J. Bradford DeLong's Grasping Reality with a Prehensile Tail

Oh Dear...

What House Majority Leader Steny Hoyer should be saying:

Because of the uniquely high unemployment rate, the benefits to government spending are much greater than usual--not only does it deliver needed services and build necessary infrastructure, but it puts people who otherwise would be jobless and broke to work. Because of the uniquely good terms on which the government can borrow, the costs of bringing government spending forward into the next three years from the distant future are much smaller than usual. But a commitment to spend more by the government over the next three years must not be allowed to destabilize expectations of the long-run fiscal soundness of the American government--that could produce an economic disaster.

Hence our commitment to create jobs by spending more in the next three years shall and must be accompanied by putting in place the institutions and procedures--automatic triggers on both the spending and tax side--to close the deficit and keep the debt from exploding should congress prove unable to do its job through the normal legislative procedures.

Thus next year the focus will be on jobs and fiscal responsibility...

What House Majority Leader Steny Hoyer is saying:

Coming Up In 2010: All About The Deficit: Top aides on both ends of Pennsylvania Avenue say 2010 will be the year of fiscal responsibility, even if President Obama has to battle with progressive Democrats to make cuts they won't like. "Next year the focus will be jobs and fiscal responsibility," House Majority Leader Steny Hoyer told TPMDC in a briefing with two reporters Thursday. Hoyer (D-MD) said one reason Democrats are having a tough time one year before the Congressional midterm elections is that voters are concerned about the nation's fiscal health, and they also want to see the unemployment rate shrink. He said he knows there may seem to be disconnect with those two things in short term, but in long term they make sense. "The American public are right, we have to do both," Hoyer said.

Deficit reduction over the long term will be the White House's primary focus next year, and Chief of Staff Rahm Emanuel said at the Wall Street Journal's CEO Council conference last month it will be a "key component" of the president's State of the Union address. "It is foremost on his mind and the mind of the economic team," Emanuel said.

Office of Management and Budget spokesman Ken Baer told TPMDC it will be a top priority. "As part of the FY2011 Budget process we are exploring a range of options to put the country back on a fiscally sustainable path," Baer said.

These strike me as very different things.

It is certainly true that you can enact bad economic policies and win both the applause of the Washington press corps and reelection--look at Ronald W. Reagan and George W. Bush. The race is not always to the swift or the battle always to the strong, nor does food come to the wise or wealth to the brilliant or favor to the learned; nor does good economic news always come to the enactors of good economic policies. Time and chance happen to them all.

But if you want the odds on your side, enact policies that make sense--not policies that leave you stammering to reporters about how you know " there may seem to be disconnect with those two things in short term," but "in the long term they make sense" even though I cannot explain how...

James Kwak Is Now Grand Heresiarch of the Ancient, Hermetic, and Occult Order of the Shrill!!

A Partisan Post: You Have Been Warned

That is all.

Ph'nglui mglw'nafh Kwak R'lyeh wgah'nagl fhtagn!!

A Nice Follow-Up Piece from Noam Scheiber on the White House's Thinking...

He writes, among other things:

Is The Administration's Economic Thinking Incoherent?: Brad DeLong parses my piece today on the administration's struggle to create jobs while still minding the deficit and pronounces himself "increasingly bewildered about administration thinking."...

Now, obviously, not every member of the administration and every Democrat on the Hill signed onto the [relatively-optimistic late-summer] consensus I describe. But, based on several conversations with people in the administration and on the Hill, I'd say it was the prevailing view. It was the September jobs report (which came out in early October) that really jarred people....

I quote a senior administration official who says that, “The reality is that it’s not too hard to find a Wall Street analyst that says a second stimulus basically cancels itself out almost immediately because of the impact at this stage on government financing costs.”... I happen to agree with DeLong that such a canceling-out is unlikely. But, in fairness to the administration official, my sense is... [he meant] just that it's a risk the administration wants to minimize when it spends money on job creation, not a reason not to spend money on job creation....

If I understand him correctly, DeLong is essentially saying that... it can either be the case that more stimulus now will be ineffective because people will assume we'll run bigger deficits in the future, which raises long-term interest rates. Or it can be the case that more stimulus now will be ineffective because people will assume we'll run smaller deficits in the future [because of higher taxes], and will simply save [to pay the taxes] rather than spend the money. But it can't be the case people will assume we'll run both larger and smaller deficits in the future....

DeLong has put his finger on a relatively important feature of administration thinking on these questions, which is that it's (understandably) a bit all over the place. Some officials think an imminent rise in long-term rates is a potential problem; others think low rates of consumption of additional stimulus is a potential problem; some think both could be problems (under different scenarios); some neither; of the people who think both, different people attach different weights to the different scenarios, etc., etc. I guess the bottom line is that there isn't really a coherent Administration Position here...

And this is the puzzle. Yes, uncertainty is enormous. And any one policy might not work. But that any one individul policy initiative might not work is not an argument for not trying anything--unless you are happy if things develop according to the current-policy forecast and we see an unemployment rate between 9% and 11% for the next year and a half at least.

Thus if I were in the administration I would be trying everything:

• pushing the Fed to buy lots of long-term private bonds by selling some more of its stock of Treasuries...
• pushing the Fed to engage in additional quantitative easing with still more of its current stock of Treasuries...
• pushing the Fed to set an explicit inflation rate target--and to set its GDP deflator inflation target at 3% per year...
• pushing the Fed to declare that if the price level falls below its target it will push to catch it up to where it had hoped to see it...
• more aid to the states to keep them from turning even more into fifty little Herbert Hoovers...
• more infrastructure spending...
• bringing forward in time spending on health care access...
• bringing forward in time spending on controlling global warming...
• tax-increase triggers should the deficit be too large in 2015 and beyond to calm fears that America's fiscal policy will be unbalanced in the long run...
• more banking recapitalization...
• more taking on of private-sector tail risk by the government...
• the full (albeit temporary) nationaization of mortgage finance...

And then reinforce whatever seems to be working.

As one notable economist said yesterday, it's as if once the banks passed their stress tests the High Politicians inside the White House decided that it should simply declare victory on macroeconomic policy and go do other things. And nobody at a higher level than the economic team thought of what had been clear to us since April, and assessed either the medium-run economic consequences--a 10% plus peak unemployment rate likely to be followed by a jobless recovery--or the political consequences--it's hard to think that congress in 2011 and 2012 will be supportive of Obama's initiatives if the 2010 election takes place in an environment of a 10% unemployment rate

This Is a Congressional Joke

Senator Mitch McConnell, that is:

Brian Beutler:

Is This a Congressional Joke?

Senator Conrad voted for Medicare Part D. Senator Gregg voted for the Bush tax cuts. Of the $36 trillion Auerbach-Orszag present-value fiscal gap through 2080 $11 trillion is due to the Bush tax cuts and $6 trillion is due to Medicare Part D. Eliminate those two fiscal policy mistakes, and our long-run (out to 2080) fiscal problem is half the size.

Isn't the easiest thing--and the most obvious thing, and the most constructive thing--Senators Conrad and Gregg could do in order to help fix the deficit is for them to stop making it worse? Isn't the obvious thing for them to resign, and as they resign to tell Americans that they should never elect senators like them again?

Yet now come Senators Kent Conrad and Judd Gregg dressed up in the feathers of deficit hawks:

Colloquy Between Senate Budget Committee Chairman Kent Conrad and Budget Committee Ranking Member Judd Gregg On the Bipartisan Task Force on Responsible Fiscal Action Act

December 10, 2009

Mr. Conrad: This is the headline from "Newsweek" December 7. In fact, it was a cover story: "How Great Powers Fall. Steep debt, slow growth, high spending kill empires -- and America could be next." If you go to the story -- and, by the way, interestingly enough, this is on December 7, Pearl Harbor day. If you go into the story that's in the magazine, it says -- and I quote -- "This is how empires decline. It begins with a debt explosion. It ends with an inexorable reduction in the resources available for the Army, Navy, and Air Force ... If the United States doesn't come up soon with a credible plan to restore the federal budget to balance over the next five to 10 years, the danger is very real that a debt crisis could lead to a major weakening of American power." All we have to do is look at the facts. This shows the debt of the United States from 2001 projecting to 2019....

I hope people are listening. I hope they're paying attention. I hope our colleagues are. A group of us yesterday introduced legislation to confront this debt threat head-on. There are now 31 cosponsors of that legislation: 18 Republicans, 13 Democrats....

It is going to take a special process, a special commitment of the members here and representatives of the Administration to develop a plan that gets us back on track. And it is going to take a special process to bring that plan to this floor for a vote, up or down. That holds, I believe, the best prospects for success. I believe this is a defining moment for this Chamber, for this Congress, for this Administration....

Mr. Gregg: Mr. President?

The Presiding Officer: The Senator from New Hampshire.

Mr. Gregg: It is an honor to join with the Chairman of the Budget Committee. We've worked together for awhile and have a piece of legislation which accomplishes the goals as they have been outlined by the Senator from North Dakota, and that's good news. And really the outpouring of support here in the Senate -- over 31 co-sponsors in just a very short time -- is a sign they are willing to move in this area, and that's good news. Right now in this country, after the possibility of a terrorist getting a weapon of mass destruction and using it against us somewhere here in the United States, the single biggest threat that we face as a nation is the fact that we're on a course toward fiscal insolvency...

I am--in normal times--a deficit hawk. I think the right target for the deficit in normal times is zero, with the added provision that when there are foreseeable future increases in spending shares of GDP we should run a surplus to pay for those foreseeable increases in an actuarially-sound manner. I think this because I know that there will come abnormal times when spending increases are appropriate. And I think that the combination of (a) actuarially-sound provision for future increases in spending shares and (b) nominal balance for the operating budget in normal times will create the headroom for (c) deficit spending in emergencies when it is advisable while (d) maintaining a non-explosive path for the debt as a whole.

But when I look at Senators Conrad and Gregg, I don't recognize fellow members of my species. They may be glueing the feathers of deficit hawks onto themeselves, but they are birds of a very different order--doves, turkeys, chickens, whatever, but I hope they are dodos.

The Bond Market Is Very Calm Indeed...

Treasury sells $13 bln in 30-year bonds at 4.52%:

Since the middle of 2008 the U.S. Treasury has increased the supply of Treasury bonds held by the public by $2.5 trillion. And it has done this without moving the needle at all on either the real or nominal interest rates it has to pay.

It requires a very strange mind indeed to say at this moment that the price elasticity of demand for U.S. Treasury securities right now is so high that additional fiscal stimulus is self-neutralizing...

Jon Chait FTW!!!!

He writes about the Conrad-Gregg deficit commission:

The Deficit Commission Bill Is Here, And It's Insane: Let me get this straight. You have a commission proposing a package of highly unpopular legislative changes. And, in addition to having to surmount the 60-vote barrier in the Senate, which is nearly insurmountable for major legislation and which was avoided for both of the last two major deficit-reducing bills, it's also going to impose a new supermajority requirement in the House and a 78% threshold in the commission itself? To say that this procedure "is designed to get results" shows a very odd understanding of American political institutions. Conrad and Gregg seem to think that instituting major reforms in the public interest is rare because the threshold for passing legislation is too low. Thus they've designed a process that creates new and higher supermajority requirements, on an issue where getting even 51% to sign on is probably impossible. And if that fails, maybe they'll conclude the process was too easy. Next time they could also require the commission members to create a cold fusion reactor or retrieve a magical ring from inside a volcano.

No, no, Jonathan! You have it wrong! The commission will have to destroy the deficit by throwing themselves and it into the erupting volcano!

in Which I Am Becoming Increasingly Bewildered About Administration Thinking

Noam Scheiber reports from inside the Obama Administration:

Balancing The Budget: As of late this summer, Democrats in Washington shared a tidy consensus about the economy: The stimulus was working more or less on schedule, and the job market was gradually recovering. That meant the administration could start thinking about how to rein in the country’s yawning budget deficit, if not actually scale it back yet...

To this my first reaction is: "Huh?" On August 16, 2009 many--Barry Bosworth for one--were saying that the stimulus was, as someone in his audience put it, "1. too slow; 2. too small; 3. too much in silly tax cuts out of which the M[arginal ]P[ropensity to ]C[onsume] will be much less than 1." It's not clear to me whether Noam is setting up an overstated rhetorical antithesis here, or whether the political Democrats really were in a bubble about the state of the economy late last summer.

What followed turned that tidy consensus into a pigsty.... “The entire town is more schizophrenic than I’ve ever seen,” says one senior administration official. “Everyone cares about jobs, and everyone cares about fiscal discipline. The weight shifts week by week, unemployment report by unemployment report.”...

[T]here’s no such win-win solution this time... the only way to further stimulate the economy is to spend. “Now is not the time politically or economically to emphasize fiscal austerity,” says Simon Rosenberg, president of NDN, a Washington think tank. “That day will come.” Rosenberg is surely right about the need to punt for the moment on the deficit. But it turns out that this choice is only the beginning of the discussion, not the end... spending more money now could actually raise long-term rates, thereby offsetting its effect. “The reality is that it’s not too hard to find a Wall Street analyst that says a second stimulus basically cancels itself out almost immediately because of the impact at this stage on government financing costs,” says one senior administration official.

To this, my reaction is: I've been looking for such Wall Street analysts, and have had a hard time finding them--except among the goldbugs, the politically-motivated fellow travelers of Donald Luskin, and others of that ilk. I see a lot of people saying that such a scenario might happen--that it is one possibility. I don't see credible people saying that it is the central tendency. And I don't see anybody selling long-term Treasuries on any substantial scale as a way of betting that such a scenario will come to pass.

Does anybody know to whom Noam and this SAO are referring?

And, of course, if you do fear adverse bond-market reaction to more shot-term government spending, there is an immediate and natural cure:

On paper, the way to deal with this is to spend now while pledging to cut later on, so as to persuade the bond market the infusion is temporary. “Everyone would of course like to be able to do something substantial on jobs in the short term and lock in tough, fiscally responsible policies in the medium term,” says a second administration official. But actually executing this fiscal maneuver is unspeakably difficult.... “The odds that you could get both done in an election year with ten percent unemployment are mighty low,” says this official. It would be hard enough to rally liberals around the cause of deficit reduction so soon after the deepest recession in 70 years; getting the GOP on board would be hopeless. Already, Republicans have shamelessly highlighted Medicare cuts in order to derail health care reform...

This seems to be simply wrong: Those Democrats concerned with jobs now appear to me to be eager to get more spending now even if they have to pay for it with spending caps and revenue triggers five years and more into the future. And those Democrats who are deficit hawks above all are willing to provide more spending now to sweeten the long-term curve bending. It might not work, but there is a sweet spot that everybody on the Democratic side is willing to vote for.

Then the administration, speaking through Noam, becomes less than coherent:

If the administration were to announce, say, a $200 billion job-creation bill along with a tough deficit-reduction package beginning in three or four years, anticipation of the latter could undercut the former. The reason: People who think their taxes will get raised save more and consume less. And, of course, the whole point of additional stimulus is to goose consumption...

You can either say that you think that bigger deficits now that create expectations of bigger deficits in the future will be ineffective, or (if you are Ricardian about it) that bigger deficits now accompanied by expectations of smaller deficits in the future will be ineffetive, but you cannot say both at the same time.

Depression Economics: Some Basic Fiscal Arithmetic

This is an exceptional time--a time in which many of the normal rules of the Dismal Science are changed and transformed. It is a time for, as Paul Krugman puts it, not normal economics but rather “depression economics.” The terms on which the U.S. government can borrow now are exceptionally advantageous. And because of high unemployment the benefits of boosting government purchases are exceptionally large.

The result is that the normal benefits and costs of borrow-and-spend policies by the government are overturned for the short run—for as long as the current economic crisis of high unemployment lasts. Yet I find that many people do not understand that and how arguments that hold perfectly well in normal times do not apply today. In normal times a boost to government purchases:

• Produces a limited increase in production and employment,
• Is associated with a substantial increase in national debt,
• Which crowds out productive private investment,
• And which then must be financed at a sizeable interest rate.

Thus only government spending initiatives that promise a high value for the dollar are worth undertaking. Now, however, things are very different. Let’s run through the arithmetic--first in normal times, and then in a financial crisis-ridden environment like this one.

20091008d epi.pdf

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DeLong Smackdown Watch (Wil Wilkinson Edition)

Will Wilkinson writes::

Anything at All?: Brad DeLong writes:

At this point, anything that boosts the government’s deficit over the next two years passes the benefit-cost test–anything at all.

30,000 more troops to Afghanistan? Anything?

He says it with special emphasis, as though he’s not goofing. But is it even possible to take a claim like that seriously?

All right. Anything that is not positively harmful on its own terms.

The point is that with so many unemployed the resource cost of the government doing things is very close to zero--it is using hands that would otherwise be idle and would not be happy being idle...

The Wrong Jobs Summit

Did I ever remember to post this here? From The Week Online:

The White House is hosting a jobs summit this week. I, however, cannot but think that it is the wrong jobs summit—that it will be the wrong people talking about the wrong things.

Let me back up. Ever since the 1930s and John Hicks--if not before--economists trying to analyze the determinants of spending have focused on two of the economy’s markets: the market for liquidity and the market for savings.

Irving Fisher first analyzed the market for liquidity—the money market—which matches the supply of readily spendable purchasing power in the economy (cash, checking account balances, credit lines) with the demand of households and businesses to hold some of their wealth in the form of readily spendable purchasing power. Supply and demand in this market is influenced by interest rates and the flow of spending.

Knut Wicksell first analyzed the market for savings—usually called “the bond market”—which matches households wishing to boost the value of their savings with businesses seeking capital to expand their productive capacity. Interest rates are crucial here, as well.

At first glance, it seems there are three variables at play: spending, income, and interest rates. But when we recognize that everyone’s spending is someone else’s income, we see that there are really only two variables—that the economy will settle at that level of interest rates, spending, and income where supply equals demand in the market for liquidity and in the market for savings.

We now have a framework for managing the economy. For the government to boost jobs, it must to do something to change the balance of supply and demand in either the market for liquidity or the market for savings. In general, the central bank—the Federal Reserve—acts to tweak supply and demand in the market for liquidity. The president and Congress act to tweak supply and demand in the market for savings. But they must make sure that whatever spending, income, and job-stimulating effect they create by intervening in one market is not undone by changes in the other market.

Right now, if you ask the decisive members of congress—by which I mean the Blue Dog Democrats in the House, or the most conservative Democrats and most liberal Republicans in the Senate —why the president and the Congress are not doing more to reduce unemployment and boost spending and income, the answer you’ll get is ... well, you probably wouldn't get an intelligible answer.

But if you did get an explanation for the lack of congressional action it would go something like this: Attempts to move supply and demand in the market for savings in order to boost spending would (a) increase the national debt burden on future taxpayers and (b) lead to a large decline in bond prices and a boost in interest rates. Why? Because businesses would try to increase their liquidity to support higher spending, driving up interest rates, which, in turn, would cause businesses to cut back on investment, thus neutralizing most or all of the stimulative policies.

Similarly, if you were to ask the Federal Reserve why it isn’t doing more to reduce unemployment and boost spending and income, the answer you would get is this: Spending is in no way constrained by a shortage of liquidity. We have already done all we can do, indeed we have “flooded the zone” with liquidity. As a result, the Fed is disinclined to pursue additional tweaks of supply and demand in the market for liquidity because it fears such efforts would fuel destructive inflation in the future without boosting employment and spending in the present.

Both of these arguments are comprehensible; each might well be true. But they cannot both be true at the same time. Either the economy is so awash in liquidity that the Federal Reserve cannot do much to boost spending—in which case additional spending by the government won’t generate any substantial rise in interest rates. Or additional government spending will crowd out investment as businesses scramble for liquidity and interest rates rise—in which case the economy is not awash in liquidity, and quantitative easing by the Federal Reserve could do a lot right now to boost spending and employment.

It appears that what we have here is a failure to communicate.

In truth, that is nothing new on this front. It was clear, for example, by Feb. 17 of this year, the day Obama signed the stimulus package, that the economy was in much worse shape than earlier projections had supposed. The administration’s policies were targeted at an economy in which the current—December 2009—unemployment rate was projected at 7.8 percent, with a decline to 6.9 percent projected by December 2010.

But we do not live in that world. We live in a world in which the unemployment rate this month is likely, in the final data, to come in at 10.4 percent, and in which the unemployment rate in December 2010 may well exceed 9.6 percent. All of this was known, or suspected, on Feb. 17. But the High Politicians and High Spinmasters of the Obama administration chose not to communicate that grim news. The problem is not that the administration’s policies have not performed as expected; they have, more or less. The trouble is they were devised to treat a bad crisis. And we were living through an even worse one.

Thus we need a jobs summit right now. We need the White House's National Economic Council and key congressional “centrists” on one side and the Federal Reserve Open Market Committee on the other to meet. Those two groups seem to have very inconsistent views of the economic situation. They seem to be working at cross-purposes. Something has to give. If they could reach agreement on whose view of the economy is likely correct, then a rescue plan—entailing either more government spending or greater liquidity—would become obvious.

Until that “jobs summit” is convened, others are moot.

Barack Obama Is On Message...

Good to see:

ROBERT KUTTNER: You know, most of the things that have been proposed today cost money, and there is this concern about the federal deficit. I hope that your administration will recognize, as I know you will, that it's possible, first of all, to reduce the deficit over time and sometimes in the short run realize that you need to increase the deficit. And I hope the concern about the deficit in the long run doesn't crowd out the need for additional spending in the short run. And I also think that some of these programs that increase jobs and increase GDP are probably the fastest way to get the economy back on a track that will reduce the deficit over time. It's certainly a better way to reduce the deficit than putting ourselves into a -- into a debtor's prison and assume we can deflate our way to recovery.

BARACK OBAMA: Well, I think this is an important point. You know, we've been talking a lot about specific initiatives. There is a macroeconomic element to this whole thing. And so let me just amplify what was just said.

We have a structural deficit that is real and growing, apart from the financial crisis. We inherited it. We're spending about 23 percent of GDP and we take in 18 percent of GDP and that gap is growing because health care costs, Medicare and Medicaid in particular, are growing. And we've got to do something about that.

You then layer on top of that the huge loss of tax revenue as a consequence of the financial crisis and the greater demands for unemployment insurance and so forth. That's another layer. Probably the smallest layer is actually what we did in terms of the Recovery Act. I mean, I think there's a misperception out there that somehow the Recovery Act caused these deficits.

No, I mean, we had -- we've got a 9-point-something trillion- dollar deficit, maybe a trillion dollars of it can be attributed to both the Recovery Act as well as the cleanup work that we had to do in terms of the banks. In turns out actually TARP, as wildly unpopular as it has been, has been much cheaper than any of us anticipated.

So that's not what's contributing to the deficit. We've got a long- term structural deficit that is primarily being driven by health care costs, and our long-term entitlement programs. All right? So that's the baseline.

Now, if we can't grow our economy, then it is going to be that much harder for us to reduce the deficit. The single most important thing we could do right now for deficit reduction is to spark strong economic growth, which means that people who've got jobs are paying taxes and businesses that are making profits have taxes -- are paying taxes. That's the most important thing we can do.

We understand that in this administration. That's not always the dialogue that's going on out there in public and we're going to have to do a better job of educating the public on that.

The last thing we would want to do in the midst of what is a weak recovery is us to essentially take more money out of the system either by raising taxes or by drastically slashing spending. And frankly, because state and local governments generally don't have the capacity to engage in deficit spending, some of that obligation falls on the federal government.

Having said that, what is also true is that unless businesses and global capital markets have some sense that we've got a plan, medium and long term, to get the deficit down, it's hard for us to be credible, and that also could be counterproductive. So we've got about as difficult a economic play as is possible, which is to press the accelerator in terms of job growth, but then know when to apply the brakes in the out-years and do that credibly. And you know, we are trying to strike that balance, but we're going to need help from all of you who oftentimes are more credible than politicians in delivering that message.

Because we want to leverage whatever public dollars are spent, and we are under no illusion that somehow the federal government can spend its way out of this recession. But it is absolutely true that any of the ideas that have been -- been mentioned here are still going to require some public dollars, and those are actually good investments to make right now.

It's so nice to have an intelligent, thoughtful, and industrious president...

CBO Fiscal Policy Multipliers

From: http://cbo.gov/ftpdocs/106xx/doc10682/11-30-ARRA.pdf

Yes, the ARRA Is Working: CBO Agrees

The fact that the ARRA was not big enough to put the unemployment rate on a downward trajectory is unfortunate. But now CBO joins in with its assessment that it is indeed working.

Menzie Chinn writes:

Econbrowser: CBO's Assessment of ARRA's Impact on Q3 Output and Employment: From CBO's just released Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output as of September 2009 :

...Economic output and employment in the spring and summer of 2009 were lower than CBO had projected at the beginning of the year. But in CBO's judgment, that outcome reflects greater-than-projected weakness in the underlying economy rather than lower-than-expected effects of ARRA.

In other words, the continued deterioration of the economy through the first few months after the passage of ARRA was not due to the stimulus package; rather underlying conditions had deteriorated, and the economy would have been in a worse state in the absence of the package.... For GDP, the... CEA report's model based approach indicates 3.1 and 3.6 ppts increment (SAAR) in Q2 and Q3, implying 1.66% higher GDP. The midpoint of the CBO range is 2.2 ppts. What about employment? CEA estimated 1.16 million cumulative jobs, by Q3. CBO estimates a range of 0.6-1.6, with midpoint at 1.1 million....

The report also includes a tactfully worded assessment of fully intertemporally-optimizing general equilibrium models, and their usefulness for real world analyses of monetary and fiscal policies in the short run.

Although some analysts favor the rigor of that approach to modeling behavior, other analysts view the assumptions underlying households' and businesses' decisionmaking in those models to be unrealistic and leading to unrealistic predictions. In particular, this type of model generally assumes that people are fully rational and forward-looking, basing their current decisions on a full lifetime plan. The forward-looking assumption implies that people expect to eventually pay for any increased government spending or reduced revenues in the form of future tax increases and that they incorporate those expected payments -- even if far in the future -- into their current spending plans. Thus, they are assumed to reduce their consumption when government spending rises, because their lifetime income has fallen by the amount of the eventual taxes. For the same reason, cash transfer payments and tax refunds have little or no effect on current consumption in such models. People in the models generally also have full access to credit markets, so they can borrow to maintain their consumption when faced with a temporary loss of income. This class of models does not typically incorporate involuntary unemployment: People can work as many hours as they choose at the wage rate determined by the market. Finally, in these models, monetary policy usually follows a fixed rule by which increased output or inflation implies higher real interest rates. [Emphases added]

This is a very clear exposition of CBO's analysis. Those who understood this post will find it very useful. Those unpersuaded by models should look elsewhere for succor.

Deficit-Neutral Stimulus

EPI's American Jobs Plan:

• Strengthen the safety net"

  • unemployment compensation
  • COBRA health coverage
  • nutrition assistance)

• Fiscal relief to state and local governments

• Investments in transportation and schools

• Direct creation of public service jobs

• A new job creation tax credit.

"The American Jobs Plan... will create at least 4.6 million jobs in the first year, at a total first-year gross cost of roughly $400 billion. This entire cost can be recouped within 10 years by enacting a financial transactions tax (FTT), which would take effect three years after enactment... a highly progressive way to raise revenue by imposing a small tax on the sale of stocks and other financial products..."

At this point, anything that boosts the government's deficit over the next two years passes the benefit-cost test--anything at all. And EPI's ways of spending money are much better than anything the Senate is likely to come up with by itself.

The problem with an FTT, of course, is that it needs to be applied everywhere in the world all at once--or midtown Manhattan simply moves to Canary Wharf

Why Are Good Macro Policies Political Losers?

First of all, three points to serve as background:

• From the day after the collapse of Lehman Brothers, the policies followed by the U.S. Treasury and the U.S. Federal Reserve and the U.S. administrations have been very helpful. They have been good ones. The alternative--standing back and watching the markets deal with the situation--would have gotten us a much higher unemployment rate than we have now. Credit easing by the Fed and support of the banking system by the Fed and the Treasury have significantly helped the economy: have kept things from getting much worse.

• The fact that investment bankers did not go bankrupt last December and are profiting immensely this year is a side issue. Each extra percentage point of unemployment lasting for two years costs us $400 billion. A recession twice as deep as the one we have had would have cost us as a country some $2 trillion--and cost the world as a whole four times as much. In that scale and context the bonuses of Goldman Sachs are rounding error. And any attempt to make investment bankers suffer more last fall and winter would have put the entire support operation at risk: as Federal Reserve Vice Chair Don Kohn said, ensuring that a few thousands investment bankers receive their just financial punishment is a non-starter when attempts to do so put the jobs of millions of Americans--and tens of millions outside the United States--at risk.

• The Obama administration's fiscal boost program has also significantly helped the economy: aid to impacted states has been a big win, the jury is still out on the effect of the tax cuts in the stimulus, and the flow of government spending on a whole variety of relatively useful causes is in train and is boosting production and employment in the same way that everyone's boost to spending boosts production and employment. And the cost of carrying the extra debt incurred is extraordinarily low: $12 billion a year of extra taxes would be enough to finance the fiscal boost program at current interest rates, and for that cost American taxpayers will get an extra $1 trillion of produced goods and services and employment will be higher by about ten million job-years.

The big valid complaints about policy over the past fourteen months are not that it has run up the national debt and not that it has rewarded the princes of Wall Street, but rather that it has, if anything, been on too small a scale--that we ought to have done more.

Yet these policies appear, somehow, to be political losers in Washington right now: nobody is proposing to do more along the same lines. This is strange: usually when something works the natural impulse is to do it again.

So we have a big puzzle: Just what is going on in America? Good policies that are working to boost production and employment without causing inflation ought to be politically popular, right?

I think two different things are going on--one with respect to the Obama fiscal boost that is the ARRA, and a second with respect to the TARP and related banking-sector support policies.

With respect to the ARRA--the stimulus package, the Obama fiscal boost--it seems to me that what is going on on the American right is simply (a) an outbreak of extraordinary intellectual and political dishonesty that (b) the press refuses to see.

For two and a half centuries economists have believed that the flow of spending in an economy goes up whenever groups of people decide to spend more. Sometimes and to some degree these increases show up as increases in prices and sometimes and to some degree as increases in production and employment. Sometimes these increases come because there is more spendable cash in the economy and sometimes because changes in opportunity cost make people want to spend the cash they have more rapidly. But always it has been that spending goes up whenever groups decide to spend more--and the government's decisions to spend more are as good as anybody else's, as good as the decisions of the mortgage companies and new homebuyers to spend more buying new houses during the housing bubble of the mid-2000s or of the princes of Silicon Valley to spend more building new companies during the dot-com bubble of the late-1990s.

Chicago economists' arguments that fiscal stimulus can't work are at best incoherent and usually simply wrong. Republican politicians' arguments that fiscal stimulus isn't working are simply ripped out of the Newt Gingrich playbook: lie all the time. Remember that back in 1993 when the Democrats' analyses led them to seek to reduce the deficit and spend less--well, back then the Republicans said that would destroy the economy too. And they were very wrong. But how many media stories about Republican claims make even a small attempt to evaluate them?

A stronger--but not much stronger--argument is that the ARRA is boosting employment and production, but at too great a long-run cost because it has produced too large a boost in America's national debt. If interest rates on U.S. Treasury securities were high and rising rapidly as the debt grew, I would agree with this argument. But that is not the case. Interest rates on U.S. Treasury securities are very low. They are not rising. The argument that the economy has too much debt--that the market does not want more debt--is belied by every single Treasury auction at which the market gobbles up huge new tranches of U.S. Treasury debt at high prices. What the market is telling us is that while the economy has too much private debt--prices of corporate bonds are low, and firms find financing expensive--the economy has too little public U.S. government debt, which everyone wants to hold. Those who claim that we have a debt problem, and you can't cure a debt problem with more debt suppress--sometimes deliberately--that since the start of the financial crisis private debt and U.S. Treasury debt have been very different animals, moving in different directions and behaving in very different ways.

That’s what is going on on the fiscal policy side—with the stimulus package. But what is going on on the banking policy side—with the TARP and its siblings? That I need to think more about...

Debts and Deficits: Martin Wolf Is Right

In general, Martin Wolf is right. Paul Krugman too. And when they explicitly degree they are superright and you can take that to the bank.

Today Martin Wolf has, as usual, very smart things to say about the deficit and the debt:

Give us fiscal austerity, but not quite yet: While the increase in the debt ratio is very large in both [Britain and the U.S.], the levels expected to be reached by 2014 are not historically exceptional, particularly for the UK.... [T]hose past record levels did not create insuperable problems. In the 19th century, both countries grew out of their debt satisfactorily, with price stability. In the second half of the 20th century, they did so again, though inflation then helped.

This is not surprising. Assume that the real rate of interest is 2.5 per cent. Then the servicing costs, in real terms, of a debt burden of 100 per cent of GDP is just 2.5 per cent of GDP – almost a bagatelle. Assume, too, that the trend rate of growth equals the real interest rate (a not unreasonable assumption). Then the requirement for debt stability is a balanced primary budget (that is, before interest payments). Again, this is hardly crippling.

So what is the problem? It is that people may lose confidence that the governments will ultimately bring deficits under control.... [C]utting peacetime deficits is hard: every pound or dollar comes with a lobby group attached. Merely promising to cut deficits lacks plausibility....

Yet even if the fiscal rope is not infinitely long, slashing deficits now would be wrong. It is extremely likely this would tip economies back into recessions, as happened in Japan in the 1990s. Furthermore, the results would also probably include expansion of quantitative and credit easing by central banks. Yet those policies, too, risk undermining credibility....

So what should be done? I agree fully with the remark by Dominique Strauss-Kahn, managing director of the IMF, in London this week that “it is still too early for a general exit” from accommodative policies.... What is needed, instead, are credible fiscal institutions and a road map for tightening that will be implemented, automatically, as and when (but only as and when) the private sector’s spending recovers.... There are losses to be shared, much of which will fall on public spending, taxation, or both. Once it becomes evident that neither of these countries can rise to the challenge, fiscal crises are inevitable. It would only be a question of when.

Britain is in slightly worse shape. But if the United States (a) sticks to PAYGO, and (b) successfully reforms health and bends the curve, it could spend as much as it wanted on fiscal stimulus without worries.

Hoisted from the Archives (2002): Mark-My-Beliefs-to-Market Time: Argentina

Hoisted from the Archives:

Mark-My-Beliefs-to-Market Time: Archive Entry From Brad DeLong's Webjournal: I am reading Michael Mussa's brand-new very short book on the latest Argentinian financial crisis [Michael Mussa (2002), Argentina and the Fund: From Triumph to Tragedy (Washington: Institute for International Economics: 088132339X)]. In The Importance of Being Earnest, Oscar Wilde gets a laugh out of the idea that a chapter on a rupee crisis is too exciting for young ladies--out of the idea that a technical discussion of anything having to do with international finance can be anything but deadly boring. But reading this is different.

First, I'm weird: I'm an economist, which means (these days at least) that I don't even have the sparkle and flash, the willingness to take risks and go out on limbs, that accountants have. Second, the Argentine crisis is an important setback for human happiness--a much more important tragedy even than the closing of a Zambian copper mine. Plus the crisis has important lessons for international economic policy in the future.

Third, Michael Mussa--former chief economist at the IMF for a decade--is a fearless and witty guy: he (reportedly) spoke of his boss at the IMF, Michel Camdessus, as a man who was 'so optimistic he always sees the glass as half full, even when there's no glass at all'; in this book, he writes of the IMF following its standard approach when a government fails to meet the policy targets it has committed to--the standard 'three-monkeys approach: see no evil, hear no evil, speak no evil'; he writes of the proposals of the Meltzer Commission for IMF reform as '...unnecessary, unworkable... fundamentally misguided...'; and he writes of the Fund staff's spring 2001 analysis of the dynamics of Argentina's debt, '...if, if, if... if my grandmother had wheels, she would be a bus...'

Thus I had no trouble staying awake through the book.

Toward its end, Mussa calls for a thorough evaluation of the Fund's role in Argentina, an evaluation to take the broadest possible scope. He writes (p. 71) that:

.>.. it is my view that the Argentine government's basic decision to combine efforts at macroeconomic stabilization with market-oriented reforms was the right policy approach... the spectacular success of the Argentine economy throughout most of the past decade is attributable to this basic policy choice... the spectacular collapse in 2001 is due to the failure to implement this strategy sufficiently vigorously, especially in... fiscal discipline. Others... may be inclined to the view that the policies... are fundamentally wrong and were doomed form the start.... An evaluation of the Fund's role in Argentina should reflect on this broad question...

And so I have begun thinking: What if I wanted to make the argument that the neoliberal policy mix adopted by President Carlos Menem and Finance Minister Domingo Cavallo was a big mistake, that it was all doomed to failure from the beginning and should not have been undertaken, that from the moment he proposed his Convertibility Plan to stop Argentina's hyperinflation the Sunday Horse was pulling the Argentine cart down a track that led nowhere? What would that argument look like?

As I see it, such an argument would have five steps:

First, the neoliberal program pushed by Domingo Cavallo demanded free markets--the end to protectionism, the end to quantitative restrictions of all kinds, the end of limits on freedom of contract, and most importantly the end to controls on the ability of not just goods but money to flow into and out of Argentina, and the end of the government's ability to force Argentines to denominate their wealth in a unit of account--the peso--whose value it controlled.

Second, the neoliberal program pushed by Domingo Cavallo required a hard peg of the value of the peso to the dollar: nothing else would convince Argentines that the days of hyperinflation had passed, and that they no longer had to dissipate resources and waste time insuring themselves against inflation, but could trust the unit of account.

Third, Argentina is a country in which the government constantly promises the people more than it can deliver. It promises rich oligarchs that it will not collect too much in taxes. It promises workers and consumers a generous social insurance state. It promises rapid economic development, large expenditures on infrastructure, jobs for politically well-connected boys, and so forth. An unequal distribution of income and wealth, a lack of social comity between the working and the middle classes, a viciousness in politics going back to General Galtieri, the Dirty War, Juan Peron and his enemies, and even before means that claims on national product and demands that the government enforce those claims are inevitably going to mount up to more than 100% of what is available. The basic political fight over how national product is to be distributed among social classes is unresolved, and any political movement that makes only promises it can keep is doomed to rapid defeat.

Hence, fourth, in Argentina government deficits--large government deficits--are a law of nature, a fact of life. Moreover, everyone knows that large government deficits are a fact of life and a law of nature. Hence interest rates on Argentine debt will be low and reasonable only rarely and for short periods.

Fifth, points one through four mean that the neoliberal reform program in Argentina in the 1990s had exactly the same chance of avoiding disaster as one would expect if one gave a modern gene-splicing biochemistry lab to Doctor Frankenstein. The fundamental unresolved conflicts of Argentine politics mean that debt is going to mount. The fact that everyone knows that Argentine politics generates chronic deficits means that the interest payments due on that debt are likely to explode. Exploding interest payments mean that the dynamics of Argentine debt are unstable, and thus that the hard-currency exchange-rate peg cannot last. And free access to international capital markets, to dollar-denominated bank accounts, and so on, and so forth, means that when the crisis caused by the contradiction between the hard currency peg and the fundamentals of Argentine politics comes, it will be five times as bad: at least with tight controls on foreign exchange and a primitive, underdeveloped banking system, the amount of damage a government default can do to normal economic life is limited.

From this perspective, pushing neoliberal, market-opening reforms on Argentina looks as wise as giving a supply of gasoline to a bunch of pyromaniacs, on the grounds that gasoline is a very useful and powerful fuel.

My intellectual problem right now is that this argument I have just constructed--which was supposed to be a strawman that I, a card-carrying neoliberal, could easily demolish--feels too convincing.

Michael Mussa (2002), Argentina and the Fund: From Triumph to Tragedy (Washington: Institute for International Economics: 088132339X).

Bergsten, p. viii: "[Mussa's] conclusion that the Fund's last pre-crisis loan to Argentina in August 2001 was 'the greatest mistake the Fund made in my ten years there' is thus of considerable importance in the ongoing debate over this crucial and tragic case."

p. 3: "...in other cases... Mexico in 1995; Indonesia, South Korea, and Thailand in the Asian crisis... Brazil... a Fund-supported program was started only after the crisis was already under way. Thus, any failures of the Fund in the pre-crisis period were those of its relatively low-intensity surveillance activities. For Argentina, the failures of the Fund are clearly associated with the core of the Fund's [activities]... when it is providing financial assistance and when the policy and performance of the member are subject to the intense scrutiny of Fund conditionality..."

p.3: "The end result in Argentina has clearly been a disaster... not intended or, until recently, broadly anticipated--by the Argentine authorities, the Fund, or anyone."

p. 4: "...the Fund did make at least two important mistakes... failing to press the Argentine authorities much harder to have a more responsible fiscal policy, especially during the high growth years... extending financial support to Argentina during the summer of 2001, after it had become... clear that... efforts to avoid default and maintain the exchange rate peg had no reasonable chance of success."

pp. 5-6: "...if the Argentines had decided to move to an alternative, more flexible exchange rate and monetary policy regime that maintained reasonable monetary policy discipline, this would also have been acceptable to the Fund. Indeed, at least some in the Fund... would have welcomed serious consideration of such a move..."

p. 6: "As the crisis deepened... and the deficit targets set in the Fund-supported program were missed, the Argentine authorities sought to undertake further austerity measures. The Fund supported these efforts.... However, had the Argentine authorities decided at some time during 2000-2001 ... to pursue an alternative... debt restructuring and a possible change in the exchange rate regime, the Fund would have supported responsible efforts in this direction..."

pp. 9-10: "In sum, if things had broken more in Argentina's favor, this surely would have helped to preserve the success.... Enumerating the many things that contributed to Argentina's tragedy, however, should not obscure the critical, avoidable failure of Argentine economic policy that was the fundamental cause of the disaster--namely, the chronic inability of the Argentine authorities to maintain a responsible fiscal policy..."

pp. 15-16: "In sum, during the period 1993-1998 when the Argentine economy was performing very well [average annual real GDP growth rate of 4.1%] and the Argentina government was receiving substantial nonrecurring revenues from privatization and enjoyed other temporary fiscal benefits [that amounted to 2 percent of a year's GDP], the public-sector debt-to-GDP ratio nevertheless rose by 12 percentage points [from 29 to 41 percent of GDP]. This clearly was not an adequately disciplined or sustainable fiscal policy..."

p. 16: "Because most industrial countries have government debt-to-GDP ratios above 50 percent and some above 100 percent, it might be asked why a debt-to-GDP ratio of just above 40 percent was worrying for Argentina. There are at least five important reasons. First... Argentina has had little success in raising tax revenues (including social security contributions) of more than 20 percent of GDP.... Second... government debt denominated in foreign currency... held externally, Argentina faced the dual challenge of persuading creditors that it was capable both of raising sufficient fiscal revenues to service its debt and of being able to convert these revenues into foreign exchange with an exchange rate that was rigidly pegged to the U.S. dollar.... the ratio of external debt to exports... more than 400 percent.... Third, it is not just the level of the government debt... it is also how the debt has been behaving.... Fourth... Argentina... was potentially vulnerable to external economic shocks.... the collapse of Brazil's crawling-peg exchange rate in early 1999 had important negative spillovers... the debt-to-GDP ratio jumped from 41 percent in 1998 to 50 percent in 2000.... Fifth... Argentina was clearly vulnerable to changes in financial market sentiment... [that might become] self-fulfilling..."

p. 18: "When the actual fiscal deficit began to exceed the program targets during 1995 because of an economy that was weaker than expected, the Fund... showed unusual flexibility (by past Fund standards) in allowing an upward revision of the deficit target. In my view, this was the right approach.... Unfortunately, the Fund's flexibility... was not applied symmetrically. Starting in late 1995, the Argentine economy began three years of very rapid recovery... one would have expected that the Argentine government's fiscal deficit would have come in well below the permitted target... [but] it was just below or even slightly above.... During 1995, when the recession turned out to be steeper... there was plausible reason to grant waivers.... At other times... it is difficult to understand why the Fund did not make active use of its conditionality to press the Argentine government to maintain a more responsible fiscal policy.... And the fiscal targets were significantly less demanding than they appeared to be (even allowing for stronger-than-expected economic growth) because they conveniently ignored... government borrowing that were viewed by the Argentines as off-budget..."

p. 24: "...the fundamental choice of Argentina's monetary policy framework and exchange rate regime was a choice for the duly constituted government of Argentina. The Fund could advise.... However, the basic choice of regime is a decision of the [Fund] member--at least up to the point where the chosen regime has no reasonable chance of success.... Thus, though an independent observer might conclude that the rigidities of the [exchange rate] Convertibility Plan deserve relatively more weight, and the failures of Argentine fiscal policy relatively less weight, in the blame for the tragedy that ultimately befell Argentina, this is not the relevant perspective from which to view the role of the Fund. For the Fund, the relevant question was--given the choice of Argentina to adopt and maintain the Convertibility Plan--what other policies were necessary to make the stabilization and reform effort a success. Given the plan, failure to maintain a sufficiently prudent fiscal policy would likely prove a fatal error. The Fund, having accepted the Convertibility Plan, had the responsibility to press very hard to avoid this fatal error."

pp. 27-30: "For the Fund, the deteriorating situation in Argentina in the autumn of 2000 presented a critical challenge.... A star pupil that the Fund had praised and supported as a model of economic liberalization and reform was in danger of turning into a basket case.... One approach would have been to continue with an essentially standard Fund-supported program... [of] up to 100% of its Fund quota.... The main difficulty... was that... it was clearly inadequate. A second approach would have been to conclude that because of the continuing recession... further official [Fund] support would be available only on the condition that Argentina reach agreement with its private creditors that would substantially reduce its financing requirements in the coming years.... Necessarily, this rescheduling of private credits could not be entirely voluntary.... [A] decision by the Fund in late 2000 to press Argentina into a debt restructuring that would have amounted to a de facto sovereign default would have been a very weighty matter. The Argentine government was dead set against such action.... At the Fund... there was little enthusiasm for such an approach... the Argentine situation was not seen as without realistic hope.... The third approach... actually adopted... [was] levels of support substantially greater than in standard Fund-supported programs... the deficit target would be set so as to carefully balance the need to keep borrowing within responsible limits... against the very real economic and political difficulties of fiscal consolidation in a deepening recession. Official financing would... meet virtually all of Argentina's projected external financing requirements for 2001, assuming the program's fiscal objectives were met..."

pp. 45-8: "By August 2001... prospects for a favorable outcome were pure fantasy.... [I]nterest rate spreads... were... in the range of 1300 to 1600 basis points. This implied nominal interest rates for the Argentine sovereign... of 18 to 22 percent, with real interest rates even higher due to deflation. Economic recovery was impossible in this situation.... The Argentine government's fiscal policy... could not meet its targeted objectives.... The political consensus to raise the huge primary surplus... required to demonstrate sustainable debt dynamics... was, quite understandably, nowhere apparent.... An emergency injection of another $6 billion in cash from the Fund was urgently needed just to stave off immediate default and keep the farce going for another few months.... [A] wide range of analysts... often with differing views on many issues concluded that the game was over for Argentina. Only a fool would conclude otherwise. Why, then, did the Fund... acquiesce in this folly?... Here there was a failure of intellectual courage... and a failure of moral courage.... Argentina was not helped... assistance that was potentially far more valuable in helping to contain the damage once a de facto sovereign default had occurred was instead squandered in a futile effort to avoid the inevitable..."

pp. 60-64: "What should be the elements of the policy program...? Six elements can be delineated.

First, the program should be based on realistically optimistic economic assumptions... real GDP will likely fall 10 to 15 percent in 2002... the value of the peso at the end of 2002... 20 or 25 U.S. cents... domestic inflation... headed over 200 percent [in 2002]...

Second.. the government budget needs... the deficit... within the bounds of what can be financed without... hyperinflation.... Tax revenues are likely to be very low because of the economic collapse and very poor tax compliance... substantial costs to the government from dealing with the mess it has created in the Argentine banking system... the absolutely essential task of reining in the deficits of the provinces and terminating their discretionary authority to borrow...

Third... a reasonable framework for monetary policy... contain the initial inflationary surge from the collapse of the peso and then bring the inflation rate down to more moderate levels during the course of the next two years...

Fourth... [a] unified floating exchange rate... the peso inevitably will depreciate very substantially (from its old parity) in real terms--and even more so in nominal terms...

Fifth, something needs to be done to clean up the horrendous mess in the Argentine banking system.... Four actions of the Argentina government have made the banking system... insolvent.... (1) The government defaulted on its... own dollar-denominated debt... held by Argentine banks. (2) The government reneged on... the Convertibility Plan.... (3) The government mandated that dollar-denominated loans of Argentine banks were payable in pesos. (4) The government mandated that dollar-denominated deposits at Argentina banks be converted into pesos at a [higher] exchange rate...

The first three actions together effectively forced a massive write-down in the dollar value of [bank] assets... a write-down that was unavoidable.... The Argentine government.. lacked the political courage to tell the Argentine people... that the U.S. dollar value of their deposits... was being sharply reduced as a result of government actions. Instead, through the fourth action, the Argentina government sought to purvey the fiction that most of the dollar value of deposits could be preserved... and shift the blame for the losses of depositors from the government to Argentine banks. Now the Argentine public has, with good reason, lost confidence in the banking system and... the government.... Moreover, the owners of Argentine banks... robbed of all their invested capital... have little reason to believe any promises of the Argentine government... no incentive for [anyone]... to put in new capital to refloat the banking system... Sixth... signal their intention to pursue good-faith efforts to deal responsibly with their external sovereign debt.... [F]oreign creditors... need to recognize that... they will not be made whole, but... need to share in the enormous economic losses.... Argentine authorities must ensure that foreign investors are... not forced to accept disproportionately large losses...

p. 67: "The Fund is expected to... act both as a sympathetic social worker and as a tough cop."

"the 'three-monkeys approach' to dealing with government failures to meet policy targets that it has promised the Fund: see no evil, hear no evil, speak no evil..."

p. 71: "... it is my view that the Argentine government's basic decision to combine efforts at macroeconomic stabilization with market-oriented reforms was the right policy approach... the spectacular success of the Argentine economy throughout most of the past decade is attributable to this basic policy choice... the spectacular collapse in 2001 is due to the failure to implement this strategy sufficiently vigorously, especially in... fiscal discipline. Others... may be inclined to the view that the policies... are fundamentally wrong and were doomed form the start.... An evaluation of the Fund's role in Argentina should reflect on this broad question..."

p. 74: proposals of the Meltzer Commission as "...unnecessary, unworkable... fundamentally misguided..."

p. 78: of the Fund staff's spring 2001 analysis of Argentina's debt dynamics, '...if, if, if... If my grandmother had wheels, she would be a bus...'

The People Who Sell Their Forecasts to Paying Clients Believe the Stimulus Is Working

Only those who make their nut one way or the other by pleasing Republicans claim that it isn't. Jackie Calmes and Michael Cooper are on the case:

Jackie Calmes and Michael Cooper: Now that unemployment has topped 10 percent, some liberal-leaning economists see confirmation of their warnings that the $787 billion stimulus package President Obama signed into law last February was way too small. The economy needs a second big infusion, they say. No, some conservative-leaning economists counter, we were right: The package has been wasteful, ineffectual and even harmful to the extent that it adds to the nation’s debt and crowds out private-sector borrowing.

These long-running arguments have flared now that the White House and Congressional leaders are talking about a new “jobs bill.” But with roughly a quarter of the stimulus money out the door after nine months, the accumulation of hard data and real-life experience has allowed more dispassionate analysts to reach a consensus that the stimulus package, messy as it is, is working. The legislation, a variety of economists say, is helping an economy in free fall a year ago to grow again and shed fewer jobs than it otherwise would...

In Which Dean Baker Is Unhappy with the New York Times's Edmund Andrews

Dean Baker:

In Just a Decade the U.S. Interest Burden Could Be as High as It Was in 1992!!!!!!!:

That might not sound scary to most people, but this was the punch line of a front page NYT news story.... The fourth paragraph asserts that:

Even as Treasury officials are racing to lock in today’s low rates by exchanging short-term borrowings for long-term bonds, the government faces a payment shock similar to those that sent legions of overstretched homeowners into default on their mortgages.

No, this is wrong.... [N]o evidence [is] presented in this article that the rise in interest rates will place the U.S. government in a situation where it will be unable to pay its bills.... [N]o one cited in this article makes such a claim.

The article is also completely unbalanced...

It is too bad. The three things people need to know about the deficit are:

• In the long term--after 2020--we get health care spending under control or else.
• In the medium term--between 2012 and 2020--we don't have a debt and deficit problem if congress sticks to PAYGO; we do if it doesn't.
• In the short term--between now and 2012--our problem is not that our deficit is too large but that it is too small.

And Edmund Andrews's piece doesn't help people learn any of those three.

The Biggest Entitlement Spending Cut in History--and "Deficit Hawks" Are Running Away from It - Health-care reform's grand bargain

It's buried in the health care bill. We think it has teeth--and the Congressional Budget Office agrees:

Ezra Klein - Health-care reform's grand bargain: This is how health-care reform controls costs. It is, at its base, a grand bargain: The coverage expansion gets liberals to agree to, and even advocate for, cost controls they would never otherwise consider. A 6 percent growth target? A super-MedPAC -- now called the Independent Medicare Advisory Board -- that reforms Medicare to save money and whose recommendations are fast-tracked and protected from the filibuster? Hundreds of pages of changes to payment rates and experiments in value-based purchasing and coordinated care efforts? This stuff is very, very real, and it goes into effect very quickly. You may think it's impossible for Congress to cut costs in Medicare and the government will just go bankrupt, but even you'd have to admit that this is what it would look like if the government was cutting costs in Medicare.

If this piece of the bill was passed on its own, it would be the most important cost control bill ever considered by the United States Congress. But you could never have passed it on its own. You needed the coverage to make the grand bargain work. Republicans like to call this bill a trillion-dollar experiment to expand the health-care system, and in some ways, it is. But it's also a multitrillion-dollar experiment to cut costs in the health-care system, and it deserves credit for that, and support from fiscal conservatives. It's easy to talk about cutting costs, but this is the chance for people to actually do it.

So why aren't the world's deficit hawks--the Blue Dogs, the (honest) Republican legislators who care about the country, the Concord Coalition, et cetera, et cetera--all out there hosanna-ing about the health care reform bill?

In the case of the (honest) Republican legislators who care about the country, they probably are--but it is hard to observe an empty set. But the rest? Where are they

"There Are... 1.1 Million More Jobs Out There... than Would Have Been Without the Stimulus"

Steve Benen:

The Washington Monthly: Republican critics of the economic recovery efforts, when they're not taking credit for the money that's benefiting their state/district, take it as a given that the stimulus "failed." For the right, it's a foregone conclusion, hardly worth discussing anymore. The New York Times reminds us today that "dispassionate analysts" agree that a fair look at the stimulus package shows that it may be "messy" but it's also "working."

Jackie Calmes and Michael Cooper: The legislation, a variety of economists say, is helping an economy in free fall a year ago to grow again and shed fewer jobs than it otherwise would. Mr. Obama's promise to "save or create" about 3.5 million jobs by the end of 2010 is roughly on track, though far more jobs are being saved than created, especially among states and cities using their money to avoid cutting teachers, police officers and other workers. "It was worth doing -- it's made a difference," said Nigel Gault, chief economist at IHS Global Insight, a financial forecasting and analysis group based in Lexington, Mass. Mr. Gault added: "I don't think it's right to look at it by saying, 'Well, the economy is still doing extremely badly, therefore the stimulus didn't work.' I'm afraid the answer is, yes, we did badly but we would have done even worse without the stimulus."

In interviews, a broad range of economists said the White House and Congress were right to structure the package as a mix of tax cuts and spending, rather than just tax cuts as Republicans prefer or just spending as many Democrats do. And it is fortuitous, many say, that the money gets doled out over two years -- longer for major construction -- considering the probable length of the "jobless recovery" under way as wary employers hold off on new hiring.

Obviously, a bigger investment would have meant a bigger return. The $787 billion package would have been more ambitious if the Senate operated on majority rule, and even White House economists have conceded that the stimulus bill should have been larger to accommodate the size of the hole in the economy. That aid to states had to be curtailed to bring on GOP votes continues to undermine the effectiveness of the strategy. But on the whole, we're talking about a recovery package that saved us from a wholesale economic collapse. Conservative Republicans -- who've been wrong about every major economic challenge of the last generation -- who whine bitterly about the stimulus are, as is usually the case, misguided.

Mark Zandi, chief economist of Moody's Economy.com and an occasional adviser to [John McCain and other] lawmakers from both parties, added, "[T]he stimulus is doing what it was supposed to do -- it is contributing to ending the recession." Zandi added that without the recovery bill, the "G.D.P. would still be negative and unemployment would be firmly over 11 percent. And there are a little over 1.1 million more jobs out there as of October than would have been out there without the stimulus."

Left unsaid is what the economic consequences would have been if we'd listened to congressional Republicans -- 95% of whom voted for a truly insane five-year spending freeze at the height of the downturn.

Politically, however, the stimulus has proven problematic -- much of the public is convinced it didn't work, since the economy is still struggling. The more effort the White House invests in explaining reality, the better.

Naughty, Naughty, Peter Orszag...

Peter Orszag writes:

STATEMENT OF ADMINISTRATION POLICY: H.R. 3961 — Medicare Physician Payment Reform Act of 2009 (Rep. Dingell, D-Michigan, and 6 cosponsors):

The Administration strongly supports House passage of H.R. 3961, the Medicare Physician Payment Reform Act of 2009, and appreciates congressional efforts to ensure that Medicare beneficiaries and TRICARE patients continue to have access to care and their physician of choice. In his FY 2010 Budget, the President recognized the need for comprehensive reform for the Medicare physician payment system. The Administration believes Medicare and the country need to move toward a system in which doctors receive better incentives to provide their patients with higher quality and more efficient care.

H.R. 3961 takes additional steps to reform Medicare physician payments. The Administration is pleased that the bill would eliminate the steep payment cut scheduled for 2010. A cut of this magnitude could reduce access to physicians for Medicare beneficiaries throughout the country. The Administration also supports the provisions that provide a boost to primary care providers by increasing payments for evaluation and management services, such as office visits. H.R. 3961 would also create incentives for broader reforms for Medicare physician payments by encouraging the formation of accountable care organizations, in which groups of providers are jointly responsible for the quality and cost of health care services for beneficiaries with chronic conditions. The Administration remains committed to working with the Congress to achieve comprehensive reforms to Medicare physician payments that will enhance efficient and high-quality care for beneficiaries and protect their choice of physicians. H.R. 3961 is an important step forward in comprehensively reforming the way Medicare pays physicians to provide the very best care to the Nation’s Medicare beneficiaries and the Administration urges the Congress to pass this legislation.

The key, of course, is that although "the bill would eliminate the steep [Medicare physician] payment cut scheduled for 2010" it contains no provisions to pay for that elimination.

If Peter and company want me to use a baseline that assumes that PAYGO will hold, they need to at least whine and whimper at bills that break it.

Just saying...

The Puzzles of American Political Economy Today

Three points to serve as background:

First of all, from the day after the collapse of Lehman Brothers, the policies followed by the U.S. Treasury and the U.S. Federal Reserve and the U.S. administrations have been very helpful. They have been good ones. The alternative--standing back and watching the markets deal with the situation--would have gotten us a much higher unemployment rate than we have now. Credit easing by the Fed and support of the banking system by the Fed and the Treasury have significantly helped the economy: have kept things from getting much worse.

Second, the fact that investment bankers did not go bankrupt last December and are profiting immensely this year is a side issue. Each extra percentage point of unemployment lasting for two years costs us $400 billion. A recession twice as deep as the one we have had would have cost us as a country some $2 trillion--and cost the world as a whole four times as much. In that scale and context the bonuses of Goldman Sachs are rounding error. And any attempt to make investment bankers suffer more last fall and winter would have put the entire support operation at risk: as Federal Reserve Vice Chair Don Kohn said, ensuring that a few thousands investment bankers receive their just financial punishment is a non-starter when attempts to do so put the jobs of millions of Americans--and tens of millions outside the United States--at risk.

Third, the Obama administration's fiscal boost program has also significantly helped the economy: aid to impacted states has been a big win, the jury is still out on the effect of the tax cuts in the stimulus, and the flow of government spending on a whole variety of relatively useful causes is in train and is boosting production and employment in the same way that everyone's boost to spending boosts production and employment. And the cost of carrying the extra debt incurred is extraordinarily low: $12 billion a year of extra taxes would be enough to finance the fiscal boost program at current interest rates, and for that cost American taxpayers will get an extra $1 trillion of produced goods and services and employment will be higher by about ten million job-years.

Thus the big valid complaints about policy over the past fourteen months are not that it has run up the national debt and not that it has rewarded the princes of Wall Street, but rather that it has, if anything, been on too small a scale--that we ought to have done more.

Yet these policies appear, somehow, to be political losers in Washington right now: nobody is proposing to do more along the same lines. This is strange: usually when something works the natural impulse is to do it again.

So what is going on?

What the U.S. Long Bond Market Is Telling Us...

Paul Krugman reads the tea leaves in what looks like the best piece of economic analysis I have read this month. When we do the things we do well, this is the kind of thing we do:

Interest rates: the phantom menace: From various bat squeaks I’ve put together a view of what I think lies behind the surprising — and damaging — deficit squeamishness of the Obama administration. So here’s what I think they’re thinking.... On the face of it, there’s no reason to be worried about interest rates on US debt. Despite large deficits, the Federal government is able to borrow cheaply.... Underlying these low rates is, in turn, the fact that overall borrowing by the nonfinancial sector hasn’t risen: the surge in government borrowing has in fact, less than offset a plunge in private borrowing.

So what’s the problem? Well, what I hear is that officials don’t trust the demand for long-term government debt, because they see it as driven by a “carry trade”: financial players borrowing cheap money short-term, and using it to buy long-term bonds. They fear that the whole thing could evaporate if long-term rates start to rise, imposing capital losses on the people doing the carry trade... driv[ing] rates way up, even though this possibility doesn’t seem to be priced in by the market.

What’s wrong with this picture?

First of all, what would things look like if the debt situation were perfectly OK? The answer, it seems to me, is that it would look just like what we’re seeing.... [T]he private sector is hurting, it’s spooked, and it’s looking for safety. So it’s piling into “cash”, which really means short-term debt.... Meanwhile, the public sector is sustaining demand with deficit spending.... [S]omeone has to be bridging the gap between the short-term assets the public wants to hold and the long-term debt the government wants to issue; call it a carry trade if you like, but it’s a normal and necessary thing. Now, you could and should be worried if this thing looked like a great bubble — if long-term rates looked unreasonably low given the fundamentals. But do they? Long rates fluctuated between 4.5 and 5 percent in the mid-2000s, when the economy was driven by an unsustainable housing boom. Now we face the prospect of a prolonged period of near-zero short-term rates... which should mean substantially lower long rates.... And if we’re facing a Japanese-type lost decade, which seems all too possible, long rates are in fact still unreasonably high.

Still, what about the possibility of a squeeze, in which rising rates for whatever reason produce a vicious circle of collapsing balance sheets among the carry traders, higher rates, and so on? Well, we’ve seen enough of that sort of thing not to dismiss the possibility. But if it does happen, it’s a financial system problem — not a deficit problem. It would basically be saying not that the government is borrowing too much, but that the people conveying funds from savers, who want short-term assets, to the government, which borrows long, are undercapitalized. And the remedy should be financial, not fiscal. Have the Fed buy more long-term debt; or let the government issue more short-term debt. Whatever you do, don’t undermine recovery by calling off jobs creation.

The point is that it’s crazy to let the rescue of the economy be held hostage to what is, if it’s an issue at all, a technical matter of maturity mismatch. And again, it’s not clear that it even is an issue....

I just don’t think the inner circle gets how much danger we’re in from another vicious circle, one that’s real, not hypothetical. The longer high unemployment drags on, the greater the odds that crazy people will win big in the midterm elections — dooming us to economic policy failure on a truly grand scale.

I am not sure Paul is correct when he says that the possible underlying problem is merely "a technical matter of maturity mismatch." The long Treasury market is thinner than many people think: it is not completely implausible to argue that it is giving us the wrong read on what market expectations really are because long Treasuries right now are held by (a) price-insensitive actors like the PBoC and (b) highly-leveraged risk lovers borrowing at close to zero and collecting coupons as they try to pick up nickles in front of the steamroller. And to the extent that the prices at which businesses can borrow are set by a market that keys off the Treasury market, an unwinding of this "carry trade"--if it really exists--could produce bizarre outcomes.

Bear in mind that this whole story requires that the demand curve slope the wrong way for a while--that if the prices for Treasury bonds fall carry traders lose their shirts and exit the market, and so a small fall in Treasury bond prices turns into a crash until someone else steps in to hold the stock...

This is something to think really hard about....

Basic Background Deficit Math

Annual change in the U.S. federal debt-to-GDP ratio, and presidential term averages:

Source: CBO Current-Law Baseline

Ford had bad luck--his presidency coincided with a down phase of the business cycle. But other than Ford, the contrast between the Democrats and the old-style Republicans (Eisenhower and Nixon) on the one hand and the new-style Republicans on the other is quite striking.

Also worth noting is that after this recession is over we do not have a pre-2020 deficit problem--if output grows as projected, and if congress sticks to PAYGO, both of which are very big ifs.

Free Exchange Seems Somewhat... Snittish...

With respect to its: "That's the nature of many of these interventions—we all live to whine another day..."...

For the record, I wrote my piece not to "get a lot of links" but because I was trying to think through what the U.S. government could do over the next two years or so while the economy is flat on its back if it was hit by another big negative shock--as it is every 40 years or so. And I was coming up empty: credit easing does little; quantitative easing would require the resignation of the Fed governors and bank presidents; fiscal policy is out because of worries about the deficit; and banking policy is out because senators won't get out in front because everybody is making money off the TARP except for the government.

So what could we do? We might have to do something, after all, Odds 5%.

It (they?) writes:

Hindsight is occasionally blurry: BRAD DELONG got himself a lot of links yesterday by writing that efforts to save the banking industry last fall, by eroding public trust in government, increased the odds of a replay of the Great Depression from virtually nothing to 5%.... One side of this discussion is whether the government was actually able to handle things differently.... Economics of Contempt says no. I'm sympathetic to Mr Contempt's view, but I also think... the government could have come with something if it had wanted to. And I agree with Felix Salmon.... "[Y]es, given a bit more aggression and foresight, the Fed could have tried to cram down a haircut onto AIG’s counterparties. But at the time, no one was particularly interested in being harsh to the global financial sector; instead, they were trying to rescue it..."

Perhaps Mr DeLong is right, and America now faces a 5% probability of Depression. On the other hand, if you swapped out the folks who were in charge last fall with a group inclined to drive a hard bargain with the banks, you might find yourself in a world in which the Fed and the Treasury fail to convince markets that they'll do whatever they have to do save the financial system, in which a nasty cycle of deleveraging continues to drive important institutions into the ground, and in which the odds of Depression rise to 5%, or higher.

That's the nature of many of these interventions—we all live to whine another day...

Ummm... With respect to Felix, the key issue is not making AIG creditors take a haircut but rather making them share the upside with the government--as Chrysler shared the upside with the government with its loan guarantee program, as Al Gore was able to stand up there at the VP debate in 1996 and say that the U.S. had made money out of its bailout of Mexico.

If Free Exchange wants to ignore the fact that we are now out of macroeconomic running room, they are of course free to do so. But it might be more constructive for Free Exchange to help me think how we can get some of that running room back. We might need it. We might need it real bad.

Fiscal Expansion That Is Deficit Neutral in the Long Run

Mark Thoma is alarmed by our president:

Economist's View: Obama's Wrong-Headed Thinking on the Deficit: Edward Harrison catches this quote from Obama....

Obama warned the United States' climbing national debt could drag the country into a "double-dip recession," though he said he's still considering additional tax incentives for businesses to reverse the rising unemployment rate. "There may be some tax provisions that can encourage businesses to hire sooner rather than sitting on the sidelines. So we're taking a look at those," Obama told Fox News' Major Garrett. "I think it is important, though, to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession."

I hope his economic advisers set him straight, though I suppose there's a chance that this nonsense is coming from them. We needed a larger stimulus package to begin with, and the economy could still use more help, labor markets in particular. Let's hope that this doesn't turn into a call to actually start balancing the budget before the economy has fully recovered as that would increase the chances of the double dip recession that he is so worried about (something we should have learned from the 1937-38 experience where an attempt to balance the budget prematurely plunged the economy back into recession)...

One way to interpret this--which may or may not be wrong--is that right now we are really and truly fracked beyond previous imagining. Let's go back to the old ca. 1960 standard macroeconomic diagram, with the interest rate on the vertical axis and the economy's level of spending on the horizontal axis. We then have:

• A red curve the IS curve, which tells us what the economy's (real) spending level is--the sum of household spending on consumption, business spending on investment, net exports, all functions of this real interest rate, plus government purchases) as a function of the current value of the (real, long-term, risky) interest rate (and also of lots of other stuff that affects the position of the curve)...

• A blue curve, the LM curve, which tells us what the (short-term safe nominal) interest rate is as a function of the (nominal) spending level that is consistent with households' and businesses' being willing to hold the economy's current money stock...

• A double-headed orange arrow, the spread, the difference between the short-term safe nomina interest rate and the long-term risky real interest rate--the difference between the two being the sum of a term premium, an expected inflation rate, and a risk and default premium...

In this framework, the problem with credit easing--the central bank increasing the money supply now and moving the blue curve to the right without changing expectations of what the money stock will be in the long-term future--is that the curve has flat because cash and short-term Treasury bonds are close substitutes, so you expand the money supply by a lot while doing little to boost spending and employment and land yourself with the problem of unwinding the money stock increase in the future in a way that does not hurt spending and employment when you do so:

(Quantitative easing--pouring a whole bunch of cash in the system with the idea of never reversing the money stock expansion could boost spending and employment considerably by creating expectations of inflation and so reducing the spread--but the Federal Reserve is not going there, and regards the idea with horror, shock, and shame.)

In this framework, banking policy--recapitalizing banks further and issuing government guarantees to shrink the spread--boosts spending and employment even when, as now, cash and short-term Treasuries are close substitutes. The problem with banking policy today is that no member of congress of either party of any political persuasion wants to get out in front supporting it.

In this framework, the problem with fiscal expansion--the government purchasing a bunch more things right now and so shifting the red curve to the right--is that it boosts the supply of government bonds in the future and so may raise the double-headed orange arrow that is the spread, getting you absolutely nowhere:

So what can we do? Looks like we are well and truly fracked.

Well. maybe not. My position on further fiscal expansion is twofold:

• The claim that further government purchases would widen the spread might be true. It might now. Let's try it and see. The debt held by the public on Monday was $7,632,033,766,420.46. The debt held by the public a year and a half ago was $5,218,570,776,014.84. We have managed to boost the debt held by the public by $2,413,462,990,405.62 in eighteen months without materially moving the term premium significantly. (The risk premium has moved--there is a financial crisis on, after all.) So let's try it and find out.

• This is an opportunity. We really need to reduce the deficit after 2030. We really need to have more government purchases now. So raise spending now, and raise taxes and impose spending caps starting in 2013 so that by the end of the 20-year budget window the projected debt is unchanged. Thus we move the red line without increasing the spread: there's now increased supply of bonds in the long term to push up the interest rate on them. And we solve both our current near-depression problem and our post-2030 structural deficit problem.

Chance of Great Depression Now 5%...

For 2 1/4 years now I have been saying that there is no chance of a repeat of the Great Depression or anything like it--that we know what to do and how to do it and will do it if things turn south.

I don't think I can say that anymore. In my estimation the chances of another big downward shock to the U.S. economy--a shock that would carry us from the 1/3-of-a-Great-Depression we have now to 2/3 or more--are about 5%. And it now looks very much as if if such a shock hits the U.S. government will be unable to do a d----- thing about it.

We could cushion the impact of another big downward shock by a lot more deficit spending--unemployment, after all, goes down whenever anybody spends more (even though sometimes falling unemployment comes at too-high a price in rising inflation), and the government's money is as good as anybody else's. But the centrist Democratic legislative caucus has now dug in its heels behind the position that we cannot undertake more deficit spending right now because we have a dire structural health-care financing proble afrer 2030. The Republican legislative causes has now dug in its heels behind the position that the fact that unemployment is 10% shows not that policy earlier this year was too cautious but rather that it was ineffective. And the Obama administration has not been able or has not tried to move either of those groups out of their current entrenchments.

We could cushion the impact of another big downward shock by recapitalizing the banks again. But the failure of the Fed and the Treasury in the aftermath of Lehman to grab a share of the upside from its capital injection and purchase operations for the public in the form of warrants means that there is no coalition anywhere for a repeat or anything like a repeat of propping-up the banking system: the right thinks it is an unwarranted intervention in the free market, the left thinks that it is a giveaway to the undeserving and feckless superrich, and the center is bewildered because it is an enormous and poorly-structured intervention in the market, it is a giveaway to the undeserving and feckless superrich, and the optics are terrible.

So if another big bad shock hits the U.S. economy, what could the Obama administration possibly do?

Hugh Son of Bloomberg:

Fed ‘Severely Limited’ Savings on AIG, Watchdog Says: n American International Group Inc.’s rescue by refusing to compel banks to take concessions, said a Treasury Department watchdog. The Fed didn’t use its “considerable leverage” as regulator of several of AIG’s counterparties to force them to accept so-called haircuts on credit-default swaps, Neil Barofsky, special inspector for the Troubled Asset Relief Program, said today in a report. The regulator gave up efforts to negotiate discounts from the banks after two days and opted to pay them in full for $62.1 billion in swaps, Barofsky said. “These policy decisions came with a cost -- they led directly to a negotiating strategy with the counterparties that even then-New York Fed President Geithner acknowledged had little likelihood of success,” Barofsky said.

Timothy Geithner, now Treasury secretary, was among officials who took over negotiations with the banks from AIG in November 2008. Lawmakers including Representative Darrell Issa have said the September 2008 AIG rescue was a “backdoor bailout” for banks that received billions in payments. The Fed contacted eight of AIG’s biggest counterparties by telephone last year to negotiate discounts, Barofsky said. While UBS AG, the Zurich-based bank, was willing to make a 2 percent concession, the Fed decided that all counterparties would receive full payment, he said.

‘Misuse’ of Power

In a letter to Barofsky included in his report, the Fed said it “would not have been appropriate to use our supervisory authority on behalf of AIG to obtain concessions from domestic counterparties.” Doing so would have been a “misuse” of power that would have given an advantage to non-U.S. banks that the Fed doesn’t regulate, the Fed said. Andrew Williams, a Treasury spokesman, said in an e-mail statement that Barofsky’s report:

overlooks the central lesson learned from the unprecedented steps taken to support AIG. The federal government needs better tools to deal with the impending failure of a large institution in extraordinary circumstances like those facing us last fall,” Williams said. “It is for these reasons that the Obama administration has proposed a regulatory reform agenda that includes giving the government the emergency authority to resolve a significant, interconnected financial institution...

"Criticizing the Health Care Bill for Not Doing Enough on Cost Control Is Like Criticizing the Yankees for Not Winning the Super Bowl..."

Ezra Klein talks to Jon Gruber:

Does health-care reform do enough on cost control?: My view is, even if the bill did no cost control it would be an incredible thing for this country. But politically, it sets the stage for cost control in two senses. First, it puts in place all the things we can do now. It does comparative effectiveness and pilots and all the rest. But second, once you get coverage off the table, the conversation gets more focused on cost control.... [I]n Massachusetts... Health Care for All... realized that they would lose all this coverage they'd gained if it didn't control costs. So they got behind real cost-control measures. A global budget, even. People say you can't do coverage without cost control. I think it's the opposite. You can't do cost control before coverage. We would do a huge amount for the cause of cost control just by covering people....

One of my frustrations with the cost-control discussion is that people set this up like a choice between this bill and a bill with more cost control. In reality, it seems more like a choice between this bill and nothing. And this bill does a lot more cost control than nothing.... Do you know Pascal's wager? Why not believe in God? I think of health-care reform similarly. We don't know if we'll really bend the cost curve. But if we do this and we don't do anything, we still go bankrupt in 100 years. We don't lose much. But if we do it and it works, then it's a savior.

It also moves the conversation on cost control.... It does real things... then it does real things to make cost control more politically viable.... To kill this bill for not doing enough on cost control would be like criticizing the Yankees for not winning the Super Bowl. They won the World Series! They did what they could do!

Economist Mom Hopes That the Obama Administration Is Thinking Sensibly About the Medium Run Deficit

Even though they are not yet talking sensibly--like about the need for sticking to PAYGO over the medium run.

Economist Mom:

Peter Orszag on the Tough Specifics of Deficit Reduction: The President’s budget director, Peter Orszag, was on NPR’s Morning Edition on Wednesday morning.  He talked about the really difficult fiscal policy dilemma the federal government faces right now–dealing with both an unusually severe recession and a worsening longer-term budget outlook (emphasis added):

“On the one hand, [you have] the GDP gap, the gap between how much the economy is producing and how much it could produce, and, on the other hand, these deficits,” he says. “If we only faced one or the other, the way forward would be clearer. But balancing between the two keeps me up at night.”

Sometime around 2011 to 2013, “that’s where we’re going to start to need some transition from the extraordinary assistance that the federal government has been providing to try to jump-start the economy,” he says. “We’re working through [this], and we haven’t made final decisions on the best path to walk down from where we are now to where we need to get.”

Personally, I’d like to believe they’re mulling over the Bush tax cuts and President Obama’s campaign promises, weighing economic and political costs versus benefits.  Here’s a little hint (emphasis added):

Orszag makes no apologies for not projecting a balanced budget anytime in the near-term: “You have to remember the situation that we inherited.”

The Medicare Prescription Drug Benefit and the 2001 and 2003 tax cuts weren’t paid for, he points out. That was compounded by the reduction in tax revenue from the economic downturn, the cost of the economic stimulus and the need for increased spending on unemployment benefits and food stamps.

“So, the point being, we inherited a big hole,” Orszag says.

Sounds like not paying for the 2001 and 2003 tax cuts was a bad idea, and that the current revenue system is not keeping up with our spending needs (even ongoing, not just the temporarily high spending needs associated with stimulus).  It sounds like by 2011-13 we ought to be considering a fundamental reform of the tax system.  I’d like to suggest that “fundamental tax reform” ought to mean more than deciding which parts of the Bush tax cuts should get extended.

And as Peter points out:

“The thing about the politics of the deficit is that the deficit is unpopular, but so are many specific steps to reduce it,” Orszag says. “There are some that will decry the deficit but are unwilling to embrace anything that will actually bring it down.”

Well, I think the Administration well understands the biggest (and specific) ways in which fiscal policy can affect the budget outlook over the next ten years– and it’s not health care reform (which is much more about the much longer-term outlook).  It’s the reason, by the way, why Concord’s online budget challenge (based on CBO’s “Budget Options”) seems lopsided in favor of tax increases over entitlement cuts:  because the fiscally-irresponsible policies of the Bush Administration that the Obama Administration now blames for the awful budget outlook were lopsided on the tax-cut side.  It’s not that CBO or Concord prefers raising taxes to cutting spending.  It’s that that’s where the biggest levers are to significantly change the budget outlook anytime soon–meaning right after the economy is strong again, maybe in 2011-13, like Peter says.

Macroeconomic Scholasticism

Brother Joseph Gagnon makes a few points:

The Liquidity Trap Does Not Make Monetary Policy Ineffective: With short-term risk-free interest rates essentially at zero in the major developed economies, conventional monetary policy is in a liquidity trap. As a number of commentators have observed, printing zero-interest-rate money to buy zero-interest-rate assets has no real economic effect because the assets are near-perfect substitutes for money. But does that mean that central banks have lost their power? Jim Hamilton asserts that central bank purchases of other assets, with positive yields, can always create inflation, though he is silent as to whether they can affect output....

In recent months, central banks have purchased large quantities of longer-term assets. These purchases appear to have been effective at pushing down longer-term interest rates, which should stimulate economic activity. For example, the Federal Reserve (Fed) has purchased large quantities of longer-term agency-backed securities and Treasury bonds.... Fed communications about such purchases had substantial effects on a range of long-term interest rates, including on assets that were not included in the purchase program, such as interest rate swaps and corporate bonds.

Since March 19, the Fed has not made any substantive changes to its planned purchases of longer-term assets. Over this period, the 10-year Treasury yield has risen about 75 basis points and the corporate yield has fallen about 200 basis points, reflecting a relaxation of the extreme financial strains and flight-to-quality that characterized the first few months of this year. Conventional fixed mortgage rates, a key target of the Fed's policy easing, have changed little on balance since late March.

Paul Krugman has argued that potential gains and losses when long-term interest rates move make a policy of purchasing such bonds especially risky, and that fiscal stimulus is a safer bet. However, central banks, including the Fed, have always held risky assets, including long-term bonds, foreign exchange reserves, loans to private banks, and even equities. In many cases, such assets comprise the bulk of the central bank's portfolio.

A good definition of expansionary monetary policy is the printing of money to purchase financial assets. Expansionary fiscal policy is the selling of financial assets to purchase goods and services, to cut taxes, or to increase transfers. On these definitions, both monetary and fiscal policy can be effective when short-term interest rates are zero.

I would prefer to divide the policy universe into four categories:

• Monetary policy is the purchase or sale of Treasury bills for cash.
• Fiscal policy is the selling of bonds by the government to cover a deficit.
• Quantitative easing policy is the altering of market expectations of the long-run path of the money stock.
• Banking policy is the altering of the quantity, duration, or riskiness of the assets (other than Treasury bills) held by the private sector.

I think this provides the cleanest and closest to orthogonal basis for discussing macroeconomic policy.

But others may agree. This is a discussion for us Schoolmen and Schoolladies, and us Schoolmen and Schoolladies only...

The Cretinism of Parliaments, U.S. Congress Class...

• In the short term, we don't have a deficit problem: as long as unemployment remains highly elevated--certainly as long as the unemployment rate stays above 7%--and as long as interest rates on U.S. Treasuries stay low a bigger federal deficit is a feature not a bug: our short-term deficit problem (and the short term lasts for most of Obama's remaining term) is that the deficit is too small, not too big.

• In the long term, our deficit problem is a federal government health spending problem. Unless medical care cost growth is brought under control--and here the drivers are not factors specific to government programs, for private-sector medical expenditures are exploding at least as rapidly as Medicare and Medicaid--then excess medical cost growth will lead the federal government health programs to first devour the rest of the social insurance state in the years after 2020 and then devour themselves.

• In the medium term between 2012 and 2020 we are, current projections tell us, on a sustainable budget path--with a budget deficit "no larger than the average of the past thirty years," as the Bush administration flacks used to tell us--with a stable debt-to-GDP ratio as long as output does not grow more slowly than projected and as long as congress observes PAYGO: as long as congress pays for whatever policy changes it makes.

Doug Elmendorf's worry--the thing that makes him pay attention not to the solid medium-term sustainable-deficit lines in the graph above but to the dotted medium-term unsustainable-deficit lines in the graph above--is that congress will not pay for the policy changes it enacts.

So now let's turn the microphone over to Matthew Yglesias:

The Surprisingly Easy Medium-Term Budget Fix: The dashed lines, however, represent a “current policy” scenario in which we assume that some of the Bush tax cuts will be extended and also that the AMT threshold will continue to be pushed up. Those are reasonable assumptions.... Elmendorf, in other words, isn’t wrong to worry about that.

But... this nuance is lost on the man in the street. The problem... isn’t... that we’re driving toward the edge of the cliff. The problem is... congress seems overwhelmingly likely to steer us [over the cliff].... It’s absurd for [congressional] politicians to be... engaged in highly public deficit hand-wringing...

while not admitting that they could solve the problem by simply saying no.

Senator Evan Bayh and others sound a lot like they are saying: "The President needs to do something to keep us from voting the way we have decided to vote!!"

That's just sad.

Just say "PAYGO," starting in fiscal 2012. That's all that it will (probably) take for the medium term...

Politics and the Federal Deficit Mess

David Wessel reports:

The Federal Deficit Mess in a Single Sentence: Douglas Elmendorf, the director of the Congressional Budget Office, gave a speech the other day at the Association for Public Policy Analysis and Management. In it, he nicely summarized the federal government’s long-term fiscal problem in one sentence:

The country faces a fundamental disconnect between the services the people expect the government to provide, particularly in the form of benefits for older Americans, and the tax revenues that people are willing to send to the government to finance those service...

Every thing else is detail.

One of the key details, I think, is that there are now three factions in American politics:

1. Democrats who think that spending should be higher than today's tax level affords--but who think that resolving the gap is the Republicans' problem.

2. Republicans who think that taxes should be lower than today's and projected future spending requires--but who think that resolving the gap is the Democrats' problem.

3. Democrats who think that spending should be higher than today's tax level affords and who think that resolving the gap is everybody's problem.

Missing are (4), the Republicans who think that taxes should be lower than today's and projected future spending requires, and who think that resolving the gap is everybody's problem. I used to think there were such Republicans--Bob Dole, Pete Domenici, Warren Rudman, Phil Gramm, Gregg Judd. But a Berkeley colleague put me straight:

Domenici talks a very good game about fiscal prudence and stability--boy does he talk a very good game--but when the chips are down he does what the Republican Senate leadership wants him to do, and he does it all the time.

You can watch Keith Hennessey freak out over this absence, spinning like mad in an extraordinarily unconvincing way, here:

The inherited deficits fallacy: Director Orszag is correct that neither the Medicare drug benefit nor the tax cuts were offset with other spending cuts or tax increases. He fails to tell you that in 2003 Congressional Democrats wanted to spend more on Medicare drugs.... He fails to tell you that President Obama did not propose means-testing the drug benefit.... He also fails to tell you that President Obama’s budget proposes to continue $3.2 trillion of the 2001 and 2003 tax cuts and the AMT patches.... Director Orszag is picking and choosing particular policies to try to assign blame.  How much of future deficits are because future Medicare spending was not offset when Medicare was enacted in 1965? This is closely related to the PAYGO myth the Administration is trying to popularize....

Republicans, including President Bush, generally try to offset proposed mandatory spending increases with spending cuts.... This was violated for the Medicare drug benefit.... President Bush developed a proposal to package the Medicare drug benefit with dramatic changes to restructure fee-for-service Medicare and make it compete with private health plans on a level playing field. This proposal would have more than offset the increased spending from the drug benefit.  House Republican Leaders (in 2003) rejected these reforms and insisted on just doing the drug benefit because AARP and Congressional Democrats opposed the reforms...

The "Republicans, including President Bush, generally try to offset proposed mandatory spending increases with spending cuts..." is, as best as I can see, either a brazen lie, a sign that Keith Hennessey has lost all contact with our reality, or a sign that he is indeed a visitor from a parallel universe in which Larry Summers still has a beard.

Hennessey wishes that he lived in a world in which there were Republicans of group (4).

But that world isn't this one.

I urge him to (i) either come across the aisle and join us Democrats in group (3) (God knows we need help), or (ii) turn all his energies not to defending the really-existing Republicans of (2) by fighting with Peter Orszag but instead to trying to destroy them. Unless and until he limits their influence, the Republican ticket is simply not something that anybody who knows the federal budget numbers can with honor vote for...

How Much of It Was Reagan's Fault?

Paul Krugman taunts the innumerate right some more:

Reagan mythbusting, productivity edition: Just to be clear: when I show that growth by every measure has been slower since 1980 than before, I’m not claiming that this shows that Reagan/finance caused the slowdown. The upper hand, in this case, is actually on the other foot: it’s the Reagan/finance enthusiasts who use the alleged fact of faster growth to make their case, so I’m just showing that it never happened. What’s funny — almost touching, really — is the way the enthusiasts respond to each refutation by claiming that there must be another number which justifies their triumphalism. Real GDP grew faster! No? OK, real GDP per capita grew faster! No? Well, productivity grew faster! Actually, no....

But there’s more to the story. Postwar productivity growth had three eras: a period of rapid growth from the late 40s to the early 70s, then a big slowdown that lasted until the mid 90s, then an acceleration that continues to this day.... [T]he Reaganauts... in addition to doing a disappearing act on the growth during the postwar generation... have retroactively attributed the post-95 productivity surge to Reagan. Because, you see, a surge that began midway through Bill Clinton’s administration was obviously caused by Reagan’s 1981 tax cut.Oh, and never mind the almost universal prediction on the right that the 1993 tax increase would lead to economic disaster.

Why did productivity stagnate for 20 years, then revive? The truth is that it probably had very little to do with anyone’s economic policies; the best guess is that businesses spent two decades figuring out what to do with information technology, then found the answer: big box stores! But that’s a subject for another post.

Run an extra 4% of GDP deficit and--if you push the social marginal product of investment up to 15% via taxes, labor rents, and spillovers--you can say that Reaganomics costs you 0.6% per year in economic growth, which over 15 years leaves you with a country 9% poorer than it would otherwise have been.

If you want to supercharge it, you can then say that the infotech revolution required that everybody have invested a certain amount in high-tech in order for Intel and company to learn-by-doing, and get bigger numbers.

And you can super-supercharge it by pointing to income and wealth inequality as well--where Reagan does leave a bunch of fingerprints--and take median wages rather than productivity as your principal outcome variable.

Take these together, and add the appropriate grains of salt, and I am happy saying that Reagan and George W. Bush cost the average worker somewhere between 5 and 10% of his or her wages as of 1994 or so. And that is pretty good...

Reed College Public Policy Lecture: Today's Financial Crisis in a Historical Mirror (November 7, 2009)

Audio: Reed Public Policy Lecture (11.07.2009 03-14-36 PM)

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Download now or preview on posterous

Reed College Public Policy.doc (3307 KB)

Download pdf: 20091107 reed slides.pdf

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Posted via email from http://braddelong.posterous.com/reed-college-public-policy-lecture-todays-fin at Brad DeLong's Scrapbook

Another Bad Employment Report

The Bureau of Labor Statistics reports:

The unemployment rate rose from 9.8 to 10.2 percent in October, and nonfarm payroll employment continued to decline (-190,000).... Since the start of the recession in December 2007, the number of unemployed persons has risen by 8.2 million, and the unemployment rate has grown by 5.3 percentage points.

Among the major worker groups, the unemployment rates for adult men (10.7 per- cent) and whites (9.5 percent) rose in October. The jobless rates for adult women (8.1 percent), teenagers (27.6 percent), blacks (15.7 percent), and Hispanics (13.1 percent) were little changed over the month. The unemployment rate for Asians was 7.5 percent, not seasonally adjusted.

The number of long-term unemployed (those jobless for 27 weeks and over) was little changed over the month at 5.6 million. In October, 35.6 percent of unemployed persons were jobless for 27 weeks or more. (See table A-9.)

The civilian labor force participation rate was little changed over the month at 65.1 percent. The employment-population ratio continued to decline in October, falling to 58.5 percent...

If you had told everyone last election day what would happen, economically, in 2009, what policies would they have adopted then to stem this disaster?

And why aren't we implementing those policies now?

We Are Hiding in Our Burrows Right Now...

Andrew Samwick is shrill:

A Question for Peggy Noonan: When Did Our Callous Childhood Begin: A friend pointed me to this column by Peggy Noonan in last week's WSJ, "We're Governed by Callous Children." I think she is right in her main point about a disheartened leadership class in business and a mindless leadership class in government. 

But she makes the same mistake that other Republican commentators make when they criticize our current leadership.  Specifically, she does not come out forthrightly to identify the one characteristic that separates adults from children: children don't have to balance their budgets, but adults do.  As much as she may admire Reagan, it was his administration that began our 30-year fascination with outsized deficits.  (The deficit mentality nearly went away with Clinton but came back with a vengeance with his successor.)

We will not get out of our current predicament until we face up to the reality that we cannot continue to spend more than we earn (or in the government's case, tax), and that the limits on spending ought to come naturally precisely because we observe not just the benefits but the costs in real time. 

I think that what has people disheartened is that there is almost no one in Washington -- not even an identifiable faction of one of the two main parties -- who is willing to act on this fact.  So people expect the so-called solutions to make the underlying problems worse.  To suggest that callousness or mindlessness (her words) are features of only the current administration and Congressional leadership is ridiculous.

Hey, this is America.  If you don't like the current leaders, we can always get some new ones.  Is it too early to start the "Bruce Bartlett in 2012" campaign?

Let me assure Andrew that the Rubin wing of the Democratic Party is still out there. My view is that making a noise right now is highly counterproductive--that for the next two years or so we need bigger government deficits, not smaller ones.

But watch for us to come out of our burrows when the unemployment rate falls below 7.5%...

Bill Galston Says: The Obama Administration Should Adopt Bad Economic Policies

It is remarkable:

More Signs Of Trouble For 2010: Still, Democrats must ask themselves whether there’s anything they can do over the next year--for example, a meaningful shift toward fiscal restraint--to reduce the intensity level of the conservative assault. If not, the combination of an energized opposition and an electorate battered by high unemployment, slow growth, and the perception of out-of-control spending could set the stage for an ugly outcome...

A "meaningful shift toward fiscal restraint" means an unemployment rate that is likely to be not steady at around 10% a year from now but rising toward 12%.

Even if one is as narrow-minded as Bill Galston and focuses not on what are good policies but what policies are politically advantageous, adopting policies to raise the unemployment rate does not seem to be the kind of thing one should advocate, does it?

Does Bill Galston ever talk to any economists?

Does Bill Galston even know any economists?

In Which Jared Bernstein Does a Bad, Bad Thing...

He talks about the federal budgetary impact of the stimulus program as if it were its net "cost." It isn't.

Of course, the misinformation starts with ABC's Jake Tapper:

$160,000 Per Stimulus Job? White House Calls That 'Calculator Abuse': Posting its results late this afternoon at Recovery.gov, the White House claimed 640,329 jobs have been created or saved because of the $159 billion in stimulus funds allocated as of Sept. 30.... Ed DeSeve, senior advisor to the president for Recovery Act implementation, said he'd been "scrubbing" the job estimates so much since they came it at the beginning of the month that he now has "dishpan hands and my fingers are worn to the nub."...

The White House argues that the actual job number is actually larger than 640,000 -- closer to 1 million jobs when one factors in stimulus jobs added in October and, more importantly, jobs created indirectly, such as "the waitress who's still on the job," Vice President Biden said today.

So let's see. Assuming their number is right -- 160 billion divided by 1 million. Does that mean the stimulus costs taxpayers $160,000 per job? Jared Bernstein, chief economist and senior economic advisor to the vice president, called that "calculator abuse." He said the cost per job was actually $92,000 -- but acknowledged that estimate is for the whole stimulus package as of the end of 2010...

Jared fell into a trap. The right way to do the accounting is, for each extra year of employment we get:

-$92,000	Direct federal cost
+$27,000	Extra federal and state revenue
$0	Extra costs of debt financing
$110,000	Value of goods and services produced
-$18,000	Discount because we are buying different goods and services than we would ideally, or buying them at a different time
$50,000	Value of having a job to the person who gets one--these aren't people who are indifferent between going to work and getting their head together, after all
+$77,000	Net Benefit to Economy

It's OK to talk about the federal budgetary impact of the stimulus program per job as a "cost" when you are talking to economists who understand the issues.

It is not OK when you are talking to Jake Tapper, who is playing a game of "gotcha."

The right way to do it is, as the table above suggests:

1. The federal government spends $92,000 and increases its deficit by that much--that's a cost.
2. Federal, state, and local governments collect an extra $27,000 in taxes--that's a benefit.
3. There are--given that we are in a liquidity trap--no additional costs of financing the rest of the government's debt imposed by this increase. Investors are not skittish and do not need to be bribed to hold extra government debt in their portfolios by the government offering to pay them higher interest rates. Instead, investors are desperate right now for more Treasury bonds to hold in their portfolios.
4. The extra people put to work produce $110,000 of useful stuff--that's a benefit.
5. However, because we are pulling forward spending from the future into the present--spending the $92,000 now rather than in the future--we are buying stuff too soon, and because the government is all thumbs we are to some degree buying less valuable stuff than we woul ordinarily by buying. Figure a 20% discount--that's an $18,000 cost.
6. The people who get the jobs are really happy--it's not as though they are indifferent between working this year and taking time off to get their head together, after all. Not having a job this year greatly harms their quality of life.

Net impact: +$77,000 for each employment-year rescued.

We should be doing more of this right now.

Why shouldn't we be doing more deficit spending all the time? Usually because of (6): when the economy is in its normal state, the marginal worker is somebody who doesn't value having a job all that much--the (6) number is usually on the order of $10,000 rather than $50,000, and so isn't worth the -$18,000 cost of having the government actually do the buying. Plus there is (3): (3)--the crowding-out term--can be quite substantial.

But it isn't now.

In Which the Financial Times Echoes St. Augustine of Hippo

"Give us fiscal continence--but not yet." That's a very good line. I am going to steal it.

You know, Warren Buffett and company could choose to make the Washington Post as informative and as witty as the Financial Times tomorrow--if they cared to. Both may die in the coming crash of the newspaper industry. But we all should really be doing everything we can to make sure that the FT and its culture survive: it is a global treasure.[1]

The FT:

US engine revs up: his spending spree is brittler than one would like. The durable goods spurt--even as disposable incomes fell--was powered by a car scrappage scheme that borrowed GDP from the future more than anything else. With motor vehicles excluded, output grew by only 1.9 per cent. Up to half of that in turn consisted of businesses rebuilding depleted inventories – a sign of optimism, but also, like cash-for-clunkers, a one-off boost to output that will not persist.

Which is why government action remains crucial to nurse this economy back to health. The administration is a good third of the way through a stimulus package that is indispensable to prevent growth from slowing down again. Federal spending rose briskly; now is not the time to cut this stimulus short.

Moreover, cash-strapped state and local governments are the dark spot in this improving picture: their spending was the only GDP component that went into decline. Congress would do well to consider using its ability to borrow cheaply to assist capitols and town halls banned from engaging in deficit spending on their own.

A credible plan for deficit-cutting is urgently needed; its implementation is not. Those who think deficit spending a sin may pray for government continence – but not yet.

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[1] And that the *Washington Post dies quickly: it is not.

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UPDATE: Paul Krugman and St. Augustine, 20 months ago:

St. Augustine and macroeconomic policy: I’ve had a few comments on my post about defining the macroeconomic problem, in which I say that the US economy is unbalanced, with too much consumption and too large a trade deficit, and that

the goal of monetary and fiscal policy should be to bridge the gap — to sustain spending until a falling trade deficit comes to the rescue, and to hasten the rise in net exports.

The objections run along these lines: since consumption has to come down, we should do nothing to delay the adjustment.

My answer, basically, is St. Augustine’s prayer:

Grant me chastity and continence, but not yet.

Ideally, we want the fall in consumption spending to move no faster than the rise in net exports caused by a weak dollar — if consumption falls too fast, we’ll have a deep recession.

Now, we can’t expect perfect timing, and my guess is that at least a moderate recession is already baked in. But we can try to make this less painful.

Mark Thoma on the Need for More Economic Stimulus

He writes:

Economist's View: "The Weakest Recovery in Modern Memory"?: Output is not expected to return to potential until well into 2012. Now recall the long delay between the end of the last two recessions and the peak in the unemployment rate.... To be fully effective, plans for additional stimulus should have been in place long ago. However, given how long the recovery is expected to take, it's not too late to do more if we get started right away. But the political climate makes it highly unlikely that labor markets and the economy will get the help that they need.

The New York Times Editorial Board Understands Macro

Unlike vote 60--or even vote 50--in the senate, and unlike every single congressional republican, they have a clue:

The Case for More Stimulus: Corporate profitability has been boosted by job cuts, pay cuts and a drive to restock depleted inventories. Immense federal stimulus has jolted the economy. But what happens when those measures run their course? The economy is going to need more government support, or it is bound to be very weak for a very long time — and vulnerable to a relapse into recession. Unemployment is expected to worsen well into next year, exceeding 10 percent. Foreclosures are expected to rise, which will push home values down further. Hundreds of small and midsize banks are likely to fail in coming years. State and local governments face budget shortfalls in 2010 that are as bad or worse than this year’s.

Yet Washington is not providing a coherent plan for effective stimulus.... Congressional Republicans say continued economic weakness is proof that February’s stimulus package failed. Lawmakers in both parties fret that large budget deficits preclude more stimulus.... Both arguments are wrong.... [T]he immediate need for stimulus trumps the longer-term need for deficit reduction....

Congress and the administration should agree on ways to ease the dire financial condition of the states. Most important is continued aid for state Medicaid programs, which would ensure vital services, support jobs and free up money for other needs. Governors will begin to prepare their new budgets in early 2010, and those budgets will be in effect for a year, starting in July....

Without another round of effective stimulus, the worst recession in modern memory will likely become — at best — the weakest recovery in modern memory. Another boost to federal spending that is targeted and timely should not be too much for politicians to deliver.

Recipes for Recovery

Sam Brittan says something smart:

Sam Brittan’s Recipe for Recovery: Commercial banks certainly worsened the recession by greedily seeking higher returns than those provided by market interest rates; and they can put grit in the recovery by refusing to lend. I can only suggest making Paul Krugman, the radical Keynesian economist, Comptroller of the US Currency with over-reaching powers to take over old banks and initiate new ones, with similar appointments in other countries...

Paul Krugman says "ahem!":

I would... quarrel with designating me a “radical Keynesian.”... A perfectly standard New Keynesian model, with intertemporal optimization and all that — the kind of model that is standard in freshwater courses — says that under current conditions fiscal stimulus should be very strong, much stronger than what we’re actually doing. Ryan Lizza’s piece on the Obama economics team makes it clear that Christina Romer — whom nobody would call radical — reached more or less the same conclusions in her economic analysis that I did. The point is that what passes for “sound” economics these days (and maybe most days) isn’t actually sound economics — it’s economic analysis trimmed and softened to fit political realities/prejudices. Questioning that notion of soundness isn’t being radical; it’s just being intellectually honest.

To put it another way, Milton Friedman and Jacob Viner would fit Brittan's definition of "radical Keynesian" these days.

You gotta get demand up. You can do it by deficit spending. You can do it by convincing banks to lend and businesses to borrow. But you gotta do it somehow, by some means.

Yes, We Can--Afford More Short-Run Deficit Spending, That Is

We are live at The Week: We Can Afford More Short-Run Deficit Spending:

This is an exceptional time—a time in which many of the normal rules of the Dismal Science don't apply because, as Paul Krugman puts it, "depression economics" is in the driver's seat. The normal benefits and costs of government borrow-and-spend policies are overturned for now—and for as long as the crisis of high unemployment lasts.

Yet I find that many people do not understand why arguments that make perfect sense in normal times do not apply today. Let's run through the arithmetic—first in normal times, and then in a financial crisis like this one.

In normal times, a boost to government purchases:

• Produces a limited increase in production and employment;
• Creates a substantial increase in national debt;
• And requires that this new debt be financed at a sizeable interest rate.

Consequently, only government spending initiatives that promise a high value for the dollar are worth undertaking. Consider a $100 billion boost to government purchases. In a normal year, the Federal Reserve will worry about inflation, and raise interest rates somewhat to offset the inflationary impact of the fiscal boost. The multiplier effect of the purchases will therefore be something like 0.4—we will spend $100 billion on government purchases and gain perhaps $40 billion in extra production and associated employment out of it. Those who earn that extra $40 billion will pay taxes—perhaps $16 billion. So the net impact on government debt is this: by spending an extra $100 billion we will have added some $84 billion to the national debt.

That debt must then be amortized. At a five-percent-per-year long-run real rate of interest on government bonds, amortizing that debt will cost Americans $4.2 billion a year.

But wait—there is more. The Federal Reserve's compensatory increase in interest rates will also reduce investment. Because of the $100 billion in government purchases, perhaps $60 billion of private investment that would have been made won't be made—it will be crowded out. As a result of the lower capital stock, some $6 billion a year of income that would have been earned won't be.

Thus the net cost will be a reduction in Americans' disposable incomes of $10.2 billion per year.

That is not an attractive bargain: to purchase $40 billion of extra production now at the expense of a reduction in incomes of $10.2 billion in every year in the future. That is a usurious real interest rate of 25.5 percent. No sane economist would recommend a policy with such costs and benefits.

But how different everything looks in those rare times—like now—when depression economics applies!

First, more government spending will not lead the Federal Reserve to raise interest rates to fight inflation; the Federal Reserve has pushed interest rates to the floor right now and wishes it could push them lower still—perhaps another 5 percent into negative terrain. Given that, the multiplier on government spending is not 0.4, but more like 1.5. In other words, we do not get $40 billion of additional production and employment for $100 billion in government spending: We get $150 billion.

How? The federal government spends money to buy something it would not otherwise have purchased, thereby taking that product out of business inventories. Typically, businesses would respond by saying, "Our goods are flying off the shelves; we should raise our prices." As businesses raise their prices, (most of) what the federal government bought would be offset by a decline in private purchases because private buyers, confronting increased prices, decide to hold off on purchases.

But, again, now is not normal. Now, businesses respond to the federal government's purchases by saying, "Demand for our goods is greater than we thought; we don't need to fire as many people." The workers who they don't fire retain incomes they would not otherwise have had, and so they are a bit freer with their spending than they would be otherwise. Add up the extra spending by the federal government, and the extra spending by people who would have been fired but for the spending by the federal government, apply the appropriate offsets, and you wind up with a multiplier that most forecasters—by which I mean people who actually make their livings selling forecasts to businesses—think is probably around 1.5. Thus we get $1.50 of economy-wide spending for each $1 of stuff bought by the federal government.

Second, that boost to production creates a substantial reflow in taxes that makes the spending program lunch not free, but cheaper; $150 billion of added production leads to $60 billion of additional tax revenue, leading to only $40 billion in increased debt.

Third, depression economics means not only that there is no offsetting Federal Reserve interest rate increase, but also that the government can borrow at uniquely favorable terms: 2 percent per year in real terms for the next 30 years. Amortizing the $40 billion of additional government debt requires only $800 million a year in additional interest payments and taxes.

Fourth, the absence of interest rate increases means that there is no crowding-out of private investment. Private-sector incomes down the road are unchanged—or increased.

So the net cost of gaining $150 billion in increased production and incomes this year is $800 million a year going forward. It's not a free lunch—they take away my union card as an economist if I start claiming that things are free lunches—but it is a very cheap lunch: like getting a 2 lb. lobster with all the trimmings for $1.95.

Clearly, a second round of stimulus right now would be a very good deal for the American economy. But how big should the fiscal boost be?

Given the arithmetic, it is a no-brainer that we should be doing an extra $100 billion in stimulus. In fact, it is a no-brainer that we should be doing several $100-billion tranches.

How many? Well, the arithmetic holds until:

• Further tranches of additional deficit spending stoke inflation and lead the Federal Reserve to offset their impact on production and employment;
• Further tranches lead to a deterioration in the long-term corporate bond market and crowd-out private investment;
• Further tranches undermine confidence in U.S. long-term public finances and must be financed at higher Treasury interest rates.

Last December, Lawrence Summers and the rest of Obama's incoming National Economic Council feared that increasing the size of the stimulus program from $800 billion to $1.2 trillion would bring the above factors into play. It is now reasonably clear that they were overly pessimistic about the effects of additional short-term government spending, in large part because they were overly optimistic about the state of the economy.

So how much should the government spend? I would favor starting with $100 billion next month, and continuing with an additional $100 billion every month thereafter. Meantime, we should keep an eye on the bond market and inflation forecasts. As long as the terms on which the U.S. government can borrow are exceptionally advantageous, and the unemployment rate remains exceptionally high, the benefits of government spending will continue to be exceptionally large.

Washington Post Crashed-and-Burned-and-Smoking Watch

Why oh why can't we have a better press corps?

James Fallows on why all the works of Fred Hiatt and his colleagues in Washington Post editorial are bad fishwrap:

Don't these people have The Google?: Would it have been so hard to mention the complicating fact that Nobel prizes are only for still-living people? And that this is a basic element of discussion when, for example, the literature prize rolls around each year?... The FAQ page at NobelPrize.org (yes! there is such a site) makes this clear... Maybe they should have exceptions for deaths within the calendar year. Etc. But these are the widely-understood rules. Who is on the copy desk these days? Or writing editorial like this?

As I have said, grave moral fault attaches to all who enable this by paying money to the Washington Post company for any purpose. And Princeton Review does a much better job of running test preparation courses than Stanley Kaplan does.

Even worse: Fred Hiatt this morning:

Re-Stimulating. Unemployment is bad. More fiscal debt might be worse: AT 9.8 PERCENT, the unemployment rate is higher than it has been since it hit 10.1 percent in June 1983. Since the recession began 21 months ago, the economy has shed nearly 7 million jobs. Whole industries -- cars, housing, finance -- have been devastated and may never recover fully. Nevertheless, White House economists reported in September that "employment is estimated to be between 600,000 and 1.1 million higher than it would otherwise have been" because of the Obama administration's stimulus plan and other government policies, especially the Fed's monetary expansion. While no one can prove or disprove that -- much less apportion credit between fiscal and monetary policy -- basic economics suggests that things might have been even worse if the government had done nothing...

It does not necessarily follow, however, that the economy needs more stimulus now. Government has managed to blunt the recession, but at a cost -- a higher national debt burden, which future Americans must pay off by working harder and saving more than they otherwise would have...

Ummm...

So far the stimulus spendout has been some $160 billion. The midpoint estimate by Christy Romer and company is that GDP is now 1% higher than it would have been otherwise. That higher level of production and employment than we would have seen otherwise is going to lead to the collection of an extra $80 billion in tax revenues. That means that the net effect of the $160 billion we have pushed out the door has been to raise the national debt by $80 billion. The Treasury can now borrow through its TIPS program for 20 years at an interest rate of 2% plus inflation. That means that taxes in the future have to be higher by $1.6 billion per year--by $5 per person per year.

Thus the stimulus package so far:

• Incur an extra forward-looking tax burden per person of 1.3 cents per day...
• Get an extra 800,000 people productively at work--and get all the stuff they make and do--this year...

That looks like a very good deal: buying an extra productive job for an American today at a cost of $2000 per year in higher taxes looking forward--particularly when you think that some of those extra jobs build up our productive capacity to make us richer in the future as well.

The stimulus arithmetic suggests we should be doing more of it. The benefit-cost ratio at current stimulus spending levels is very good, and there is no reason to think that Olympia Snowe was a proper judge last February of when the benefit-cost ratio turns down.

But nobody on Fred Hiatt's staff realized this. For nobody on Fred Hiatt's staff thinks that doing any arithmetic is part of their job description. Indeed, nobody on Fred Hiatt's staff is capable of doing any arithmetic at all.

They blather on:

The real question is whether the benefits of pumping even more government fuel into America's engine outweigh the risks. We see several reasons to doubt it. The first is the sheer immensity of stimulus policies already in place.... A second reason for skepticism is the intellectual poverty of some policy proposals.... [B]orrowing new money to move demand from the future to the present -- whether it's demand for houses, cars, or workers -- is a dubious proposition.

Let's set ourselves a national goal: close down the Washington Post down by July 2012.

Robert Waldmann on Justin Fox Trying to Referee John Cochrane v. Paul Krugman

I really think Robert's head exploded somewhere in here:

Cochrane Vs Krugman ~ Angry Bear: According to Fox, [Cochrane] wrote:

The centerpiece of our crash was not the relatively free stock or real estate markets, it was the highly regulated commercial banks...

Now he can't believe that.... No one could be that ignorant... fail to have noticed that commercial banks are more tightly regulated than investment banks (especially recently after capital requirements for investment banks were massively relaxed). Writing "commercial banks" when everyone knows that "investment banks" would be closer to the truth is not plausible ignorance.

Cochrane may be completely ignorant about the macro literature except for that recently written somewhere near a great lake, but he must know that investment banks suffered more dramatically than commercial banks. I'm not sure he has noticed that there are no longer any investment banks -- that is all banks in the US are now parts of partly FED-regulated firms, but I am sure that he knows that Bear Sterns, Lehman, and Merrill Lynch are not commercial banks.

One more thing about [Justin] Fox, he concedes that Krugman's arguments are not based on formal models, he fails to note that the arguments made by the Fresh water economists aren't based on any models at all.

I'd be the first to agree with Cochrane that Krugman's vigorous pro-stimulus arguments are based more on hunches and guesswork and politics and history than on any kind of rigorous economic model. I've been even less impressed, though, with anti-stimulus arguments that claim to be based on rigorous models but are utterly devoid of historical perspective, curiosity and common sense.

They have models in which the labor market clears, they are not quite crazy enough to argue that there is no unemployment right now. They make arguments which don't make sense... certainly are less based on any formal model than Krugman's arguments. Fox clearly knows this. That's why he puts in the disclaimer "claim to be based". However, he is a journalist so he can't note that the arguments are definitely not based on formal models. This is he-says-she-says journalism. I'm sure Fox has read Krugman and DeLong on the lack of a model behind the arguments.

It is easy to see if there is a model or there isn't (hint there are models on Krugman's blog -- Fox can check if Fama or Cochrane have presented a model which supports their conclusions. He can ask them to send him their model. He should be able to tell if there is a model of if there isn't and if the model leads to the conclusion.

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Let me say that I am with Robert in the exploding-head brigade. Two years ago, if you had asked me, I would say that practically all economists shared a consensus theory of nominal spending and income. It is Milton Friedman's theory. It goes like this:

• Demand for money is proportional to the benefits of holding money--which are in turn proportional to nominal income.

• Demand for money is also a declining function of the costs of holding money: the short-term nominal interest rate on Treasury securities.

• You can flip the money demand function around and get a prediction of what spending will be as an increasing function of the money stock and of the interest rate, and of other things.

• Expansionary open-market operation monetary policies that raise the money stock also lower interest rates, and have strong effects on nominal spending and income when interest rates are normal, but have weak effects on spending when interest rates are very low and bank reserves and short-term Treasury securities are close substitutes.

• Banking and fiscal policies can affect interest rates and thus change the level of spending holding the money stock constant, but there is lots of uncertainty and disagreement about how well these policies work.

Yet now I find that Luigi Zingales does not know what I thought was this consensus theory. David K. Levine does not know this consensus theory. John Cochrane does not know this consensus theory. Edward Prescott does not know this consensus theory. Eugene Fama does not know this consensus theory but somehow thinks the equilibrium condition that is the savings-investment identity is also a behavioral relationship. Michele Boldrin does not know this consensus theory. Peter Diamond assures me that Robert Lucas does know this consensus theory of nominal income but you could have fooled me from what he has been writing over the past year.

Objects in Your Calendar Are Closer than They Appear...

Reed College:

Reed College | Public Policy Lecture Series: Brad DeLong: “Financial Crisis and the Macroeconomy, 1825-Present”

Saturday, November 7, 2 p.m., Vollum lecture hall: J. Bradford DeLong, who served during the Clinton administration as deputy assistant secretary of economic policy for the U.S. Department of the Treasury, is professor of economics at UC Berkeley, chair of UC Berkeley’s political economy major, and a research associate of the National Bureau of Economic Research.. He has written on the evolution and functioning of the U.S. and other nations’ stock markets, the dynamics of long-run economic growth, the making of economic policy, the changing nature of the American business cycle, and the history of economic thought. Before joining the Treasury Department, DeLong was Danziger Associate Professor in the economics department at Harvard University. He has also been a John M. Olin Fellow at the National Bureau of Economic Research, an assistant professor of economics at Boston University, and a lecturer in the department of economics at MIT.

Presented in partnership with the economics department and Reed's Parent & Family Weekend. Sponsored by the Walter Krause Fund for Lectures in Economics.

Rolling Sisyphus's Boulder Uphill a Little...

Atrios watches:

Eschaton: If only they'd listened to the DFHs to begin with. At least the Obama people are now musing out loud about further don't-call-it-a-stimulus stimulus measures.

It would be very nice to pass something through the congress this month...

Ryan Lizza, Dean Baker, and the "Worst Fears" of Advocates of More Expansionary Fiscal Policy

Dean Baker complains about Ryan Lizza:

New Yorker Rewrites Economic History/a>: We get no mention of the stock bubble when the piece extols the wonders of the economy in the Clinton years. Nor do we get any mention of the over-valued dollar, a direct outcome of the Rubin-Summers management of the East Asian financial crisis. The collapse of the stock bubble in 2000-2002, coupled with the over-valuation of the dollar, created the serious downturn from which the housing bubble arose. Summers role in ignoring financial bubbles and touting financial deregulation gives him a good share of the credit for the current crisis.

Finally, we are told in conclusion that: "So far, none of the worst fears of those who believed that the stimulus was too small or that nationalization was the only option or that taking over car companies would destroy the fabric of capitalism have materialized." Sorry, but this is wrong, big time. The worst fears of some of us who said that the stimulus was too small were that we would be sitting around with 10 percent unemployment for a long period of time and that stimulus would be discredited. That pretty well describes the world we live in, even that may not be the case in New Yorker land...

Now, now, Dean. Expansionary. is not discredited--in large part because we have been loudly yelling for nine months now that it looked too small to do the job properly.

And Ryan Lizza is careful: he does not say "none of the fears of those who believed that the stimulus was too small have materialized"; he says "none of the worst fears of those who believed that the stimulus was too small... have materialized." Our worst fears were that right now the unemployment rate would be screaming upwards toward fifteen percent. And it hasn't even breached twelve yet.