time, easy monetary policies threaten the health of financial institutions and the functioning of financial markets, which are increasingly intertwined. This provides another negative feedback loop to threaten growth. Further, such policies threaten the ‘independence’ of central banks, and can encourage imprudent behavior on the part of governments. In effect, easy monetary policies can lead to moral hazard on a grand scale. Further, once on such a path, ‘exit’ becomes extremely difficult. Finally, easy monetary policy also has distributional effects, favoring debtors over creditors and the senior management of banks in particular. None of these ‘unintended consequences’ could be remotely described as desirable.”

    I do not necessarily agree with all of either Woodford’s or White’s arguments, but in light of my soundings of unsophisticates and sophisticates alike, I felt an urge at the meeting last week to tie the chairman to the mast, Odyssean-style, and to stuff wax in the ears of my fellow committee members, in order to resist the Siren call of further large-scale asset purchases.

    But I have no such powers. I am only one officer in the loyal crew that sails under the command of Admiral Bernanke. My reports were given a fair hearing. But neither they, nor the arguments of others who questioned the need to provide further accommodation, carried the day, and a decision was made.

    Having weighed the various tactical and strategic arguments of his officer corps, our helmsman decided to call down to the engine room and request that more coal be shoveled into the economy’s boilers. It was decided that further accommodation would be required in the form of mortgage-backed securities purchases of $40 billion per month and that Operation Twist and the reinvestment of principal payments from our current holdings of agency debt and MBS would be maintained: A total of $85 billion a month in additional accommodation would be added to the system at least through the end of the year. For added measure, the committee announced that if the outlook for employment does not improve “substantially,” it “will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved.” As it always does, the FOMC noted that it will “take appropriate account of the likely efficacy and costs of such purchases.”[7]

    A Fair Assessment and a Prayer

    Even though I am skeptical about the efficacy of large-scale asset purchases, I understand the logic of concentrating on MBS. The program could help offset some of the drag from higher government-sponsored entities’ fees that have been recently levied, will likely lower the spreads between MBS and Treasuries and should put further juice behind the housing market—one of three durable-goods sectors that is assisting the recovery and yet is operating well below long-run potential (the other two sectors are aircraft and automobiles). The general effects of inducing more refinancing may aid housing and households in other ways. Lower mortgage rates could help improve the discretionary spending power of some homeowners. Underwater homeowners might have added incentive to continue meeting mortgage payments, spurring demand and preventing underwater mortgages from sinking the emerging housing recovery. Of course, much depends on the transmission mechanism for mortgages, as my colleague Bill Dudley spoke about yesterday.

    Despite my doubts about its efficacy, I pray this latest initiative will work. Since the announcement, interest rates on 30-year mortgage commitments have fallen about one-quarter percentage point—about what I had expected—so, so far, so good.

    Our Dysfunctional Congress and Drunken Sailors

    I would point out to those who reacted with some invective to the committee’s decision, especially those from political corners, that it was the Congress that gave the Fed its dual mandate. That very same Congress is doing nothing to motivate business to expand and put people back to work. Our operating charter calls for us to conduct policy aimed at achieving full employment in addition to preserving price stability. A future Congress might restrict us to a single mandate—like other central banks in the world operate under—focused solely on price stability. But unless or until that is done, we have to deliver on what the American people, as conveyed by their elected representatives, expect of us.

    One of the most important lessons learned during the economic recovery is that there is a limit to what monetary policy alone can achieve. The responsibility for stimulating economic growth must be shared with fiscal policy. Ironically, and sadly, Congress is doing nothing to incent job creators to use the copious liquidity the Federal Reserve has provided. Indeed, it is doing everything to discourage job creation. Small wonder that the respondents to my own inquires and the NFIB and Duke University surveys are in “stall” or “Velcro” mode.

    The FOMC is doing everything it can to encourage the U.S. economy to steam forward. When we meet, we consider views that range from the most cautious perspectives on policy, such as my own, to the more accommodative recommendations of the well-known “doves” on the committee. We debate our different perspectives in the best tradition of civil discourse. Then, having vetted all points of view, we make a decision and act. If only the fiscal authorities could do the same! Instead, they fight, bicker and do nothing but sail about aimlessly, debauching the nation’s income statement and balance sheet with spending programs they never figure out how to finance.

    I am tempted to draw upon the hackneyed comparison that likens our dissolute Congress to drunken sailors. But patriots among you might take umbrage, noting that a comparison with Congress in this case might be deemed an insult to drunken sailors.

    The Plea of the Navy Hymn and ‘Illegitimum Non Carborundum’

    If you want to save our nation from financial disaster, may I suggest that rather than blame the Fed for being hyperactive, you devote your energy to getting our nation’s fiscal authorities to do their job.

    Since 1879, every chapel service at the Naval Academy concludes with a hymn that contains the following plea: “O hear us when we cry for Thee, for those in peril on the sea.” We cry for a nation that is in peril on the blustery seas of the economy. Our people are drowning in unemployment; our government is drowning in debt. You—the citizens and voters sitting in this room and elsewhere—are ultimately in command of the fleet that sails under the flag of the United States Congress. Demand that it performs its duty.

    Just recently, in a hearing before the Senate, your senator and my Harvard classmate, Chuck Schumer, told Chairman Bernanke, “You are the only game in town.” I thought the chairman showed admirable restraint in his response. I would have immediately answered, “No, senator, you and your colleagues are the only game in town. For you and your colleagues, Democrat and Republican alike, have encumbered our nation with debt, sold our children down the river and sorely failed our nation. Sober up. Get your act together. Illegitimum non carborundum; get on with it. Sacrifice your political ambition for the good of our country—for the good of our children and grandchildren. For unless you do so, all the monetary policy accommodation the Federal Reserve can muster will be for naught.”

    But, then again, I am not Ben Bernanke. And I imagine that after listening to me this evening, you might be grateful I am not.

    Now, in the great tradition of central banking, I will do my utmost to provide you with the “straight skinny” and avoid answering any questions you might have.

    Thank you.

    http://www.realclearpolitics.com/art...rs_115536.html

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    Article seems chock full of wishful thinking, and relatively scarce on reasoned analysis.

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    Quote Originally Posted by onemoretime View Post
    Article seems chock full of wishful thinking, and relatively scarce on reasoned analysis.
    To which article are you referring?

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    Quote Originally Posted by DiscoBiscuit View Post
    To which article are you referring?
    Bloomberg article.

    1) Looser monetary policy will increase jobs - why? Especially when the tendency has been to sit on cash, given the low rates of inflation that were essentially unaffected by the last two rounds of quantitative easing.
    2) It's an incredibly specious claim to say that tight monetary policy caused the crisis, without looking at things like overleveraging and excess productive capacity.
    3) Depends solely on the assumption that QE3 leads to economic growth. Meanwhile, it does not address the inflationary effects of an increased money supply, nor the fundamental uncertainty that leads to greater rates of savings.
    4) Expectation of growth and profits, and we have to be assured this is a "good thing." Mainly because it does not address unemployment or median wages. It's also a cute just-so story about the 1970s, ignoring the huge economic complexity of the time.
    5) There is no reason whatsoever to think that a boost in the price level will cause an increase in wages, when unemployment is as high as it is. Where is this magical economic strengthening coming from? Seems like we've still got a problem if food prices are higher, but I still can't get a job because forty people are competing for each opening.
    6) This is correct, and it completely subverts the previous five arguments.
    7) What is this drag?
    8) That is idle speculation.
    9) No consideration of other reasons for the decline in nominal spending, such as increased wealth disparity leading to a generally suppressed marginal consumption rate.

    Just shoddy analysis riddled with hard-monetarist assumptions, unsubstantiated speculation, and a failure to consider other perspectives.

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    Quote Originally Posted by onemoretime View Post
    Bloomberg article.

    1) Looser monetary policy will increase jobs - why? Especially when the tendency has been to sit on cash, given the low rates of inflation that were essentially unaffected by the last two rounds of quantitative easing.
    2) It's an incredibly specious claim to say that tight monetary policy caused the crisis, without looking at things like overleveraging and excess productive capacity.
    3) Depends solely on the assumption that QE3 leads to economic growth. Meanwhile, it does not address the inflationary effects of an increased money supply, nor the fundamental uncertainty that leads to greater rates of savings.
    4) Expectation of growth and profits, and we have to be assured this is a "good thing." Mainly because it does not address unemployment or median wages. It's also a cute just-so story about the 1970s, ignoring the huge economic complexity of the time.
    5) There is no reason whatsoever to think that a boost in the price level will cause an increase in wages, when unemployment is as high as it is. Where is this magical economic strengthening coming from? Seems like we've still got a problem if food prices are higher, but I still can't get a job because forty people are competing for each opening.
    6) This is correct, and it completely subverts the previous five arguments.
    7) What is this drag?
    8) That is idle speculation.
    9) No consideration of other reasons for the decline in nominal spending, such as increased wealth disparity leading to a generally suppressed marginal consumption rate.

    Just shoddy analysis riddled with hard-monetarist assumptions, unsubstantiated speculation, and a failure to consider other perspectives.
    Well we are back on familiar territory then.

    Maybe a better question (so that we don't retread discussions we've already had about market monetarism specifically) would be what you would do if you were in charge.

    While I think your pessimism is warranted given the behavior of corp america over the past 36 months, I think it may be overblown.

    I don't see QE 3 catalyzing the recovery. However, I do think that it will create a more attractive environment for corp investment. This combined with the nascent housing recovery we're already seeing I think will lead to stronger growth.

    In the long run, I don't see things really getting started until the gov't is able to take real action on the economy (entitlement reform, tax reform, financial regulation). By real action I mean, prudent steps that address our problems in a substantive way so that the powers that be can have the confidence to stop hiding under their rocks and actually tap into the oceans of pent up capital in our corporate system.

    That wont be until 2013 at the earliest.

    For right now, I think we have taken the most prudent course possible.

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    Also I think the market had it right with it's response to the QE 3 announcement.

    This wont be some magic wand, and it would be stupid to act like it is, but the market thinks it will be helpful, if not transformative, and I do to.

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    Quote Originally Posted by DiscoBiscuit View Post
    Well we are back on familiar territory then.

    Maybe a better question (so that we don't retread discussions we've already had about market monetarism specifically) would be what you would do if you were in charge.

    While I think your pessimism is warranted given the behavior of corp america over the past 36 months, I think it may be overblown.

    I don't see QE 3 catalyzing the recovery. However, I do think that it will create a more attractive environment for corp investment. This combined with the nascent housing recovery we're already seeing I think will lead to stronger growth.

    In the long run, I don't see things really getting started until the gov't is able to take real action on the economy (entitlement reform, tax reform, financial regulation). By real action I mean, prudent steps that address our problems in a substantive way so that the powers that be can have the confidence to stop hiding under their rocks and actually tap into the oceans of pent up capital in our corporate system.

    That wont be until 2013 at the earliest.

    For right now, I think we have taken the most prudent course possible.
    Honestly, I'd rather have token efforts at tackling those huge structural issues at this point. I think small and medium-sized businesses would enjoy the breath of fresh air that comes with the government even appearing to take on the issues that most directly affect them.

    As for immediate action? Direct jobs programs with clear sunset provisions and explicit goals. A rural broadband installation project. A survey of the 500 bridges most in need of replacement, and direct coordination with local contractors to make it happen as quickly as possible. Coordinate with the railroads to electrify their most critical corridors, with an eye for having all mainlines electrified by 2025, and provide direct funding for its implementation. Use these programs to provide employment and execute the visionary tasks that private companies would like to do themselves, but cannot given the economic uncertainty.

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