Posts Tagged ‘Fiscal Policy’

A Libertarian’s Case For Government Intervention

August 16, 2011 Leave a comment

Bryan Caplan is one of my favorite libertarian writers. He’s very persuasive and even when he doesn’t convince me he’s consistently insightful. In his Wall Street Journal review of Nick Powdthavee’s book, The Happiness Equation, he highlights one of the most important metrics for evaluating public policy:

For instance, happiness research makes a powerful case against European-style labor-market regulation. For most economists, the effect on worker well-being is unclear. On the one hand, regulation boosts wages; on the other, it increases the probability that you will have no wages at all. From the standpoint of a happiness researcher, however, this is a no-brainer. A small increase in wages has but a small and ephemeral effect on happiness. A small increase in unemployment, by contrast, has a massive and—unlike most other factors—durable effect on happiness. Supposedly “humane” regulations to boost workers’ incomes have a dire cost in terms of human happiness.

At the other end of the political spectrum, consider immigration. The most pessimistic researchers find that decades of immigration have depressed native wages by about 5%, total. The effect of immigration on Third World migrants’ wages, by contrast, is massive: One recent paper finds that allowing a Haitian to take a low-skill job in the U.S. increases his earnings 10 times. If you care about happiness, the implication is clear: Government should get out of the way.

In many instances, he’s right, government should relax regulations that obstruct full employment. But maximum freedom doesn’t always lead to full employment. Market economies with lax regulation can suffer from painful volatility.

Furthermore, during times of high unemployment like today, government could boost employment at relatively low cost to future growth (or possibly no cost). The corollary to when Caplan argues that a “small increase in wages” isn’t worth the “small increase in unemployment” is that a small decrease in future wealth is worth an increase in today’s employment. Caplan’s sound logic should help convince policymakers to support public investment programs that employ idle workers and to reverse the fall in public employment.

(The surge around May and subsequent drop is mostly due to the temporary census workers)

Over regulation can often raise unemployment, but during downturns it can also provide worker safety as some German labor policies demonstrate. From The Economist’s Free Exchange blog:

Germany proceeded to protect its labour market from major disruption by the great recession, through the use of its “short work” labour sharing programme. Firms were encouraged to cut hours rather than jobs, and workers facing reduced work hours were provided an income subsidy. The result? Germany’s huge output fall produced only a labour market wiggle.

Caring about people’s happiness also makes a further mockery of the hysteria around any Fed policy that might generate higher inflation, which would certainly boost growth and lower unemployment.

If you care about happiness, the implication is clear: Bryan Caplan makes a great case for occasional government intervention.

Scott Sumner Vs. The World of Progressives

March 30, 2011 2 comments

In a recent post Scott Sumner challenges a number of progressive assumptions and calls them out for the “”faith-based” reasoning that they tend to deride in conservatives.” Sumner is a monetary economist that progressives should be required to read to see that rational critiques actually exist of their fiscal policies. Sadly, the mainstream conservative movement gave up on dispassionate evaluation of public policy.

Sumner’s “progressive wishful thinking” criticism defends Greg Mankiw’s posts that upset the standard liberal story on the progressiveness of the US tax regime and on fiscal stimulus. The defense credibly knocks down some of the more fragile volleys from the Left flank.

Lindert showed that Europeans were able to raise more tax revenue only by having more regressive tax systems than the US, i.e. tax systems that relied more heavily on consumption taxes. This is now pretty much common knowledge in the public finance area.

That is an important point to disrupt some common progressive assumptions, but I don’t think it directly counters Ygelsias’s and others’ point that the wealthiest “pay a huge share of the total taxes in the United States because they have a huge share of the money.” But it seems to me that Sumner is largely right that the US tax code has a progressive rate structure even compared to Europeans.

Sumner also weighs in on where the US sits on the Laffer curve:

I’d argue that this data is strongly supportive of the view that both the US and Europe are near to tops of the Laffer Curve for total taxation.  I did not say then, nor do I claim now, that we are precisely at the top.  But I also don’t see any reason to believe that if we raised taxes from 28% to 40% of GDP, that revenue would rise anywhere near proportionately, with no change in GDP per capita.

I do think the Laffer curve is “far-fetched” but I don’t deny that revenues always rise “proportionately, with no change in GDP per capita.” It is illustrative that Sumner doesn’t quote anyone making that claim he’s rebutting. Most popular proponents of the Laffer curve like to claim that tax cuts actually raise revenue not just that tax increases dampen receipts a bit. But the Left should think harder about challenging their assumptions with reference to European models if they’re going to argue for a much more progressive tax code. I’m with him on a progressive consumption tax.

Most interesting, and surprising, to me was Sumner’s claim that “for decades our best macroeconomists have been saying that that fiscal stimulus is a bad idea.” I really wish he cited something here because if true I’m embarrassed that I wasn’t aware of this. I always assumed economists like Christina Romer were true authorities on this, but I willing to confront a counter consensus of experts if it exists. Not that a consensus of experts is always correct but we should be giving more deference to it, as Bertrand Russell makes clear in Let People Think:

(1) that when the experts are agreed, the opposite opinion cannot be held to be certain; (2) thet when they are not agreed, no opinion can be regarded as certain by a non-expert; and (3) that when they all hold that no sufficient grounds for a positive opinion exist, the ordinary man would do well to suspend his judgment.

Sumner correctly emphasizes the need for more monetary action, which could be even more important than fiscal stimulus to help our economy. I haven’t neglected monetary policy but have focused mainly on the fiscal side because (1) it’s easier to convey (2) it’s more direct (3) it’s something that politicians (and, therefore, the public) have more influence over. Matt Yglesias is certainly right that progressives need to grapple more with Fed policy (must read) and that Obama’s biggest mistake might be his lack of focus staffing the Fed.

I’m extremely disappointed Sumner is taking a break from blogging. I hope he returns soon and continues to offer insightful and challenging commentary. I’ll be sure to rummage through his archives – others should too.

The Socratic Method and Right-Wing Talking Points

November 22, 2010 Leave a comment

Whenever evaluating policies, I find it useful to form a logical model in my mind of how different scenarios should plausibly work out. Doing so requires I walk through various alternatives through their logical steps. I hope some Socratic questioning can be illuminating for us.

Questions for inflationists:

Do you think inflation, currently at historical lows, would be higher, lower, or the same had we not used fiscal stimulus and the first round of quantitative easing?

The Fed has already loosened monetary policy and previously tried the first round of quantitative easing which expanded the money supply in the economy. The Bush and Obama administrations expanded the money supply through fiscal stimulus. Presumably we’d have lower inflation had those policies not happened. At 0.6% annual increase in CPI, wouldn’t deflation have been a likely possibility?

Given all their rhetoric about soaring inflation and the dangers of flooding the economy with cheap money, you’d think they’d answer it’d be lower. But if it was any lower it’d be outright deflation.

Finally for all those worried about the dangers of printing money to fight off potential deflation, what would the inflation picture have to look like for you to argue that the government or the Fed should add more money into the economy?

Questioning uncertainty:

There is no doubt that there is uncertainty in our markets. Advocates of fiscal and monetary stimulus are under no obligation to deny that uncertainty can negatively affect the economy. In their popular Keynesian book, Animal Spirits, George Akerlof and Robert Shiller approvingly quote Washington Post writer Anna Youngman from the Great Depression:

At present, Mr. Dupont [president of the chemical company] notes, there is uncertainty about the future burden of taxation, the cost of labor, the spending policies of the Government, the legal restrictions applicable to industry-all matters affecting computations of profit and loss. It is this uncertainty rather than any deep-seated antagonism to governmental policies that explains the momentary paralysis of industry…

If it actually exists to the level some conservatives now say it does (I’m still waiting on the evidence: here and here), how far does this etherial “uncertainty” go?  And to what extent should it affect our policy decisions?

This is how I come at the question. Currently aggregate demand is very low. Small businesses are reporting in greater numbers that “poor sales” is a major problem. Personal consumption and retail sales remain low.

Graph: Retail Sales: Total (Excluding Food Services)

Earlier last year government consumption was offsetting some of the drop in private consumption, but as fiscal stimulus fades that has also dropped off.


So imagine you own a company that produces shoes. You’re uncertain how different legislation will affect your future costs – you may believe your taxes could go up, so maybe you shouldn’t hire another worker despite receiving lots of applications. You’re making decent money now and your workers are producing more than enough shoes to satisfy their current customers. You have plenty of excess capacity to make more shoes but, since labor costs a lot (healthcare, taxes, salary, training, etc) you may even be keeping your workers’ hours fairly limited and may even cut back. I think that largely encapsulates the uncertainty picture for a business.

Now let’s assume that all of a sudden there is a big spike in demand for your product (which is what stimulus advocates want to create). You’re selling your supply out. There is NO CHANGE in healthcare legislation, tax rates, labor costs, and shoe material costs, although you’re still uncertain about the future of those costs. If you were the shop owner, can you imagine yourself still not hiring new workers if doing so would be the only short-term way you could satisfy the increased demand for your product?

I submit that businesses aren’t going to forgo making more money now to sell customers more of what they want because they are “uncertain” about various potential future problems. This scenario doesn’t suggest that uncertainty doesn’t matter at all; it just suggests that when looking at the policy prescriptions it seems to have little value for our short-term unemployment crisis.

Now consider another scenario. You’re a business owner that has poor sales, but the congress decides to repeal the healthcare bill, permanently continue all the Bush tax cuts currently in place, cut unemployment benefits, cancel any unspent stimulus money, downsize the federal employment roles, and will promise not to add any new regulations on business. Furthermore, the Fed decides not to add any more money into the economy.

I can’t prove that businesses wouldn’t upon hearing this news and rush out and hire lots of new workers, but let’s just say I’m skeptical of how strong that changes the incentive of businesses to hire new workers.

In our economy we have poor sales and, according to many, policy uncertainty created by the Obama administration and the Fed. In scenario 1, there are poor sales and uncertainty. If poor sales change to strong sales while uncertainty continues, it seems businesses will still hire new workers. In scenario 2, there are poor sales and uncertainty. Nothing was done to directly shift demand rightward by increasing consumption, but some supply side and other right-wing wishes were granted. So we supposedly tackled “uncertainty” but not sales. I personally don’t see how that clearly answers the unemployment problems in our economy. Yet this is the position of some on the political right (via Kevin Drum).

What am I missing? What’s Phase 2?

No More Uncertainty: It’s Demand

September 16, 2010 Leave a comment

Catherine Rampell, of the Economix blog at the New York Times, shows what “the biggest single problem facing America’s small businesses” is right now.

Much of the debate about how to spur growth and encourage hiring has focused on making the tax picture temporarily more business-friendly. But as you can see, the portion of small businesses citing taxes as their superlative problem has remained about the same — mostly in the 17-22 percent range, say — for about a decade. (my emphasis)

It’s clear that “poor sales” is what has changed (look from Sep ’07 on) and why employers aren’t hiring right now. That’s not to say that taxes aren’t a concern – of course they are a concern – but if you’re trying to argue that small businesses aren’t hiring now because of the increased weight of Obama’s Marxist regulations (dark orange), new crushing tax increases, the recent Nazi-like health insurance scheme (light orange), or because evil unions are keeping wages artificially high (light blue) you might reexamine those views in light of the, you know, evidence. 

Note to policymakers: craft policies that best increase aggregate demand. 

Moreover this demonstrates the continued lack of evidence for the argument from uncertainty (i.e. policy uncertainty is causing businesses not to hire) (see: here, here). Yglesias also asks proponents of that argument to justify their argument from history.

I’d be fascinated to hear Otellini describe to me the past era in which firms knew exactly what their health care, energy, and tax costs were going to be. This was a time in which the future trajectory of oil prices was entirely predictable, and it was clear that congress would never again alter the tax code. A time when general macroeconomic conditions were not subject to any vagaries of fortune. A magical time.

The biggest uncertainty to businesses right now is whether their sales will grow. They don’t see consumers demanding more goods so if they think sales will stay low they won’t hire new workers to supply for that demand. Welcome to Econ 101.

[update 09/18]: I got in a little debate on this topic over at Rick MacDonald’s blog. I’ll crosspost it here but I encourage readers to check out the original post and following discussion at the source. Enjoy. I threw in a couple more links and a graph so readers have an easier time following what I’m referring to. 

Dan:  I’m sympathetic to the argument that we should make tax policy simple, clear, and as least burdensome as possible for the engines of economic growth – businesses. But I have to say I’m completely unpersuaded that the primary trouble for our businesses right now is taxes or policy uncertainty. There just doesn’t seem to be much of any evidence that demonstrates that either of these are unique or major problems to our current economic climate. It seems you’re a proponent of this view and I’ve tried to find some evidence to support those positions (especially the latter). I was wondering if you could respond to my questions regarding this theory. It seems to me that the real problem for small businesses is lack of aggregate demand manifesting in poor sales.

Rick: I’ve provided interviews with Donald Trump, Jim Rogers, T. J. Rodgers and Steve Wynn…if the direct statements of billionaires can’t convince you about the importance of unpredictability and their view that the uncertainty of markets, tax policy and government intervention are inhibitors; it would seem that you are content to remain unconvinced. The consensus as stated by these gentlemen is the consensus on Wall Street among the majority who are holding onto their capital reserves and only betting on the short term.

Dan:  It’s not that I’m content to remain unconvinced, it seems you’ve mistaken some anecdotes for data. In the link I provided survey evidence (close to 4,000 businesses were surveyed) from respected National Federation of Small Businesses, and policy uncertainty doesn’t show up – or at the least isn’t nearly as big a concern as other issues. Poor sales seems to be the overriding concern. Also, I linked to a graph of recent major legislation paired with the stock market and the passing of the bills never seems to greatly affect the stock market in a negative way. Even with healthcare where you’d suppose the most uncertainty resides, that industry has seen the most job growth out of the major sectors of our economy. Furthermore, it’s not clear that if uncertainty is a problem that it’s a major problem (I’m not saying that it’s not a problem AT ALL, even slightly) or that it’s uncertainty with policy rather than run of the mill economic uncertainty. Consider that quote from Matthew Yglesias I referenced, where he makes the point (I made it to you before myself in a previous exchange) that there is no time in history where there is complete economic certainty. Therefore, how can anyone say now that it is a special problem? 

So in light of all this (survey data from thousands of small businesses, stock market/legislation comparative analysis, the case of the healthcare industry, and the general historical perspective) what can you point to that demonstrates that uncertainty is a MAJOR problem? A few businessmen just saying so isn’t especially persuasive – if a few other extremely rich businessmen said the opposite would you find that convincing of my case? If all this doesn’t make you question your case, maybe it is you who “are content to remain unconvinced.” Notice I am just merely asking you to provide some evidence to support your position aside from a few anecdotal statements you have already quoted. I didn’t think it was absurd to ask you to justify your claims or respond to my counter-evidence.

Rick: It’s my view that you are content to remain unconvinced. The “anecdotes” come from 4 major investors and holders of wealth in the form of fixed capital.

As to statistics; many on the left claim that we are not suffering inflation. If you’ve been shopping on your own for a while, you will notice that prices (especially food prices) have been steadily rising even though interest rates remain low. Jobs are still disappearing at over 400,000 a week, wages are beginning to fall as well and credit is tighter than ever in spite of the government spending the wealth of 2-3 generations or more. As I’ve said before, I have too much to do to debate on line via a blog.

The Keynesians say this and the Austrians say that…I tend to agree with the Austrian economists and see hope that Keynesian economics will soon be tossed aside as a failed system and buried in a grave alongside communism. I know, the video is all ancedotal, but it’s also true.

Dan: Well if you’re not interested in convincing people who don’t already share your views that’s your choice I suppose. I know you’re not interested in debating this and that’s fine, I’ll just make a few points and I’ll end my side of the conversation if that’s your preference. First, it’s not just a “claim” on the left that we’re not suffering from inflation. We’re actually not suffering from inflation. I mean honestly, in the past 2 or 3 years has your money really lost all its value? When was the last time you took a wheelbarrow to the store to buy stuff? We’re not even suffering from moderate inflation. The BLS’s core inflation rate is slightly above zero right now
Your example of food prices is especially dubious because that’s not even included in the rate because prices for things like food and energy are very volatile. Even still it’s not like food or energy prices have jumped very much either.
The video you linked is interesting and I’m slightly familiar with Peter Schiff. Just realize that the idea that because 1 austrian economist predicted a few things correctly than the entirety of mainstream economics has been overturned is preposterous and borderline delusional. You realize Keynesian economists make correct predictions too, right? Has an austrian economist ever got anything wrong? If so, does that invalidate the entirety of the discipline for you? He seems to be getting the whole hyperinflation thing wrong – but I guess we’ll just have to see. Another thing, maybe I’m missing it, but nothing he said in the video seems to directly contradict much of anything in new Keynesian economics. I mean it’s not like mainstream economics doesn’t recognize the possibility of housing bubbles or think that selling toxic financial gimmicks are a good thing for the economy.
Also understand that I’m not saying Schiff’s perspective isn’t informative or impressive. I fully concede that mainstream economics may be able to learn from some of the insights of the Austrian school. But your hyperbole about Keynesian economics belonging in the dustbin of history is too much – as if 80 years or so of economic research has been entirely fruitless. Please.
I guess I shouldn’t be surprised that you’d punt rather than grapple with any of my challenges. The Austrian School which you find so persuasive seemingly rejects the whole concept of empiricism and the scientific method. Peter Schiff didn’t bury Keynes, and his shovel hasn’t even broken ground on the Enlightenment.

Rick: Opinions vary, and it’s not that I’m not interested; as I stated earlier, I have little time for long pedantic discussions via comments.

As to the “scientific method” of Keynes, that is all well and good; however, Keynesians leave out the inate tendany of people in power abusing power and acting in ways that are irrational and anti-scientific. They leave behind common sense and ignore corruption and other human factors that one can’t chart except, perhaps, with a Ouija board.
President Obama claims the economy is improving, yet the evidence in housing, unemployment, and contraction of businesses and investment say otherwise. I would tend to call the administration’s opinions more delusional than appreciating what one experiences at the cash register during checkout more so than the comments by the President’s economic team, or his own mouth. Wasn’t it President G. H. W. Bush’s appearance in a store where he couldn’t come close to pricing items? That was the beginning of his reform, and Obama’s “willful suspension of disbelief (H.T. to Hillary Clinton) that will ultimate end his tenure in a vein similar to Jimmy Carter’s.
Of course Austrian economists make mistakes, but they have yet to put the entire global economy in jeopardy to the extent Keynesians have in our current fiasco. I’ll take my chances siding with people like Peter Shiff over others like Art Laffer and Krugman (Keynesians both by definition and admission, but on opposite sides of the Keynesian fence that segments his pragmatic followers according to how much “science” they choose to apply to their “methods”.
Thanks for commenting. Hopefully, you now have a clearer expectation as to what this blog is about and to the audience it tries to serve. Best wishes.

The Great Revision

September 8, 2010 Leave a comment
Every time I argued with Keynes, I felt that I took my life in my hands and I seldom emerged without feeling something of a fool. Bertrand Russell 

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. 

First and most glaring is her pathological undercounting of jobs during the New Deal. She doesn’t count “work relief jobs” even though these jobs actually help living people and help generate more spending; the only reason I can see not counting them is because they make her argument even worse. Her whole thesis is basically torpedoed with one glance at a graph of the economic performance under the New Deal. 

So there’s your “easy to find historic facts.” No matter how many anecdotes she can cram into her revisionist history, they won’t blind us to the data. When Roosevelt came into office unemployment was over 20% and he cut it by more than half. Not really a glaring indictment. 

I’m also not sure she actually understands that critiquing the New Deal or FDR isn’t the same thing critiquing Keynesian economics or even Keynes himself. Knowledgable Keynesians don’t even make the argument that FDR ended the Great Depression, he helped in some ways and hurt the cause in others. The spending from the WWII and getting off the gold standard, which broke loose the contracting money supply, were far more instrumental. Drop Amity Schlaes and pick up some Milton Friedman at least

Here’s Bruce Bartlett, policy advisor to Ronald Reagan’s and a former treasury department economist.

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)

It also becomes clear trying to read her buckshot critique of Krugman that she doesn’t understand the dynamics of labor price. First of all, rampant deflation is the major cause of real wage rises and real interest rates. So monetary policy, not fiscal or labor policy is the culprit here. Also, when a depression is happening and interest rates are at the lower bound, lowering wages for all workers would be coupled with a lower real price level so demand for labor wouldn’t necessarily change that much.

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. 

The point here is that these extreme government interventions are only necessary during specific recessionary conditions. The government isn’t taking private capital out of the economy when it is jump starting idle factories and workers. The whole point is that the resources aren’t being used at all. If we don’t use them we’d get what happened in Japan, a lost decade. 
Let’s see why “simply printing” money can lead to prosperity during these types of economic conditions. When the government prints money it causes inflation, but since we’re well below inflation targets (we actually have a bigger potential problem with deflation right now) more inflation is a good thing. What more money in the economy will do right now is combine “together unemployed workers and idle factories. Remember a recession is a time when we have increasing unemployment and declining capacity utilization. We have factories without workers and workers without factories. Those are resources that could be used to produce things but are not being used.” 

The problem is that since there isn’t enough money in the economy right now consumers can’t spend enough of what’s available to push businesses into hiring more workers. Fortunately, the government can print more money and spend it directly to put those idle resources to use. Interest rates also happen to be at historically low levels so it won’t even cost us that much in future (less valuable) dollars to do so. 

Here’s another helpful way to look at it: “Long-term economic prosperity is determined by how much value a country is capable of creating. […] But in the short-term, gaps can arise between what could be produced and what’s actually being produced. If that gap is small or nonexistent, efforts to “stimulate” production will lead to inflation or mere shifting of resources around. But if the gap is large, then policy needs to induce people who are currently not doing anything to start producing goods and services again.” Stop caring about dollars and start caring about wealth. 

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 (herehere) 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. 

Krugman’s column.
Schlaes’ response.

Intervene Now, Fix for Later

August 3, 2010 Leave a comment

I’m sorry I missed this piece from early July. Conservative/Libertarian economist Edward Glaeser, who I’ve always been a big fan of, makes the case that the federal government should send aid to the states. He and I disagree with Rep. Paul Ryan on this issue, but Glaeser proposes a solution that maybe Ryan could compromise and sign onto – I wish I thought of it. It uses the same logic that says we should spend now during the recession and cut spending and reform entitlements later.

Given the current system, federal stimulus aid for states makes sense. There is no better use for public funds than making sure that schools remain strong and streets remain safe. But a system that uses Texas’s taxes to pay for California spending is badly flawed. Just as the International Monetary Fund has made aid conditional upon political reform, federal aid to states should be tied to reforms that would make future federal interventions less necessary.


It is easy to envision state systems that allow more budgetary flexibility during downturns, while still maintaining fiscal discipline. Instead of a strict balanced-budget system, a better rule might require the state government to save significantly when the unemployment rate is below the historical norm and allow borrowing when the unemployment rate is above the historical norm. States can either borrow on the private market, or, as Chris Edley has suggested, the federal government could lend to states during downturns. (my emphasis)

"Walking And Chewing Gum"

June 19, 2010 2 comments

Martin Wolf explains to deficit hawks that tightening fiscal policy too early could cause more problems in global markets.

Despite the most aggressive monetary policy ever, private sectors moved into huge surpluses. Monetary policy was “pushing on a string”. The fiscal offsets – overwhelmingly due to built-in fiscal stabilisers, not the discretionary stimulus – helped sustain demand in the crisis. But they were insufficient, even with monetary support, to prevent deep recessions. The argument that stimulus was unnecessary is hard to accept. It is easier to believe it was too small, albeit also ill-targeted.

So how quickly should deficits be eliminated? We must recognise the danger here: cutting public spending will not automatically raise private spending. The attempted reduction in the structural deficit might lead, instead, to a rise in cyclical fiscal deficits, which would be running to stand still, or to a reduction in the private surpluses only because income fell even faster than spending. Either outcome would be grim. Yet neither can be ruled out.

As long as output remains depressed, the fiscal support is most unlikely to be inflationary. Nor will it crowd out the private sector: it is more likely to crowd it in. The big question, then, is whether deficits can be financed. My answer is: yes. Remember that so long as the private sector runs financial surpluses it must buy claims on the public sector, unless the developed world as a whole is about to move into huge external surpluses.

Deficits are a real problem, just not now. It’s clear that we should reassure private investors and financial markets by setting up long-term policies for controlling the deficit that don’t depress demand in the short-term. A VAT would be one obvious revenue side solution. Controlling health care costs is the biggest on the spending side. The good news is that the best way to curb the deficit is to enact policies that promote economic growth now. Fiscal restraint now isn’t one of those policies.

More Stimulus Needed?

I’ve defended the stimulus and criticized some of its design; well I still feel similarly, but as Matthew Yglesias points out (via Mark Thoma) fiscal stimulus on net hasn’t happened. Read his whole short post – but here’s the relevant quote from Thoma:

But it’s important to remember that the proper measure for fiscal stimulus is not spending by the federal government; it is spending by all levels of government. And when you look at the contributions to US GDP growth (Table 1.1.2 at the BEA site), total government spending has been a drag on growth over the past two quarters. The increases at the federal level have not been enough to compensate for the spending cuts at the local and state levels.

It is also important to realize that a $787 billion stimulus package over 3 years seems large, but compared to the size of the US economy as a whole (14.2 trillion in 2009) it is easy to see why it might not have been large enough. According to the IMF, “U.S.’s planned stimulus amounts to 2 percent of output in 2009 and 1.8 percent” in 2010.  Krugman most frequently made this point before the Recovery Act passed and argues it now to push for further stimulus.

Consider the long-run budget implications for the United States of spending $1 trillion on stimulus at a time when the economy is suffering from severe unemployment.

That sounds like a lot of money. But the US Treasury can currently issue long-term inflation-protected securities at an interest rate of 1.75%. So the long-term cost of servicing an extra trillion dollars of borrowing is $17.5 billion, or around 0.13 percent of GDP.

And bear in mind that additional stimulus would lead to at least a somewhat stronger economy, and hence higher revenues. Almost surely, the true budget cost of $1 trillion in stimulus would be less than one-tenth of one percent of GDP – not much cost to pay for generating jobs when they’re badly needed and avoiding disastrous cuts in government services.

Also, Bruce Bartlett links to a study which “found that fiscal contraction in the states offset almost 100% of the fiscal stimulus at the federal level in 2009.”

Federal fiscal expenditure stimulus has mostly compensated for the negative state and local stimulus associated with the collapsing tax revenue and the limited borrowing capacity of the states. While this is a significant accomplishment, the net effect is that the consolidated fiscal expenditure stimulus is small, at a time when the private sector’s deleveraging has reduced private consumption. Thus, the fiscal expenditure stimulus did not manage to provide a viable cushion for the negative stimulus associated with private sector’s declining demand.

Paul Ryan on Hardball

Wow! A serious conversation between a sitting congressman and a TV pundit on cable news.

I’d love to carpetbag Ryan’s district.

Sizing Up the Bill

Ross Douthat has a blog post worth reading covering an exchange between Ezra Klein and Rep. Paul Ryan.  He adds his thoughts on the size of the bill and what it means for our fiscal future.

Deficit-neutrality is a very good thing, but it isn’t the only factor to consider when faced with a massive piece of legislation. For one thing, as Ryan suggests, there’s the drag on economic growth from the tax increases required to keep a $2.3 trillion bill safely in the black. 


And the Obama administration, to its credit, has done what the Bush administration never did, and proposed ways to offset every dollar (and then some) of new spending. But even acknowledged and potentially offset, the cost matters. The health care bills would lock us into trillions in required spending (private as well as public), required taxes, and necessary spending cuts at a time when our economy is stagnant, our fiscal situation parlous, and our need for flexibility immense. 

%d bloggers like this: