Larry Mishel reminds me…
CAP’s rethinking of the grand bargain path is good. Now CAP should rethink their role in putting us on that path: On September 30th, 2009, EPI sponsored a forum, 'Generating a Robust Recovery', on the need to undertake further action to generate jobs. Princeton’s Paul Krugman, Berkeley’s Brad DeLong and EPI’s John Irons were featured in a panel…
My part of the transcript, cleaned up:
Let me go back 13 months to August 2008, when Lawrence Summers, speaking for the Obama campaign:
- writes of a gap between actual and sustainable production of $300 billion a year,
- forecasts that the gap is going to persist for quite a while,
- calculates a cumulative production shortfall of maybe 1.4 trillion (dollars), and
- notes that this is in a situation in which our standard tool, monetary policy, can do very little to correct it.
Prudent discretionary fiscal policy would raise the government’s budget deficit by a third to a half of your forecast cumulative production shortfall. That meant that the appropriate size of discretionary expansionary fiscal policy--as the situation looked in August 2008--was something like $450-$700 billion in cumulative discretionary deficit funding, spread out over the next four years.
Then comes September 2008, the mensis horribilis of Lehman Brothers and AIG. Our recession problem immediately doubles. Over the next four-and-a-half months, until the February 17th signing of the ARRA, the recession problem doubles again as the magnitude of the financial crisis’s impact on the real economy became clear.
If $450-$700 billion was the appropriate size of a short-term deficit-spending program for the cumulative production shortfall that Lawrence Summers had anticipated in August 2008, then the appropriate size of the boost as of February 2009 was some $1.8-$2.8 trillion over four years or so.
What we actually got was a real fiscal boost number of $600 billion--roughly one- third aid to the states, one-third useful tax cuts in an effort by the Obama administration to propose a bipartisan plan that would get Republican legislators to sign onto it, one-third infrastructure and other direct government purchase increases, intended not so much to slow the decline as rather to boost the recovery two or years down the road.
At the technocratic level, the disproportion between the size of the response and the magnitude of the need is obvious. We did somewhere between a third and a fifth of what the technocracy would say we ought to have done with the ARRA.
Now, suppose you go a little bit west to Lafayette Park, and suppose you address the air and ask: Why is it that the administration did not pass or at least propose a larger short-term deficit spending fiscal boost program last January? If you do that, you hear four answers coming back echoing out of the wind:
The program Obama proposed and got passed was the most he could get 60 senators to vote for in a Senate that, in Majority Leader Harry Reid’s words, takes 48 hours to flush the toilet, and that we needed to spend our very scarce legislative calendar time on legislative initiatives that could pass rather than on those that certainly would not.
Further expansionary fiscal policy would be counterproductive. It would impose on America a very large long-run debt burden and cause a sharp spike in U.S. long-term interest rates, which would generate a much bigger crisis and deeper depression--just as Austria’s issuance of huge amounts of debt in 1931 in its Creditanstalt crisis set off the wave of economic disruptions that turned the recession of 1929 to ’31 in Europe into the European half of the Great Depression. Paul Krugman has already answered this: as long as Treasury bond interest rates stay low, this argument is simply not coherent.
Some places you hear that further expansionary fiscal policy would be counterproductive because it’s theoretically impossible for it to work. And I’m going to pass over that in silence. (Laughter.)
The ARRA is only one of a large number of initiatives to stimulate the economy outside of the normal open-market operations’ monetary policies. When you include the likely effects of the TARP, the PPIP, the MMIFL, the TALF, the CPLF, the TAC and the other 17 acronyms, you find that even though we have only about $600 billion of cumulative expansionary discretionary fiscal policy, we have much more in terms of total non-standard monetary and banking policies.
Argument one, the political one, is above my pay grade.
Argument two is, I think, a genuine fear--but it is one that Paul Krugman has already answered here this afternoon, I believe convincingly. It is not 1993. Right now the U.S. government can borrow for 10 years at 3.34%/year in nominal terms. The time since the summer of 2007 has seen a collapse in the price of private and a rise in the price of government securities.
If market prices signal anything, they signal that you should make more of things that become more valuable. Right now the market is sending us a very strong signal that the debt of the U.S. Treasury is very valuable indeed. Thus we ought to make more of it--simply on free-market principles if for no other reason--than we were planning to make two years ago.
I’m going to restrain myself with respect to argument three and not say a word about it.
As for the argument that the asset purchase, asset guarantee, bank recapitalization, and other financial stabilization and boost polices are about to have a big effect and boost the recovery--I really wish it were true. Yes, spreads have narrowed. But asset values are still low. The S&P 500 stands about where it stood last October, after Lehman, after AIG.
And it is by asset prices that the banking sector support should be judged.
Monetary and financial policy, after all, manipulate asset prices. The Central Bank buys and sells and guarantees and regulates and subsidizes and nationalizes with an eye toward pushing the price of financial assets to levels where businesses seeking to raise capital to expand capacity can easily access the money to push their spending to a level corresponding to full employment--or at least out of depression. The Federal Reserve sells its policies as opaque technocratic adjustments to the money stock or to a federal funds interest rate that real people never see. But the polices are and always have been aimed at manipulating asset prices. Although we may believe in a market economy, we also believe that asset prices are too important to be left to the market to determine--especially when their market levels will produce either depression, unemployment or runaway inflation.
Thus the right way to analyze the stimulative effect of banking policies is to focus on what they have done to the prices of risky financial assets. When we do this, we find that the prices of risky financial assets are still very low. Why? Because the risk tolerance of the private market has collapsed.
Last week I listened to a tape of Bloomberg’s Tom Keene interviewing University of Chicago’s Nobel Prize-winning economist Bob Lucas. Lucas said that his portfolio was now “100 percent in cash":
There is no question that fear is what this liquidity crisis is. I mean, the reason I got into money is I got afraid to leave my pension fund in other securities, so I’m sitting there with a portfolio full of zero-yield stuff just because I’m afraid to do anything else.
Now let me pick on Lucas:
- because he’s not here to defend himself, and
- because earlier in the interview he had told Tom Keene "our economy has got a remarkable ability to return to its long-term growth trend, and for most of the depressions, with the exception of the Great Depression we’ve had, the return has been quick--two, three or four years.”
That presumably means that in two, three or four years we will have:
- a normal level of unemployment,
- a normal share of profits in national income,
- a normal level of dividends and capital gains, and
- stock prices back to a normal multiple of long-run earnings--which means an S&P 500 by 2013 of 2,000 or so, compared to its current value of 1,000.
Thus, from Lucas’s perspective--the perspective of someone who trusts the market to return to equilibrium--investing in the S&P 500 for a four-year horizon is a no-brainer. It is risky, certainly, but the expected return is 25 percent per year.
So what does Lucas think he is doing, passing up such expected returns according to his own academic theories and professional judgment in order to hold his entire TIAA-CREF portfolio in zero-yielding cash?
The answer is: he’s irrationally panicked. (Laughter.)
And he says there are millions like him.
The lesson is that until such investors recover from their panic, even a perfectly-constructed banking and financial system will not produce the level of asset prices needed for private investment spending to drive us to full employment.
This is not to say that banking sector support policies have not been a boost. They have surely kept things from getting much worse. But they have not and cannot do much to close the production gap anymore than monetary policy can, because the banking policies will only work if we have a private investment community that has a normal risk tolerance, and at the moment we do not have that.
The Congressional Budget Office currently forecasts the unemployment rate will average 10.2 percent in 2010 and 9.1 percent in 2011.
If you’re happy with that forecast, with unemployment above 9 percent for the next two-and-a-half years, and think it’s appropriate, then no further support for the recovery appears needed at this time.
If you’re unhappy with that forecast--and with the enormous red blotch going forward of the shortfall of American employment and production from anything we could call a normal level--then additional federal government action is definitely advisable.
What kinds of action? Well, the obvious would be additional short-term deficit spending on the federal level, but there we run into the 60-votes-in-the-Senate problem. With a large number of senators apparently unable to distinguish between short-term deficits that are good in a recession and long-term structural deficits that are bad in a generational context, prospects are slim
At the very least, we can think about triggers to extent existing expansionary fiscal policy measures should the unemployment rate not decline rapidly. Christy Romer of the CEA is already out there saying this: Don’t repeat the mistakes of 1937-38.
You could--last January I know a number of us were saying that $800 billion then was fine, but there ought also to be a trigger in the budget resolution so that if unemployment topped 9 percent, a fall Reconciliation bill could be used to do what additional things were necessary.
That didn’t happen.
It ought to have happened.
It would be nice to make it happen.
It still could happen: you can pass a new Budget Resolution any time, with a House majority and with 50 votes in the Senate.
Moreover, there is a deal to be struck: more deficit spending in the short term, and triggers to ensure that there is more deficit reduction in the long term, should the deficit not return to sustainable levels after the recession passes.
Less obvious are other measures to aid useful deficit spending at other levels of government. One of the many reasons I envy Paul Krugman’s pen was his phrase of last year about how the recession was turning the state governments into “50 little and not-so-little Herbert Hoovers.” The obvious thing to do would be to have the federal government support the price of deficit-spending bonds issued by state governments that put credible and automatic amortization plans in place. The Federal Reserve exists and the Treasury Department exists in large part to help the flow of credit though the economy. Certainly state governments that want to maintain their effort in their level of services in spite of the recession should be allowed to do so, encouraged to do so, and supported when they do so.
And let me stop there.
As to Qs:*
MR. DELONG: Yes, a carbon tax should definitely be border-adjustable, right? One of the points is to get the global system up and running, and that has to be a piece of it. Otherwise, I think they should have Tim Geithner go out there someday and say a strong dollar is no longer in America’s interest and see what happens. (Laughter.)
MR. DELONG: I definitely do [believe in long-run budget balance], right? I think that if you look at the politics of Washington, that remains an aspiration until the public health-care cost curve is in some sense bent, and what it will take to successfully bend the public health-care cost curve I don’t really know.
David Cutler and Peter Orszag seem to place a lot of trust in competition between medical groups and comparative effectiveness research. Doug Elmendorf seems to believe in a public plan and then tighten the screws on reimbursement rates for a public plan, and that’s a question that I know just enough health economics to know that I really don’t know. (Laughter.)
MR. DELONG: No, you have described the European recovery of the 1980s, and here I would like to kick it to Larry Mishel and ask him to get his plan for a new employment tax credit out as fast as possible.
Q: So my question is, what will it take to make it politically palatable or socially palatable or professionally palatable for someone, a politician or a journalist or an economist, to say let’s borrow and spend to put America back on its feet and put Americans back to work? MR. DELONG: I thought that [making it politically palatable or socially palatable or professionally palatable for someone, a politician or a journalist or an economist, to say let’s borrow and spend to put America back on its feet and put Americans back to work] was what I was doing…. But there is the long term that – actually, if you were going to freeze medical technology at its 2009 level and say, all you get from now forward off of Medicare or Medicaid is the level of medical technology we had in 2009.
Then the chances we have a significant long-run deficit program, the chance that our national debt grows faster than the rate of growth of GDP as a whole is about 30 percent, right? There is a chance there will be a problem but the weight of that is that there probably won’t be.
From one perspective at least, the long-term deficit and the long-term debt problem that America faces truly is an opportunity, right? That is, it’s based on the Congressional Budget Office’s and the Center for Medicare and Medicaid Services’ assessment that our doctors and our pharmacists and our nurses are going to figure out who to do wonderful things and they’re going to be expensive and we’re going to want them.
That is, both my grandfathers lived to be 95, and I know that when I’m 90 in 2050 I’m going to want to have a heart grown from my own cloned tissue on reserve in the basement of the nearest hospital in case my heart gives out so I can get an extra couple of years. And I’m going to vote against any politician who says that this isn’t medically necessary and appropriate.
So that talks about the general long-run fiscal crisis of the American state seem to me, from one perspective, to be greatly counterproductive. There is an opportunity created by future – by expected future developments in medicine, and the question is how to grasp that opportunity to get as much as possible of future medical technology into the bodies of as many people as possible while still having the funding all work out so we don’t wind up with a bout of hyperinflation.
And yet that’s not what focuses on the long-run deficit or even on the entitlement crisis.
That’s not the direction that tends to lead people to think.
No, I’m not going to get my cloned heart paid for by Medicare.
I’m going to have to tell my wife to go to work for some private sector law factory to make the money so I can have it.