I’ve returned from my hike across the beautiful Crawford Path. Sunday night, slightly sore and groggy, I read Paul Volcker’s warning in the New York Times to not pursue an inflationary monetary policy to solve our employment crisis.
My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.
What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost.
Reading his op-ed left me slightly more sore and groggy. It is important to notice that Volcker implies that inflation would be stimulating in the short-run. I can’t for the life of me understand why he doesn’t consider 9% unemployment a “real problem,” but let’s move on. Volcker never explains why keeping inflation at 1 or 2 percent is optimal policy – he only worries that 3 or 4 percent will lead policymakers to try higher and higher rates. I guess once the Fed gets a little hit of that inflation soon they’ll be desperate for more only to keep up with those expectations. It’s only a matter of time, I suppose, that the abuser will be stagflating on the treasury room floor.
But is this gateway drug theory of inflation accurate?
I can’t be the only one that notices that inflation goes up and down. Every time we hit 3% inflation, we didn’t get hooked and ruin our longterm economy, right? Every person that takes a painkiller doesn’t become an oxycontin addict. Even though Volcker knows some junkie from the ’70s we shouldn’t conclude that sick people shouldn’t take medicine.
Here’s some other commentary on Volcker’s column:
Every morning that I wake up worried that I might end up in too positive a frame of mind to properly mope through my day, I make sure to read a Paul Krugman column. Today he further crushes my optimism for the future by explaining why increased innovation is reducing the demand for educated workers.
Computers, it turns out, can quickly analyze millions of documents, cheaply performing a task that used to require armies of lawyers and paralegals. In this case, then, technological progress is actually reducing the demand for highly educated workers.
And legal research isn’t an isolated example. As the article points out, software has also been replacing engineers in such tasks as chip design. More broadly, the idea that modern technology eliminates only menial jobs, that well-educated workers are clear winners, may dominate popular discussion, but it’s actually decades out of date.
[T]he notion that putting more kids through college can restore the middle-class society we used to have is wishful thinking. It’s no longer true that having a college degree guarantees that you’ll get a good job, and it’s becoming less true with each passing decade.
As computers and other technologies get better at preforming more complex tasks the more our labor markets will dramatically change. From reading this you might come away awash in despair at the prospect of the inevitable march of robots taking your good jobs away. But hold on a nanosecond. (I was so tempted I was to write an updated Candlemakers’ petition.) This march isn’t inevitable; we could become luddites and stop innovating – problem solved, right? Framing it that way concentrates the mind a bit: I’m not saying better technology and innovation don’t pose any problems for us, but those problems come linked to massive gains in productivity and material wealth. That we don’t need “armies of lawyers” to analyze legal documents is a good thing. When was the last time you thought, “man, getting good legal help was just too damn inexpensive!”? Yes, many jobs in the medical field may soon be obsolete; but, if our country’s finances face any problem right now it’s not cheaper medical costs.
These same “problems” also come with free trade and immigration. Policymakers need to help transition workers displaced by trade, technology, and immigration, but we can’t forget that these things bring enormous benefits. We could all go back to hiring lamplighters, typists, and switchboard operators yet somehow I think most people realize we’re better off because we don’t have to.
When most people look at a political question objectively they try to determine which side is right and which is wrong. But that framework doesn’t properly illuminate what’s going on in Wisconsin (or most other political dilemmas). Just making this a battle between pro-union Democrats and taxpayer Republican advocates obscures some of the deeper issues going on.
Most attempts to make one side righteous and the other wicked come off as silly.
Here’s Paul Krugman in an otherwise decent piece on the issues:
What Mr. Walker and his backers are trying to do is to make Wisconsin — and eventually, America — less of a functioning democracy and more of a third-world-style oligarchy.
As Clive Crook notes Mr. Walker may be disingenuous when he claims busting the unions is all about the budget (“the unions have agreed (under pressure) to the cuts in pay and benefits he was seeking”), but suggesting Walker and allies are trying to bust not just unions but American democracy is ridiculous. Do fair-minded people really think Walker is sitting in his office rubbing his hands dreaming of undermining our founding fathers? It’s is also a weird charge since the only thing preventing Walker from stripping public employee’s collective-bargaining rights is a group of Wisconsin Democrats fleeing the state so a democratic vote can’t proceed.
It happens that I actually side mostly with the pro-union side and think collective-bargaining isn’t incompatible with balanced budgets. Yet after complaining strongly about how filibusters and other anti-majoritarian legislative tools cause more harm in the long run I feel compelled to condemn the technique of fleeing the state to break the quorum. It’s not in some misguided offering to the alter of political consistency, but as a “secular consequentialist” (via Scott Sumner) I think even if this counts in the negative column, more good comes from allowing legislatures to actually govern.
With that out of the way allow me to clear up some lingering issues. A lot of the debate centers on whether or not public employees are “overpaid” compared to their privately employed counterparts. In the much passed around EPI study, we have strong evidence that in Wisconsin comparable public employees are actually compensated less than private workers. Jim Manzi calls into question some of the assumptions in the study and argues that without factoring in an “all-but infinite number of such relevant potential differences” we can’t say for sure that public workers “are underpaid, overpaid, or paid just right.” To a certain extent he’s correct, but as Ezra Klein notes, the EPI study shifts “the burden of proof [onto] those who say Wisconsin’s public employees make too much money.” Anyone who argues that they are overpaid is arguing in spite of available evidence, and public policy shouldn’t be made on sheer opinion.
The reason so many people conclude public employees are overpaid is because those people often have an ideological commitment to that assumption. Many on the right hold as an article of faith that government a priori causes more problems than it solves and doesn’t work as well as the private sector. Given that premise, it’s perfectly logical to reason that public workers are necessarily overpaid. Any cost above 0 is overpayment for a counterproductive job.
Some on the left assume that any benefit cut or pay cut is automatically unreasonable, but given that the union itself has agreed to cuts and compromises we can’t say this about the union itself. The budget shortfall is largely caused by the recession which dried up revenues and for much of the poor reasoning behind cutting the wealthy’s taxes when facing large deficits, Wisconsin’s public workers were going to have to give up a little make the budget math conform to a fair deal for Wisconsin’s taxpayers. With an absence of the ideological assumption that the government can’t provide anything of value, taxpayers need to balance the need for qualified workers with their tax burden. If you think government can provide useful services it’s important to try to attract public employees that won’t cause a potentially self-fulfilling prophecy. It’s only a correlation but “the two states with the lowest public sector unionization rates — Louisiana and Mississippi — have the highest corruption rates.”
Also, the 5 states without collective bargaining for educators rank last or near last on their SAT/ACT scores (h/t Heidi).* I don’t believe that the lack of collective bargaining is directly causing corruption or low test scores but if you look at the labor market as one competitive entity it seems natural that lower compensation leads to a weaker work force as better workers flow to higher paying jobs.
Everything unions want isn’t always in the best interest of the state or even of workers generally, but there is no persuasive reason to believe that removing unions as a counterweight to corporatist (anti-market) influence and demonizing public workers leads to a stronger middle class, better public services, or even balanced budgets.
I’m about as big a fan of markets you will find from someone on the center-left (a very imprecise designation). I prefer the government allow free interaction between people as much as possible unless the negative externalities outweigh the positive consequences of the exchange. But certain recessions seem to call out for intervention.
So I have a serious question for all readers that favor government inaction during strong recessions and high unemployment. Let’s abstract away from our current economic predicament. Paul Krugman in an interview with Rachel Maddow discussed our current unemployment mess, but regardless of if you think his analysis of the current economy is accurate try to grapple with this chain of logic:
We don’t have jobs because businesses aren’t hiring. Businesses aren’t hiring because they don’t have sales. Businesses don’t have sales because people don’t have money. People don’t have money because they don’t have jobs.
He believes in these situations the government needs to step in to break that cycle by boosting aggregate demand and putting people to work. For those who don’t favor fiscal or monetary stimulus, what is supposed to break that cycle? Falling prices don’t seem to do it. First deflationary cycles can happen and those are very dangerous. Also “sticky wages” won’t allow businesses to cut nominal wages enough for the market to easily self adjust. Economists George Akerlof and Robert Shiller in Animal Spirits discuss the topic.
Yale’s Truman Bewley gives qualitative evidence on money wage stickiness. He conducted an intensive interview study of New Englanders involved in the wage setting process. He asked why money wages had not declined in the New England recession of 1991-92. With the high unemployment of the time, any worker who might quit in response to a wage cut could have been replaced easily and rapidly. But Bewley found that employers were loath to reduce wages during the recession. In the employers’ opinion workers would view such wage cuts as unfair. They would reduce their commitment to their jobs. Furthermore, when the economy revived they would still be angry and thus more likely to quit. Bewley found a few firms that made such cuts, but only after considerable agonizing and also after continued losses. In those rare instances workers accepted wage cuts as fair. They were a last resort, necessary to save their jobs.
It might be an irrational feature of human nature that causes that but it exists and can’t be wished away to fit an ideological commitment to free markets. I suppose one could argue that after the economy completely crashes with prolonged periods of high unemployment which causes huge amounts of human suffering, economic loss, and lost opportunity the economy might eventually self-correct. That might be a necessary evil if it prevented all future recessions, but it obviously wouldn’t.
What is supposed to break that cycle? Are you conceding that a devastating depression is necessary for the market to realign? If so, why is your commitment to markets stronger than it is to people?
I try not to make too many predictions on this blog. If I do the only prediction I’m likely to correctly make is that my predictions will be off. Jonah Lehrer shares the results of a big study that calls into question the ability of experts to accurately forecast.
How did the experts do? When it came to predicting the likelihood of an outcome, the vast majority performed worse than random chance. In other words, they would have done better picking their answers blindly out of a hat. Liberals, moderates and conservatives were all equally ineffective.
The reason so many experts were wrong was due to confirmation bias – they were confident they were right so they ignored evidence that undermined their preconceptions. While reading up on whether or not anyone should be concerned about inflation right now (due to Obama’s or the Fed’s policies) I feared ending up in that pitfall. So in my quest to find diverse viewpoints I discovered some older Art Laffer and others making predictions about future inflation because of Obama’s policies. Determined not to prove Lehrer wrong, who writes, “Famous experts were especially prone to overconfidence, which is why they tended to do the worst,” Laffer and gang’s predictions turned out to be almost exactly antithetical to reality.
On June 11, 2009, Laffer wrote a column Ehrlichianly titled, Get Ready for Inflation and Higher Interest Rates: The unprecedented expansion of the money supply could make the ’70s look benign. Now that we stand over a year later, let’s take a look at accuracy of some of his and other inflation Chicken Littles’ predictions.
It’s difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed’s actions because, frankly, we haven’t ever seen anything like this in the U.S. To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits.
His primary evidence for his fears is this chart:
But let’s now check out this updated chart (upper-right), courtesy of Martin Wolf, from a few days ago.
The rate of change in M1 has plummeted and the new data doesn’t look so scary or out of place with history now, does it? M2 (the money in circulation) also dropped to very low levels. We can also see US inflation rate/expectations (lower-left) hit negative levels and currently floats under 2 (below the Fed’s target rate). With all the current talk about QEII and deliberately raising inflation expectations, the inflation alarmists are back, but as Martin Wolf points out, even if we were to see inflation growing too fast (which there is currently no evidence for) we could always just scale it back.
The hysterics then add that it is impossible to shrink the Fed’s balance sheet fast enough to prevent excessive monetary expansion. That is also nonsense. If the economy took off, nothing would be easier. Indeed, the Fed explained precisely what it would do in its monetary report to Congress last July. If the worst came to the worst, it could just raise reserve requirements. Since many of its critics believe in 100 per cent reserve banking, why should they object to a move in that direction?
Mark Thoma at his blog, Economist’s View, discusses further some mistakes that people worried about the growth in currency are currently making. It’s worth reading but here is the graph that he uses, which shows that the currency in circulation is not outside the historical norm.
Over at the American Principles Project, a conservative Christian organization, Samuel Gregg (who cites Laffer) also worries (7 July 2009) Obama’s policies are going to lead to 1970s style inflation – he even mentions Mugabe’s Zimbabwe.
More than one economist believes that it is only a matter of time before the third member of the 1970s trio – growing inflation – will be back to wreck havoc upon us.
Most amazingly, Gregg’s article stumbles onto an important insight about inflation. Since he takes for granted inevitable skyrocketing inflation, he spends the bulk of his article explaining why having to lower inflation will be so terrible.
Seriously fighting inflation entails a willingness to tolerate increasing unemployment. This is the price of reducing the excessive amounts of money sloshing through an economy.
So if lowering inflation will increase unemployment, what might raising inflation do? Yup, increase employment. Considering 15 million sit out of work right now, which is about 4 million people greater than the entire population of Greece, I think we could stand to raise the inflation rate a tad.
We can see that inflation expectations are low right now; it’s also worth going over some other measures of inflation and potential inflation. Here’s the Consumer Price Index.
And here is core inflation (which is the CPI minus volatile items like food and energy):
(By the way, you can have more fun data like this at the St. Louis Fed’s great website.)
Here’s our current core inflation overlaid with what happened in Japan (via Krugman):
Here’s the Treasury Maturity Spread (via DiA). Yup, also low.
Many alarmists point to rises in gold and other commodity prices. What about those? First it is important to remember that we don’t usually consider volatile commodities when looking at inflation because unpredictable spikes can occur. They’re also traded on world markets so judging US inflation can be thrown off because of that. Consider if a huge new supply (or disruption) of oil or gold was discovered that could suddenly change the price of those commodities, but that wouldn’t really represent a significant change in inflation. Commodities aren’t entirely useless (they’re not all constantly and extremely volatile) and inflation predictors keep using them, so let’s take look at some of them anyway.
On gold, many have been unnerved by the “record high” of its price. Yet, as David Leonhardt points out, it’s not true.
Gold is at a record only if you fail to adjust for inflation. And you should almost always adjust for inflation.
This isn’t simply a question of math. Anyone who says gold is at a record high (or who said oil was several years ago) is getting the story wrong. Why? Because $10 today is not more valuable than $9 a few decades ago. Claiming otherwise is tantamount to saying that 10 rupees is more valuable than $9 because 10 is a bigger number than 9.
Here’s a graph (via Krugman) that isolates commodity prices for us.
I don’t know about you, but it doesn’t really look like any historically high jump in commodity prices going on.
Everyone is entitled to make some bad predictions, but I’m not sure what Sarah Palin’s excuse is for her inability to predict the past. Here she is on grocery inflation.
“Everyone who ever goes out shopping for groceries knows that prices have risen significantly over the past year or so.”
The Wall Street Journal reporter who had the gall to question her responded.
The Nov. 4 Wall Street Journal article noted, in its first sentence, “the tamest year of food pricing in nearly two decades.” It does indeed report that supermarkets and restaurants are facing cost pressures that could push their retail prices higher — but it hasn’t happened yet on a large scale. Critics of the Fed’s quantitative easing policy are focused primarily on concerns about potential future inflation.
Let’s now take a look at few other predictions on inflation at about the time Laffer and Gregg wrote their pieces.
Paul Krugman (28 May 2009):
It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.
Seems he was correct.
Paul La Monica, CNNMoney Editor (4 June 2009):
So with all due respect to the Fed chair, he can talk as much as he wants about how he’s not too worried about inflation. But investors disagree. And Hoenig thinks that the Fed would be unwise to dismiss what’s going on with bond rates, currencies and commodities.
Score that one: Bernanke 1 – La Monica/Hoenig 0.
The Economist (22 Oct 2009):
In short, the likeliest triggers of an acute crisis—a lenders’ strike, a crash in the dollar or inflation—seem remote.
Cheers to the Brits on that one.
None of this should suggest that Krugman or The Economist is always correct or that La Monica, Laffer, and Gregg are always wrong (Palin I’m not so sure about). Remember Lehrer told us that “Liberals, moderates and conservatives were all equally ineffective.” But it does suggest to me that we shouldn’t keep listening to the same voices on a topic they’ve been so utterly wrong about until circumstances change (or they change) and indicate things might be different. For example, here’s Laffer -again in a WSJ Op-Ed- from 2 days ago.
Outlining his growth agenda he recommends,
2) Price stability. Congress should revise the Federal Reserve’s mandate, making it serve only the goal of price stability (and not also full employment). In addition, the Fed should follow a monetary rule, targeting either the quantity of money or the price level. There can be no prosperity without price stability. (my emphasis)
He’s still worried more about inflation than our current unemployment crisis. Can editors explain to me why we keep hearing more and more from those with such bad records? The inverse correlation between the voices of inflation alarmists and the actual inflation rate is surreal. We have plenty to worry about without concerning ourselves with phantoms and problems that only occur if we’re more successful.
I hope I’m not giving the impression that I think I know what will happen with our inflation rate or commodity prices. If I did I’d be in the markets right now, not writing blog posts. But what I can tell is that the bizarro Chicken Littles (“The ground is rising?!”) keep being wrong and the available data suggests we’re not in imminent danger of turning into Zimbabwe. So if you think Greece’s economy is bad and you realize that just because the overall health of our economy is better doesn’t mean that virtual unemployed nation we have living within our borders isn’t feeling real pain. Unconventional ways to further loosen monetary policy aren’t likely to solve all our problems but it could help alleviate a lot of needless suffering.
I’d rather not make a prediction, but I think we should put some money on this.
Again, where and when did the switch to socialism happen? I can’t seem to find it in the data… Hmmm…. Also, where was the massive increase in spending for stimulus?
Total Government Spending (all levels of government):
The only way you see a massive increase in government is if you only look at short term federal government spending AND ignore the fact that GDP collapsed because of the recession. Yes, taxes coming in are much less because of cuts and because of the recession – that’s what’s really causing the short term deficit.
We’re not going bankrupt because we’re spending too much on infrastructure or any such nonsense. It appears we’re still short about $2 Trillion for infrastructure (well, according to some reports anyway). Entitlements need to be reformed, the tax base increased, and we need to find a way to increase economic growth. Maybe the Fed actually intends to try something new now.
(graph via Krugman)
Paul Krugman asks a simple question to all those that believe President Obama “presided over a huge expansion of goverment.”
What major new federal programs have started up since Mr. Obama took office? Health care reform, for the most part, hasn’t kicked in yet, so that can’t be it. So are there giant infrastructure projects under way? No. Are there huge new benefits for low-income workers or the poor? No. Where’s all that spending we keep hearing about? It never happened.
A great reminder to always examine the foundation of any common knowledge. Here’s the graph he provides on his blog.
The question is the important part though.
You’ve all heard the cliche enough times used in international diplomacy: “All options are on the table.” Of course, that’s code for the military option or even the nuclear option. Here, I want to use that metaphor to discuss our current debate about tax policy. Since the previous administration and legislature wrote into law that the “Bush tax cuts” must expire, we’re now faced with the predicament that lots of taxes will be raised amidst an anemic economy if something isn’t done, but if we extend them the deficit problem will be even worse. The locus of the debate or, if you will, the options on the table seem to be that we do nothing and let all the tax cuts expire, extend all the tax cuts, extend all but those for the wealthiest taxpayers, or compromise by extending the tax cuts for only 2 years.
The argument for extending all the tax cuts is pretty simple. Raising taxes now during a weak economy is going to make the economy worse, not better. Cato’s Jeff Miron wants to see them extended permanently.
Extending the Bush tax cuts — permanently — is a crucial step in restoring economic growth. The Bush cuts provided lower taxes on ordinary income, especially for taxpayers at the high end of the income distribution. These are some of the most energetic and productive people in society; raising tax rates would discourage their effort and entrepreneurship. High-income taxpayers also have multiple ways of avoiding high tax rates, so any revenue gain from raising rates would be modest.
Alan Viard of AEI likes them all too.
The figure shows the increases that will occur in marginal tax rates at the top income levels if the high-income rate reductions (including the dividend tax cut) expire. Beginning in 2011, the top income-tax bracket for wages and self-employment income, and for ordinary investment income, would revert from 35 to 39.6 percent; wages and self-employment income would continue to face an additional 2.9 percent Medicare tax. The top capital-gains tax rate would revert from 15 to 20 percent. Dividends would lose their current 15 percent tax rate and become taxable as ordinary income, subject to the new 39.6 percent rate. All four categories of income would also face a 1.2 percent stealth-tax-rate increase, from the restoration of a provision that phases out itemized deductions at high income levels.
Economists left of center like Paul Krugman think that extending the top-rate tax increases is not worth the $700 billion price tag (sounds hypocritical but it’s well reasoned).
Now, consider first what would happen if we extend the [high-end] tax cuts for the next 10 years. This would add $700 billion to the debt (pdf). If the rich spread their windfall evenly across the decade, that’s $70 billion a year in additional consumer spending — or $140 billion during the period when we need it. So, $700 billion in deficits for $140 billion in stimulus; not a good bargain!
Alternatively, suppose we extend the tax cuts for only 2 years. That’s only $140 billion on the deficit. But the rich, knowing that it’s temporary, won’t spend much of it — if they really operate on a 10-year horizon, they’ll spend only $14 billion a year more, so $28 billion of stimulus when we need it, in return for $140 billion of debt; still a lousy bargain!
Just for the record, it’s not like the rich wouldn’t get a tax cut under the Democrat’s proposal.
Most famously President Obama’s former OMB director, Peter Orszag wants to extend all the tax cuts for 2 years, then let them all expire.
In the face of the dueling deficits, the best approach is a compromise: extend the tax cuts for two years and then end them altogether. Ideally only the middle-class tax cuts would be continued for now. Getting a deal in Congress, though, may require keeping the high-income tax cuts, too. And that would still be worth it.
In a great piece, Bruce Bartlett explains why the Bush tax cuts were inefficient, of little benefit, and harmful to the debt, but acknowledges that during this
recession recovery economy it’s probably best we just extend them.
Subsequent research by Federal Reserve economists has found little, if any, impact on growth from the 2003 tax cut. The main effect was to raise dividend payouts. But companies cut back on share repurchases by a similar amount, suggesting that only the form of payouts changed. (See here, here, and here.) Moreover, according to a study by Steven Bank of the UCLA law school, the fact that the dividend tax cut was temporary was a key motivation for higher dividend payouts; had the dividend tax cut been permanent, as the supply-siders favored, the impact probably would have been much less.
Maybe the answer is obvious (politics) but I’m not sure why these are the only options on the table. Can’t we extend the table? The nuclear option doesn’t even seem to be an option right now. But now may be the perfect time to blow up the tax code and put a new one in place. Here’s the diplomatic stick for the Administration to use: “Let’s put in a simpler, better tax code or all the tax cuts are going to expire and opponents will be responsible for raising taxes on Americans at the worst possible time.” There’s a carrot too: “You get to support a simple efficient tax code that everyone has long claimed they support.”
I honestly have trouble understanding why we have to extend poorly designed, little bang-for-the-buck tax cuts rather than doing something that could really be a huge boon for the economy. Talk about a game-changer from the Obama Administration! A Democratic administration gets to be the one supporting fundamental and economically productive tax reform while forcing the Republicans (or Democrats), if they vote against it, to be essentially responsible for raising taxes and blocking what a lot of their supporters favor. If Republicans are really worried, rest assured that the tax reform wouldn’t be able to save the economy soon enough to have a dramatic positive effect by the election so the GOP candidates will still have a great chance to pick up a ton of seats – and most likely take the House. Will businesses, conservative intellectuals, and angry tea-partiers (so-called small government types) really be able to support the Republicans ever again if they don’t jump on an opportunity like this?
I’ve long touted a VAT as a potential replacement for our absurd tax code. Many mainstream conservatives have even had good things to say about it assuming it was replacing the tax code, not being added on top of it. Here’s a favorite option of progressive policy wonks – something that might appeal to Obama, that I’d be excited to support: the progressive consumption tax. Maybe the Democrats could even slip in some decent energy policy (that they’ve given up on) by raising energy taxes as part of tax reform. Even a flat tax that conservatives have often pushed for would be better than the status quo. Lots of different and better options have to exist rather than being stuck with tinkering with the Bush tax cuts.
If the problem is just lack of time, I’m not sympathetic – everyone has known since the Bush tax cuts passed that they were going to expire. It seems difficult to imagine a potentially better time to force lawmakers’ hands to simplify the tax code than now. We’re in desperate need of new revenue, the weak economy could strongly benefit from a more efficient tax code, taxes will automatically rise if nothing is done, and sometimes it takes the people you’d least expect to be able to dramatically shift course. Think of Nixon going to China or Clinton with welfare reform. What Republican wants to be outflanked by a “socialist president” on tax reform? President Obama might be able to drag along enough in his own party to support a tax reform that the business community surely must favor.
It seems perverse that such extreme options can be on the table for international relations but are so limited for domestic issues. When it comes to tax policy, I welcome the mushroom cloud.
In the past few days I’ve come across some common misunderstandings of what actually happened during the The Great Depression and what lessons it should provide us for monetary and fiscal policy today. One came from my uncle’s coworker and another from a fellow blogger. So readers here get a better sense of my thoughts on both with a risk of being slightly unfocused, I’ll just include some parts from my private email correspondences in with my response to “Rick.”
Oh Rick, I’m almost sorry to have to chip away at the icon you’ve placed a top the pedestal. Maybe your love of one-dimensional Randian characters explains it, but Amity Schlaes and The Forgotten Man are hard for most of us to sympathize with. You ask your readers to “compare the two statements against easy to find historic facts and decide for yourself whose opinion is the most accurate.” Well, I did. I can understand the appeal of a novel like Atlas Shrugged, but I can’t get behind any of Schlaes’ fiction.
I am not dogmatic on this issue. I am willing to look at evidence or analysis that recovery from the Great Depression would have been faster if spending had been cut to the level of revenues or even lower or whatever, but I have been unable to get any conservative critic of the New Deal to say that this is what they believe. They always change the subject to various other things Roosevelt did, much of which I agree was mistaken. I just want a simple answer from Amity Shlaes, Jim Powell, and Burt Folsom, all of whom have recent books critical of Roosevelt, to this question: Would recovery have been faster if spending had been cut and deficits had been smaller during the 1930s? If the answer is yes, please provide some logical and empirical evidence supporting this view. (my emphasis)
Suppose that wages across the US economy had been, say, 20 percent lower than they actually were. You might be tempted to say that this would make hiring workers more attractive. But to a first approximation, prices would also have been 20 percent lower — so the real wage would not have been reduced. So how would lower wages lead to higher demand for labor?
What Keynes realized by applying the concept of “sticky prices/wages” (which Shlaes largely ignores) is that the government needs to intervene and push aggregate demand rightward while expanding the real money supply.
Don’t forget too that Keynes wasn’t a marxist, he wanted to save capitalism. Here he is on Hayek’s Road to Serfdom:
I find myself moved, not for the first time, to remind contemporary economists that the classical teaching embodied some permanent truths of great significance, which we are liable today to overlook because we associate them with other doctrines which we cannot now accept without much qualification. There are in these matters deep undercurrents at work, natural forces, one can call them, or even the invisible hand, which are operating toward equilibrium. If it were not, we could not have got on even so well as we have for many decades past.
Another common criticism that keeps turning up is the “uncertainty” critique. It argues that businesses are uncertain what certain legislation and other government policies will result in so they won’t hire new workers, but will sit on their profits until they have a better idea of what is going to happen. Aside from not having much evidence (here, here) to support this claim, I’m also baffled that people somehow think the free market is more certain. The free-market does a lot of good things, but certainty isn’t really what defines it. Also, will sweeping reform that pulls the government out of huge portions of the economy really make things more certain? If you think it’d be better, than make that argument – just don’t tell me it’d make things less uncertain.
Don’t trust Amity Schlaes and others that don’t seem to even understand the arguments for stimulus. Seek out actual economists on the left and the right for more useful arguments for and against stimulus; after reading “historian” Schlaes, it seems we should trust them more on history as well.
Here’s a bit of a roundup from around the web on Paul Ryan and his budget plan.