Grasping Reality with Both Hands

Something to Fear in Health Reform

Andrew Biggs: The problem is not that health spending is growing too rapidly--we want it to grow about as rapidly as it is. The problem is that the level of health spending is about twice what it should be. (I would add: and that the distribution of our health spending is all wrong as well.)

He writes:

A Dog in the Healthcare Fight: [S]pending on veterinary care... and national health expenditures (for people).... Two things are interesting here: first, the rate of growth of spending from 1984 to 2006 wasn’t all that different--and in both cases, spending grew faster than the rate of economic growth. As new technologies are developed for humans, we adopt them for Bowser and Fifi—because we can afford to and we think it’s worth it. I personally took my Alaskan Malamute to a Washington-area practice that was known as the “Mayo Clinic of veterinarians” —and I suspect this wasn’t because, like the real Mayo Clinic, it keeps costs low.

?But second, the level of spending was very, very different: we spend hundreds of times more on ourselves than on our pets. The main reason for this is obvious: we value our own lives and those of our families more than we do our pets or other animals. At the same time, however, veterinary care is one of the few areas of health where we are directly confronted with difficult decisions regarding the costs and benefits of additional treatments. As the famed RAND health experiment showed, out-of-pocket costs can significantly affect the level of health spending without changing health outcomes.

This again highlights that the real issue with healthcare may not be the rate of growth but the level of health spending--and the fact that so much of it seems to be wasteful. This distinction is important because it shapes our policy priorities. The level of spending has different causes than the rate of growth of spending, among them our healthcare system’s structural incentives to overspend. Rather than attempting merely to temper cost growth, plans that remove incentives for overspending, improve consumer choice, or pay doctors based on quality rather than quantity of service could reduce the overall level of spending.

Andrew is scared of a health reform focused on restraining the rate of growth of health spending that does so by slowing down the rate of adoption of new health techologies. The alternative--a health reform that gets us better value for our money and that leads us to spend less--gores powerful oxen because each dollar not spent will be a dollar that does not flow to the income of somebody who votes today. By constrast, the people who will die thirty years hence becaues we haven't invested in growing cloned kidneys don't know now who they are.

I am scared too.

Cracking Christiano, Eichenbaum, and Rebelo's Big Multipliers without Coffee...

Greg Mankiw asks a question:

Greg Mankiw's Blog: Modern macro even Paul Krugman will love: Lately, Paul Krugman has been dissing modern macroeconomics, mainly because many macroeconomists do not agree with his conclusions about fiscal policy. This new paper by Marty Eichenbaum, Larry Christiano, and Sergio Rebelo should, however, make Paul happy. They report large fiscal policy multipliers in a new Keynesian DSGE model when the economy is at the zero interest lower bound.

An open question: How can the results in this paper be reconciled with results by John Cogan, Tobias Cwik, John Taylor, and Volker Wieland, who seem to perform a similar policy simulation in a similar model but reach a very different conclusion? Are there subtle differences in the models? Or subtle differences in the policy experiments? Or did one team simply make a mistake of some sort?

Figuring out why these two prominent teams of researchers come to opposite conclusions about fiscal policy multipliers, and which conclusion is more applicable to actual policy, would be a good paper topic for an ambitious grad student.

As I understand it, the big problem with Cogan, Cwik, Taylor, and Wieland is that there is nothing special going on at the zero nominal interest rate bound. In their model, a fiscal expansion (a) raises expected future inflation, which (b) creates expectations of future interest rate rises by the Federal Reserve to cool off that inflation, which (c) damps present spending, and so (d) shrinks the multiplier. Their model is a model of a small multiplier in an economy away from the zero nominal interest rate bound when central banks are targeting inflation.

Christiano, Eichenbaum, and Rebelo, by contrast, have a model in which:

a shock increases desired savings.... When the shock is small enough, the real interest rate falls and there is a modest decline in output. However, when the shock is large enough, the zero bound becomes binding.... The only force that can induce the fall in saving required to re-establish equilibrium is a large transitory fall in output. The fall in output must be very large because hitting the zero bound creates an economic meltdown. A fall in output lowers marginal cost and generates expected deflation which leads to a rise in the real interest rate. This increase in the real interest rate leads to a rise in desired savings which partially undoes the effect of the fall in output. As a consequence, the total fall in output required to reduce savings to zero is very large. This scenario captures the paradox of thrift originally emphasized by Keynes (1936).... The government spending multiplier is large when the zero bound is binding because an increase in government spending lowers desired national savings and shortcuts the meltdown created by the paradox of thrift...

That said, I think that the CER multipliers are much too large to be applicable to our world today. If I understand CER completely (which I may not: the coffee has not yet hit the brain this morning), their Calvo pricing assumption creates a direct link between output Y and inflation π. Recall the flow -of-funds balance equation:

S(Y, 0-π) = D + I(0-π)

Savings S as an increasing function of income Y and of the real interest rate, which is the nominal interest rate 0 (we are at the lower bound) minus the inflation rate π, is equal to the government deficit D plus investment I which is a decreasing function of the real interest rate, which is the nominal interest rate 0 minus the inflation rate π.

An increase in the deficit thus (a) directly increases saving S necessary to finance the deficit which requires a direct increase in Y. But this direct increase in Y then increases inflation π--there is less deflation. And less deflation means both less savings and more investment. So the direct effect increase in Y does not generate enough savings to close the gap in the flow-of-funds market: savings must increase by more--which requires that Y increase by even more. The government deficit thus genuinely "primes the pump" and the multiplier is very large.

This channel is, I think, the channel pointed to by those who think that the New Deal had an enormous impact, as Roosevelt's deficits in combination with the increase in price rigidity produced by the NIRA and the breaking of deflationary expectations created by the abandonment of the gold standard diminished desired S.

But I don't think we have big expectations of deflation right now. And I don't think fiscal policy moves right now are having a great deal of effect in reducing expected deflation. So I don't think the interaction of output gaps and deflation is playing a big role in boosting the multiplier right now...

I may well, however, assign CER next March when I hit the Great Depression week in Econ 210a as an argument for why Cary Brown's estimates of the fiscal policy effect of the New Deal are too low...

And it is nice to see a model in which J. Bradford DeLong and Lawrence H. Summers (1986), "In Increased Price Flexibility Destabilizing?" American Economic Review makes a reappearence...

Effects of the Stimulus Package: in Which the Usually Sharp-Eyed Felix Salmon Is Wrong!

Felix Salmon:

Why I’m unconvinced by calls for a second stimulus package: Let me try to hazard an answer to that. Start with the guiding assumption, as stated by Larry Summers when the stimulus bill was going through Congress, that the risks of spending too much paled in comparison with the risks of spending too little. And because the effects of government spending on GDP and unemployment are hard to predict with any accuracy, there was a strong case that a monster $800 billion stimulus bill was in many ways the prudent course of action.

Since then, however, the economy has done much worse than anybody thought it would. Which is one way of saying that the stimulus has not done as well as people thought it would. This is a useful datapoint — and one way of looking at it is to conclude that the stimulus was so big that the last few hundred billion dollars have had virtually no positive effect at all. And that any extra stimulus would similarly achieve very little...

Ummmm.... No.

Jared Bernstein and Christy Romer constructed extremely crude estimates of the delta-effect of the stimulus package on the economy by taking when they thought the different components of the $787 billion would be spent and how long it would then take for the government spending to have an impact on the economy. Their estimate is that we saw the effect of $0 (zero) (none) (nada) dollars of the stimulus package on the economy in the first quarter, that we saw the effects of only $14.5 billion in the second quarter, and that we are about to see the effects of $38.6 billion now in the third quarter as the effects of the ackage ramp up to their peak in the fall of 2010, when we will see $82.1 billion of stimulus spending hit the economy.

To say that what happened in the second quarter means that "the last few hundred billion dollars have had virtually no effect" is like sticking your toe into the ocean and pointing out that your hair is still dry...

Fiscal Policy: The Obama Administration Is Not Making Much Sense These Days

Tim Geithner is not making sense:

Geithner: Too soon to decide on more stimulus | Reuters: U.S. Treasury Secretary Timothy Geithner said it was too soon to decide whether the U.S. economy would need the help of a second round of government stimulus to recover from recession. "I don't think that's a judgment we need to make now, can't really make it now prudently, responsibly," Geithner said in a taped interview with CNN that will air on Sunday. According to a transcript provided by CNN, Geithner said the "biggest thrust" of the $787 billion package of spending and tax cuts signed into law earlier this year would take effect in the second half of the year...

Let's review the bidding:

Last December the Obama administration to be decided on a fiscal stimulus package which they believed would have minor effects on the economy in the first two quarters of 2009 and major effects--would push unemployment down below what it would other wise have been by more than half a percentage point--starting in the third quarter of 2009. They believed that the economy was not that weak, and that with the fiscal stimulus package taking effect unemployment would be peaking now at a rate of 7.9%.

Instead, unemployment is now probably in the 9.5-9.7% range--and without the stimulus package it would right now have turned out to be above 10%:

The financial crisis of last fall hit the economy's levels of production, spending, and employment much harder than people thought at the time. If we had known then what we know now, it would have been prudent then to propose twice as large a fiscal stimulus program as the Obama administration in fact did propose.

If Tim Geithner is not making much sense, neither is Barack Obama. Keith Hennessy directs us to quotes:

Dan Balz: The Take: Obama Stands to Be Judged on Economic Recovery: Obama, in Moscow yesterday, tried to modulate the impact of the vice president's words that the administration had somehow miscalculated. "No, no, no, no, no," he told NBC's Chuck Todd. "Rather than say 'misread,' we had incomplete information." To ABC's Jake Tapper, he said, "There's nothing that we would have done differently"...

And in Dan Balz's judgment:

Scrambling for a macroeconomic message: It seems hard to square an assessment that the administration underestimated the severity of the recession and the assertion that the White House wouldn’t have done anything differently had it known how bad things really were...

All in all, it looks like the unemployment rate in 2009 is going to average 1.2 percentage points above where the administration last December thought we would be. First quarter real GDP was $11.36 trillion year-2000 dollars--and second-quarter real GDP will be the same. Thus year-2009 real GDP is going to be close to $11.40 trillion--1.2% lower than the administration forecast that real GDP in the four quarters of 2009 would average $11.53 trillion.

It is interesting and important to note that the excess unemployment now forecast over 2009 relative to last December's forecast is of the same magnitude--1.2%--as the deficiency in real GDP. In earlier decades this would not have been the case. In earlier decades the economy was ruled by Okun's Law, and the rule-of-thumb was that the excess unemployment was 2/5 of the magnitude of the deficiency in production, not equal (see "labor hoarding by firms in American recessions, end of"). In earlier decades a 1.2 percentage point rise in unemployment would have meant a $420 billion shortfall in year-2009 nominal GDP, not a $170 billion shortfall.

If I were running the government, I would be trying to make up that GDP shortfall right now: I would be rushing a clean $170 billion--$500 per citizen--aid-to-states-that-maintain-effort package through the congress this week. It would seem the right and the obvious thing to do.

Paul Krugman on the Stimulus Trap

What Paul Krugman wrote:

Paul Krugman: The Stimulus Trap: As soon as the Obama administration-in-waiting announced its stimulus plan — this was before Inauguration Day — some of us worried that the plan would prove inadequate. And we also worried that it might be hard, as a political matter, to come back for another round. Unfortunately, those worries have proved justified.... There’s now a real risk that President Obama will find himself caught in a political-economic trap....

[H]ow [should] concerned citizens... be reacting to the disappointing economic news. Should we be patient and give the Obama plan time to work? Should we call for bigger, bolder actions? Or should we declare the plan a failure?...

When there’s an ordinary, garden-variety recession, the job of fighting that recession is assigned to the Federal Reserve. The Fed responds by cutting interest rates in an incremental fashion [to raise asset prices]. Reducing rates a bit at a time, it keeps cutting until the economy turns around. At times it pauses to assess the effects of its work [on asset prices and thus on private spending by businesses making investments in plant and equipment and on households that feel richer are willing to spend more]; if the economy is still weak, the cutting resumes.

During the last recession, the Fed repeatedly cut rates as the slump deepened — 11 times over the course of 2001. Then, amid early signs of recovery, it paused.... When it became clear that the economy still wasn’t growing fast enough to create jobs, more rate cuts followed. Normally, then, we expect policy makers to respond to bad job numbers with a combination of patience and resolve.... And that’s what the Obama administration should be doing right now with its fiscal stimulus. (It’s important to remember that the stimulus was necessary because the Fed, having cut rates all the way to zero, has run out of ammunition to fight this slump.) That is, policy makers should stay calm in the face of disappointing early results, recognizing that the plan will take time to deliver its full benefit. But they should also be prepared to add to the stimulus now that it’s clear that the first round wasn’t big enough.

Unfortunately, the politics of fiscal policy are very different from the politics of monetary policy. For the past 30 years, we’ve been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression. Predictably, then, Republicans — and some Democrats — have treated any bad news as evidence of failure, rather than as a reason to make the policy stronger. Hence the danger that the Obama administration will find itself caught in a political-economic trap, in which the very weakness of the economy undermines the administration’s ability to respond effectively....

It’s perfectly O.K. for the administration to defend what it’s done so far.... It’s also reasonable for administration economists to call for patience, and point out, correctly, that the stimulus was never expected to have its full impact this summer, or even this year. But... [i]t was disturbing when President Obama walked back Mr. Biden’s admission that the administration “misread” the economy, declaring that “there’s nothing we would have done differently.” There was a whiff of the Bush infallibility complex in that remark... that’s an attitude neither Mr. Obama nor the country can afford.

What Mr. Obama needs to do is level with the American people. He needs to admit that he may not have done enough on the first try... and that some course adjustments — including, quite possibly, another round of stimulus — may be necessary...

Bruce Bartlett Argues Against a Second Stimulus

He writes:

We do not need a second stimulus plan: As the US unemployment rate has risen to 9.5 per cent from 8.1 per cent since the $787bn fiscal stimulus package was enacted in February, many Democrats have become very nervous. They say that another large stimulus may be needed to keep unemployment from rising.... Another stimulus would be a grave mistake. The first one was justified by extraordinary circumstances. But it must be given time to work. People should not allow their impatience to lead to the adoption of policies that will not only fail to reduce unemployment this year, but could stoke inflation in the not-too-distant future....

The forecast also showed the unemployment rate peaking at 8 per cent with the stimulus and 9 per cent without. Obviously this was wrong. Yet it would be incorrect to conclude that the stimulus was doomed to failure, as many Republicans and conservative economists argued.... [T]he Romer-Bernstein document presents reasonable estimates of how quickly different forms of spending would raise gross domestic product. Tax cuts and government transfers are slow to have an effect and have a low multiplier, raising GDP less than $1 for every $1 increase in the deficit even when fully effective after two years. By contrast, government purchases stimulate growth much more quickly and have a higher multiplier, raising GDP by $1.57 for every $1 spent. Unfortunately, the low-impact spending has been the fastest to come online while the high-impact spending is dribbling out very slowly.

In a recent report to the International Monetary Fund, Doug Elmendorf, Congressional Budget Office director, looked at the rates of spending for different components of the stimulus package. He estimates that by the end of fiscal year 2009, which falls on September 30, 32 per cent of the income transfers for things such as food stamps and extended unemployment benefits will have been spent and 31 per cent of the tax cuts will have been disbursed. By the end of fiscal year 2010 virtually all of the money allocated to these programmes will have been spent.

However, just 11 per cent of the discretionary spending on highways, mass transit, energy efficiency and other programmes involving direct government purchases will have been spent by the end of this fiscal year. Even by the end of 2010 less than half the funds will have been disbursed and by the end of 2011 more than a quarter of the money will be unspent. Consequently, it is hardly surprising that five months after the stimulus bill passed it has not yet affected the unemployment rate....

What all this means is that it is foolish to think that any sort of stimulus that is enacted now will have an impact on the economy any time soon. We just have to wait for the medicine we have already taken to work. Pushing ahead with another stimulus will only make it harder to tighten fiscal policy down the road to keep inflation in check.

It's a balance of risks. Any second stimulus package passed this fall would have little impact on the economy until late 2010, that is true. But come late 2010 we might really need more demand to curb unemployment. On balance the inflationary risks of having an extra stimulus hit the economy in late 2010 if it is not needed are outweighed by the deflationary risks of not having an extra stimulus hit the economy in late 2010 if it is needed.

It is like driving a car with its windshield painted black by looking in the rear view mirror.

Second Stimulus Program...

Last December I said that a $1 trillion stimulus looked appropriate but that the incoming administration should get a second stimulus into the budget resolution, with appropriate triggers so that it would be sprung if things turned out to be worse than we then expected.

If the Obama administration had done so, right now we wouldn't be trying to persuade a political system that a stimulus designed for an 8% peak unemployent recession is too small for the 10% unemployment recession we have--let alone the 12% peak unemployment recession we fear.

I wish I weren't so smart...

Laura Tyson adds her voice to the good guys:

naked capitalism: Submitted by Edward Harrison of Credit Writedowns. Laura Tyson, an advisor to President Barack Obama, said in a speech to day in the lead up to the –8 conference that the ground work for a potential second stimulus bill must be laid now. To be sure, the G-8 leaders are expected to recommend continued policy accommodation worldwide. However, Vice President Joe Biden recently suggested that the Obama Administration has no plans for a second stimulus bill on the political TV show Meet the Press (transcript here).  So, which is it – stimulus or no stimulus?

The U.S. should consider drafting a second stimulus package focusing on infrastructure projects because the $787 billion approved in February was “a bit too small,” said Laura Tyson, an adviser to President Barack Obama.

The current plan “will have a positive effect, but the real economy is a sicker patient,” Tyson said in a speech in Singapore today. The package will have a more pronounced impact in the third and fourth quarters, she added, stressing that she was speaking for herself and not the administration.

Tyson’s comments contrast with remarks made two days ago by Vice President Joe Biden and fellow Obama adviser Austan Goolsbee, who said it was premature to discuss crafting another stimulus because the current measures have yet to fully take effect. The government is facing criticism that the first package was rolled out too slowly and failed to stop unemployment from soaring to the highest in almost 26 years.

Obama said last month that a second package isn’t needed yet, though he expects the jobless rate will exceed 10 percent this year. When Obama signed the first stimulus bill in February, his chief economic advisers forecast it would help hold the rate below 8 percent.

joe Biden Misses the Point...

If the Obama fiscal boost program has its anticipated impact on the economy as its main effects take hold over the next year, it is still half the size of the program it now looks like we need. Only if it magically turns out to be twice as strong as we think--only with simple Keynesian multipliers of 3 rather than 1.5--is it the right size.

And, of course, if the situation deteriorates further we will need an even bigger stimulus, while if the situation improves having too-big a stimulus is not a problem because we can soak up the demand through monetary policy.

So Vice President Joe Biden completely misses the point when he says:

I think it's premature to make that judgment [that we need a larger stimulus]. This was set up to spend out over 18 months. There are going to be major programs that are going to take effect in September, $7.5 billion for broadband, new money for high-speed rail, the implementation of the grid -- the new electric grid. And so this is just starting, the pace of the ball is now going to increase.

Of course, he is paid to miss the point. Which is one reason why being Vice President is a really lousy job.

Sam Stein reports:

Biden Ignores Warnings Of Krugman, Stiglitz, Roubini And Others: During his interview with ABC's This Week on Sunday, Vice President Joe Biden made what will be a much-discussed admission in the week ahead. The Obama administration, he said, had "misread" the extent of the economic catastrophe it inherited. "The truth is, we and everyone else misread the economy," declared Biden. "The figures we worked off of in January were the consensus figures and most of the blue chip indexes out there. We misread how bad the economy was, but we are now only about 120 days into the recovery package," the vice president said later in the interview. "The truth of the matter was, no one anticipated, no one expected that that recovery package would in fact be in a position at this point of having to distribute the bulk of money."

Certainly, the Obama administration's acknowledgment that it misjudged the crisis it inherited is rife with possibilities for its political opponents. House Minority Leader John Boehner rapped the White House repeatedly on Sunday for presiding over the loss of more than two million jobs since January. Former Bush strategist Matt Dowd, appearing on the ABC panel after Biden, did much the same. For an Obama White House that, two weeks ago, told the public to measure the success of its policies based on jobs they created, it is difficult to decry these critiques as inherently unfair, regardless of what troubles were passed on from the Bush administration.

But equally problematic is Biden's assertion that "everyone" - not just the White House - was off in their prognostications. This is simply untrue. Host George Stephanopoulos pointed out that "a lot of people were saying that you needed to do something bigger and bolder" when it came to the stimulus package. He named New York Times columnist Paul Krugman as one example. There are many others. The prize-winning Columbia University economist Joseph Stiglitz not only warned that the stimulus was too small during its construction, the day after Obama signed it into law he predicted how its shortcomings would make themselves apparent. "I think there is a broad consensus but not universal among economist that the stimulus package that was passed was badly designed and not enough. I know it is not universal but let me try to explain. First of all that it was not enough should be pretty apparent from what I just said: It is trying to offset the deficiency in aggregate demand and it is just too small," Stiglitz said. "The shortfall in state revenue [is] probably in the order of 150 to 200 billion dollars a year. And the states have balanced budget frameworks so if you follow the newspaper you know the drastic problems that California and New York are in, these are really serious problems and because of their balanced budget frameworks they have to reduce their spending... if their income comes down. So that would be a negative stimulus of 150 to 200 billion unless there is federal aid. And the stimulus package there was a little of federal aid but just not enough. So what we will be doing is we will be laying off teachers and laying off people in the health care sector while we are hiring construction workers. It is a little strange for a design of a stimulus package. You ask, why do you want to hire construction workers and fire teachers. I don't know what is the rationale behind that." Stiglitz was joined by a whole host of liberal economists -- from the University of Texas' James Galbraith to Dean Baker of the Center for Economic and Policy Research -- who warned that the stimulus package inexplicably underestimated the size of the crisis.

Several weeks after the stimulus passed, economist Nouriel Roubini, known affectionately as Dr. Doom, made the case that the administration's approach to stabilizing the economy lacked an effective international component. "You have to have a set of concerted, coherent policies done not just by the U.S. but by Europe, Japan, China and everyone else," he said. "The credit crunch is just massive. One thing that's needed is much more aggressive monetary easing. The second dimension is that you need much more fiscal stimulus -- in the countries that can afford it -- that is front-loaded. The U.S. [stimulus package] is $800 billion, but only $200 billion is front-loaded. Of that $200 billion [in stimulus] this year, half of it is tax cuts. That's going to be a waste of money, because people are not going to spend it." In mid-June, weeks before the latest round of poor job numbers came out, U.C. Berkeley professor and former Clinton administration official Brad DeLong was arguing that "the Obama administration's federal fiscal stimulus programs are on the low side of what is appropriate by a substantial margin. This is the largest economic downturn since the Great Depression and the standard tools of expansionary monetary policy are tapped out and broken right now," he wrote.

The day that June's job numbers came out, meanwhile, Nassim Taleb, principal of Universa Investments and author of 'The Black Swan,' offered a far more grim interpretation of what was transpiring, though one relatively consistent with what he had said in the past. "We're in the middle of a crash," said Taleb during an appearance on CNBC. "So if I'm going to forecast something, it is that it's going to get worse, not better."

Certainly Krugman himself has aired his share of skepticism. In late June, he reminded his readers that his early concerns had not been misplaced. "[S]ome of us warned about what might happen: if unemployment surpassed the administration's optimistic projections, Republicans wouldn't accept the need for more stimulus," he wrote in the Times. "Instead, they'd declare the whole economic policy a failure. And that's exactly how it's playing out. With the unemployment rate now almost certain to pass 10 percent, there's an overwhelming economic case for more stimulus. But as a political matter it's going to be harder, not easier, to get that extra stimulus now than it would have been to get the plan right in the first place. This past week, meanwhile, he declared once more that the Obama stimulus plan, while "better than nothing" needs to be supplemented with something more.

To be fair, the process of economic forecasting is, as Taleb noted in his CNBC segment, an inherently tricky proposition. In October 2008, for instance, Roubini was arguing that the government needed a $400 billion stimulus package, which ended up being just more than half of what the Obama White House settled on.

But among those who were sounding the loudest alarms about the potential inadequacies of the economic recovery plan, the consensus seems to be emerging that more now needs to be done. Later in his ABC segment, Biden - who is responsible for overseeing the stimulus - was asked if a second package was in the offing. No, he replied, without dismissing the possibility outright. "I think it's premature to make that judgment. This was set up to spend out over 18 months. There are going to be major programs that are going to take effect in September, $7.5 billion for broadband, new money for high-speed rail, the implementation of the grid -- the new electric grid. And so this is just starting, the pace of the ball is now going to increase."

Krishna Guha: Please Discipline Your Headline Writers!

Krishna Guha to the orange courtesy phone, please.

The headline over your article is:

Romer Upbeat on US Economy

The quotes from the Hon. Christina D. Romer are:

• We do not want to repeat the mistake Japan made in the 1990s, when the moment things started to improve they tightened policy...

• [Stimulus spending is] going to ramp up strongly through the summer and the fall. We always knew we were not going to get all that much fiscal impact during the first five to six months. The big impact starts to hit from about now onwards...

• [Stimulus spending] should make a material contribution to growth in the third quarter...

• I am more optimistic that we are getting close to the bottom...

• I still hold out hope it will be a V-shaped recovery. It might not be the most likely scenario, but it is not as unlikely as many people think. We are going to get some serious oomph from the stimulus, there is the inventory cycle, and I believe there is some pent-up demand by consumers...

If that is what the FT calls "upbeat," what would be "downbeat"? "CEA Chair Romer advised Americans to stockpile bottled water, ammunition, gasoline, and sewing needles; and to start training for the Thunderdome"?

FT.com / US / Economy & Fed - Romer upbeat on US economy: The US economy will feel a substantial boost from the Obama administration’s emergency spending package over the next few months, says Christina Romer, a senior White House official, who has warned against tightening monetary and fiscal policy before recovery is well established. Ms Romer, chairman of the US president’s council of econ omic advisers, told the Financial Times in an interview she was “more optimistic” that the economy was close to stabilisation. But while hopeful that America could yet experience a V-shaped recovery, she said it was much too soon to begin tightening policy: “We do not want to repeat the mistake Japan made in the 1990s, when the moment things started to improve they tightened policy.”

Meanwhile, David Axelrod, a senior White House adviser, told NBC Television on Sunday the administration would be open to further stimulus if needed. “Let’s see in the fall where we are, but right now we believe what we have done is adequate to the task. If more is needed, we’ll have that discussion.”

Ms Romer’s comments come as opposition Republicans step up their attacks on the $787bn fiscal stimulus, pointing out that it has not prevented unemployment from hitting a quarter-century high of 9.4 per cent. Ms Romer said stimulus spending was “going to ramp up strongly through the summer and the fall. We always knew we were not going to get all that much fiscal impact during the first five to six months. The big impact starts to hit from about now onwards,” she said.

Ms Romer said that stimulus money was being disbursed at almost exactly the rate forecast by the Office of Management and Budget. “It should make a material contribution to growth in the third quarter.” But she acknowledged that cutbacks by states facing budget crises would push in the opposite direction. Ms Romer said the latest economic data were encouraging, following a weaker patch a month ago. “I am more optimistic that we are getting close to the bottom,” she said.

The CEA chairman, who has forecast a sharper rebound in 2010 than most economists, said she had lowered her estimates for growth this year “and also for next year, a bit” since the start of the year. She said the consensus forecast that unemployment would continue to rise for the rest of this year and peak early next year was probably accurate. But she added: “I still hold out hope it will be a V-shaped recovery. It might not be the most likely scenario but it is not as unlikely as many people think. We are going to get some serious oomph from the stimulus, there is the inventory cycle and I believe there is some pent-up demand by consumers.”

Fifty Little Herbert Hoovers Watch

The Economist's free exchange:

Fifty little Hoovers, hoovering up stimulus: MATTHEW YGLESIAS makes a good point:

Reading Harold Meyerson’s column on the looming devastation of California public services was yet another reminder of the remarkable extent to which the terrible continuing economic situation has bizarrely dropped off the political agenda. Even the whole “green shoots” debate is really about whether we can expect things to be somewhat better or somewhat worse six months out from now. In either case, things really are really bad right now. And a whole bunch of states—including large ones like California and Pennsylvania—are soon to implement substantial cutbacks in services at just the time when the objective need for social services is going up.

The American economy appears to be nearing the end of contraction. That's good news, particularly when one considers that only about 10% of the funds authorised in this year's stimulus bill has been spent; the plan is only beginning to ramp up and outlays will peak in 2010. We should expect that injection to provide the economy with a nice boost at a critical time.

On the other hand, state budget policies are sharply contractionary at this point. Despite allocations of federal aid to states, services are being cut, state employees are being laid off, and taxes are being raised in order to balance the budgets of local governments constitutionally unable to run deficits. It's not at all clear that the federal stimulus will entirely compensate for state-level fiscal tightening, which means that American fiscal policy could, on net, be contractionary.

Easy money is doing its part, of course, but the bottom line is that the fiscal boost many are expecting may not actually materialise. This will end up causing a lot of human suffering, and it may make for a long and shallow recovery—or worse, a tipping back into contraction.

Nobody thinks that it's time to go back in the water yet. And we do need a bigger stimulus.

That Fiscal Stimulus Packages Work Is "Not Controversial," Says Bush CEA Chair Greg Mankiw

He said it back in 2003, when it was a Bush stimulus rather than an Obama stimulus program. But sauce for the goose...

Mark Thoma deals the deck:

Economist's View: "Deficits are Worrisome, but Not as Worrisome as an Economy that is Not Growing and is Rapidly Shedding Jobs": What do you think of this administration's arguments for deficit spending to spur the economy?:

Remarks of the Chair of the Council of Economic Advisers: I... want to discuss some larger issues about how fiscal policy should be evaluated.... I view the economy as experiencing something similar to a tug of war.... On the contraction end of the rope are the shocks that the U.S. economy has experienced.... Pulling hard on the other end of the rope are the expansionary forces of monetary and fiscal policy--the Federal Reserve’s series of interest rate cuts and the Administration’s... stimulus package.... I will not say much today about monetary policy.... But fiscal policy is my beat as CEA chair....

[A]nalysis done within the Administration has shown ... that ... the ... job market is not what we would like it to be right now, but it would have been worse without the Administration’s actions.... [Our stimulus] helps maintain the aggregate demand for goods and services. There is nothing novel about this. It is very conventional short-run stabilization policy: You can find it in all of the leading textbooks....

The qualitative effects... on the short-run output gap... are not controversial. There is less agreement on quantifying these effects.... To answer these questions, one would normally turn to a macroeconomic model such as those maintained by private forecasting firms.... I view such models as being very useful....

Deficits can raise interest rates and crowd out of investment, although I should note that the magnitude of this effect is much debated in the economics literature. The main problem now facing the U.S. economy is not high interest rates.... The Administration would prefer not to have deficits, but deficit reduction is only one of many goals.... Deficits are worrisome, but not as worrisome as an economy that is not growing and is rapidly shedding jobs....

The most important fiscal challenge facing the United States is not the current short-term deficits... but instead the looming long-term deficits associated with the rise in entitlement spending.... These longer-term issues, however, should not blind us to the immediate needs of the economy. The President came into office inheriting an economy... [in] a recession. He has responded vigorously to the challenges and, as a result, the current outlook for the U.S. economy is bright...

That was Greg Mankiw, on September 15, 2003 in a speech to the NABE. [Note: verb tense changed from past to present in a few places, 'chairman' was changed to 'chair,' and he is, of course, mainly promoting tax cuts, not government spending.]

I want to thank Mark for making me laugh louder than I have in two months.

The Structural Deficit

It is, I think, much too early to be worrying about closing America's structural deficit through any policies other than trying to set health care cost-containment in motion. Recession-fighting should be the agenda for 2009-2010. Structural balance should be the agenda for 2011-2012.

Ed Luce disagrees:

Deficit disorder: Back in February, Barack Obama’s presidency suffered an early setback when Judd Gregg, the Republican senator from New Hampshire, withdrew as his nominee for commerce secretary... decided he could not belong to an administration that would preside over such high budget deficits.... The Congressional Budget Office, a nonpartisan watchdog, forecasts that the US will post deficits in excess of a trillion dollars in each of the next 10 years... national debt will double to 82 per cent of GDP in the next decade – a level not seen since the second world war.... America’s fiscal outlook has rapidly become the object of widespread alarm....

The administration cannot be blamed for what is this year an almost entirely inherited deficit. Mr Obama’s new spending accounts for only about one-tenth of it. The effects of the recession, the costs of the bank bail-out and the structural legacy of the three large tax cuts and two wars bequeathed by George W. Bush account for the remainder. Nor do critics, including Mr Gregg, blame the new president for pushing through a $787bn two-year fiscal stimulus within a month of moving into the White House. “We needed to dig the economy out of a hole,” says Mr Gregg. “I understand that.”...

Barack Obama made it clear this week that the door to further fiscal stimulus is wide open – even as he stressed that his administration has not yet decided to seek one from Congress, writes Krishna Guha. “I think it’s important to see how the economy evolves and how effective the first stimulus is,” he told a news conference. But the US president added that “nobody understood what the depths of this recession were going to look like” when the current stimulus package was passed weeks after he took office in January. Many analysts think it is all but inevitable that the administration will end up seeking an additional stimulus if only to smooth the cliff-edge effect when the effects of the previous boost fade and tax cuts introduced under George W. Bush expire from late 2010. Otherwise, many see a serious risk of a double-dip recession in 2011....

But politics is quick to change. The otherwise deeply unpopular Republican party is starting to sense an opportunity. A rapidly growing proportion of the US public is registering anxiety at the sea of red ink.... Ben Bernanke, governor of the Federal Reserve, told Congress this month: “Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth.” All this leaves Mr Obama in a deepening quandary. In Augustinian style, he needs to keep pumping the economy in the short term, since consumers, who are the mainstay of the US economy, are unlikely to resume spending soon. But he needs simultaneously to reassure investors that he has put in place plans for a return to fiscal responsibility the moment recovery sets in.

The White House promises to halve the deficit it inherited by the end of Mr Obama’s first term in 2012. But few believe the economic growth numbers on which its projections are based. “I probably shouldn’t say this but President Obama’s plans remind me of George W. Bush,” says Douglas Holtz-Eakin, a former head of the CBO who was John McCain’s chief economic adviser during the the presidential election. “Both presidents experienced a crisis – 9/11 and the financial meltdown. Both promised to halve their resulting budget deficits. Neither were credible.”...

[T]he vast looming deficits in Medicare and Medicaid.... Conventional wisdom says Mr Obama should set up a bipartisan commission to tackle the problem. This would be the only way of shielding both parties from the political fall-out that would undoubtedly result from a cut in benefits.... Most Republicans, meanwhile, would agree to join the commission only if it excluded the possibility of tax increases – a precondition that would in effect kill the exercise before it began....

A plausible alternative scenario is that Mr Obama will head into next year’s midterm congressional elections, which will help determine his re-election chances in 2012, facing a sullen electorate that fears the Democrats are taking their country towards bankruptcy. It might not be fair – Mr Bush, rather than Mr Obama, deserves most of the blame for America’s deepening structural deficits. But it is the kind of message that could help bring a moribund Republican party back to life...

In Which Stanford Economist John Taylor Adopts the False, Exploded "Treasury View" of More than Eighty Years Ago...

You know, it is very odd: When nominal interest rates on short-term Treasury securities are at their normal levels--4% or 3% or even 2% per year--I am among the very first to declare that discretionary fiscal policy has no proper role to play, and that the task of managing the business cycle should be left to the fiscal automatic stabilizers and to the Federal Reserve.

But things are--as we economists have known for nearly a century--different when short-term safe nominal interest rates are at their floor to make safe short-term bonds nearly perfect substitutes for cash, for then the standard mechanisms of monetary policy--flooding the system with cash and relying on the fact that holding wealth in cash is expensive (for it means that you forego interest) to trigger a rise in spending--is not guaranteed to work. And then fiscal policy has a place. To deny that fiscal policy has a place is then, it seems, to me, to fail the most basic test of thinking like an economist. As John Hicks put it back in 1937, we know that the speed at which people spend their cash--the velocity of money--is a function of the short-term safe nominal interest rate. And we know that the velocity of money becomes very elastic as the short-term safe nominal interest rate becomes very low:

On grounds of pure value theory, it is evident that the direct sacrifice made by a person who holds a stock of money is a sacrifice of interest; and it is hard to believe that the marginal principle does not operate at all in this field. As Lavington puts it:

The quntity of resources which (an individual) holds in the form of money will be suh that the unit of money which is just and only just worthwhile holding in this form yields him a return of convenience nad security equal to the... net rate of interest.

The demand for money depends upon the rate of interest!...

It is not only possible to show that a given supply of money determines a certain relation between [national] income and interest... it is also possible to say something about the shape of the cure. It will probably tend to be nearly horizontal on the left.... If is lies to the right, then we can indeed increase employment by increasing the quantity of money; but if IS lies to the left [and short-term safe interest rates are at their minimum], we cannot do so; merely monetary means will not force down the interest rate any further...

and we have to resort to fiscal policy and banking policy--things that affect not the quantity of money but the flow-of-funds through financial markets.

Now, however, we have to add John Taylor to the votaries of the 1920s-era "Treasury View": the claim that fiscal policy must be ineffective. He is thus one of those who, as Olivier Blanchard puts it, does not know things that Irving Fisher and Knut Wicksell (or at least John Hicks) knew.

Why John Taylor believes in the "Treasury View" is not at all clear. Paul Krugman writes:

The virus is spreading: I just taped Fareed Zakaria with John Taylor, who is a fine economist. But if I understood John’s position, it was that fiscal expansion is actually contractionary, because deficits drive up interest rates, unless the fiscal expansion takes the form of permanent tax cuts...

I'm not so sure about Taylor. The last paper of his I cracked... wasn't impressive. It was supposed to show that fiscal policy could not be powerful. And it didn't deliver.

Here's what I had to say about it at a conference at Stanford early in May:

Tuesday afternoon I sat down to... Cogan, Cwik, Taylor, and Wieland (2009).... I dug--and found that Cogan et al.’s claim [that they and the Obama administration had analzyed] “exactly the same policy change” was simply wrong. Romer-Bernstein model an increase in government spending with the Federal Reserve expanding and keeping on expanding the money supply in order to keep the short-term Treasury Bill interest rate the same. Taylor (1993) models an increase in government spending with the Federal Reserve contracting the real money supply to push the short-term Treasury Bill interest rate up over time as unemployment falls and inflation creeps up. There is no “robustness” problem with Romer-Bernstein at all: the results are different because the policy changes are different.

“Geez,” my first thought was, “this is embarrassing--none of four coauthors of Cogan actually read Romer-Bernstein at all carefully. Sloppy.” Then I got to page 5 of Cogan: “Romer and Bernstein assume that the Federal Reserve pegs the interest rate....” Cogan et al. know perfectly well that the policy changes are not “exactly the same.” They just say they are.

I am sorry. In Europe that gets you four red cards. In America that gets you sent to the showers. The first intellectual responsibility of critique is to accurately present what you are critiquing. When Cogan et al. learn that they can come back into the game. But not until then.

What is their explanation for not telling us up front that they are assuming a different monetary policy? They give none. What is their explanation for assuming a different fiscal policy? It is this:

Romer and Bernstein assume that the Federal Reserve pegs the interest rate—the federal funds rate—at the current level of zero.... [S]uch a pure interest rate peg is prohibited in new Keynesian models with forward-looking households and firms because it... lead[s] to instability and non-uniqueness.... Inflation expectations of households and firms become unanchored and unhinged and the price level may explode in an upward spiral….

In short, the monetary policy rule that Romer and Bernstein believe that the Federal Reserve is following makes fiscal policy incredibly powerful: so powerful that the level of nominal spending explodes. So we are going to make a different assumption about monetary policy that makes fiscal policy weak because we assume the Federal Reserve neutralizes the effects of government spending.

Do they provide any reason to justify their monetary policy assumption--any reason to believe that the Federal Reserve is currently engaged in raising short-term interest rates to neutralize the effects of fiscal expansion? No, they do not.

---

Open publication - Free publishing - More macroeconomics

In Praise of Good Government by Barack Hussein Obama

Stan Collender watches Obama take his responsibilities to the nation seriously:

Attention All Deficit Hawks: Do You Know Where Your Veto Threats Are? | Capital Gains and Games: The White House yesterday did something that should truly warm the hearts of deficit hawks everywhere: it threated to veto the 2010 military authorization bill over two big spending issues -- the F22 and the alternate engine for the F35.

A little background.  Although both of these programs were questioned for years by the Bush White House, Congress kept insisting that the Pentagon spend the money anyway and the president always went along.  This year, The F22 was a target of Secretary of Defense Robert Gates ....

The Obama veto threat is a much bigger deal than it seems.

First, the White House didn't have to do it.  It's threating to veto an authorization bill that, even if it's adopted, won't actually spend any money.  That will happen later in the year with the appropriation.  That means that the administration is drawing the line now and trying to stop the spending for both programs from gaining any momentum.  That's a good sign.... Second, the veto threat came in the midst of the much bigger fight for the White House on health care.  The White House could have backed away so that it didn't antagonize the members who support these programs... but it didn't.  Again, another good sign for deficit hawks who want proof of the president's devotion to reduced spending...

Fiscal Policy Watch: Anyone Have a Good Feeling About the Next Employment Report? Anyone? Anyone? Bueller?

I certainly don't.

And once again I am reminded of the two rules for understanding the world:

1. Paul Krugman is right.
2. If you ever think Paul Krugman is wrong, refer to rule #1.

Paul Krugman:

What I was afraid of: Back in March, when I was lamenting the inadequate size of the Obama stimulus, I made this prediction:

Republicans are now firmly committed to the view that we should do nothing to respond to the economic crisis, except cut taxes — which they always want to do regardless of circumstances. If Mr. Obama comes back for a second round of stimulus, they’ll respond not by being helpful, but by claiming that his policies have failed.

And I laid out the following scenario:

So here’s the picture that scares me: It’s September 2009, the unemployment rate has passed 9 percent, and despite the early round of stimulus spending it’s still headed up. Mr. Obama finally concedes that a bigger stimulus is needed. But he can’t get his new plan through Congress because approval for his economic policies has plummeted, partly because his policies are seen to have failed, partly because job-creation policies are conflated in the public mind with deeply unpopular bank bailouts.

It’s only June, but Republicans are already claiming that the Obama economic plan has failed. (Yes, that’s insane — hardly any of the money has flowed to the economy yet — but this was predictable.) Meanwhile, unemployment is already above 9 percent. And the green shoots are looking browner by the week, especially on the jobs front: new claims for unemployment insurance are stubbornly running at more than 600,000 a week, far above the 350,000 or so that would be consistent with a stable unemployment rate.

We really do need a bigger stimulus. But it’s going to be hard slogging.

I understand that last December we thought (wrongly) we had a one-quarter long and not a two-quarter long collapse in the economy and thus that the unemployment rate could be kept from rising above 8%. I understand the (wrong) judgment that Congress would increase and make more effective rather than diminish and make less effective whatever stimulus program bid Obama put on the table. But what I don't understand is the failure to understand that a too-big fiscal boost package could be neutralized by the Federal Reserve's raising interest rates while a too-small package could not be further boosted by the Federal Reserve's lowering interest rates, and hence that prudent policy last December involved at least planning for a fiscal boost package that would then look very large indeed.

Remember: World War II-style deficit spending was needed to get the unemployment rate down from 10% to 3%, suggesting to me at least that a truly effective fiscal boost capable of doing half that would have to be a quarter to a third of large. And we are not there: we are far from there:

Why Does Ric Mishkin Insist on Talking in Code?

Ric Mishkin writes:

How to Get The Fed Out Of Its 'Box': When the Federal Open Market Committee meets this Tuesday and Wednesday, the Federal Reserve will face a serious dilemma. Since the last committee meeting six weeks ago, the 10-year U.S. Treasury yield has risen by around 70 basis points (0.70%), with the result that the interest rate on 30-year mortgages has risen by a similar amount. The rise in long-term interest rates is particularly worrisome, because it has the potential to choke off economic recovery and lead to further deterioration in the housing market. That would put an already weakened financial system under stress. Does the situation call for the Fed to expand its purchases of Treasury bonds to lower long-term interest rates?

To answer this question, we need to look at why long-term interest rates have risen. Here, there is good news and bad news. One cause of the rise in long-term rates is the more positive economic news of the past couple of months, particularly in financial markets. The bad news is that long-term interest rates are higher because of concerns about the deteriorating fiscal situation, with massive budget deficits expected for the indefinite future. To fund these budget deficits, the Treasury has to sell large quantities of bonds both now and in the future, causing bond prices to fall and interest rates to rise. The increased supply of Treasury debt puts pressure on the Fed to buy it up.... The Fed is boxed in. The slack in the economy that is likely to persist for a very long time suggests the need for stimulative monetary policy to lower long-term interest rates through the purchase of Treasurys. The fiscal situation argues against this policy action, because it would weaken the Fed's inflation-fighting credibility.

How can the Fed get out of the box and pursue the expansionary monetary policy that is needed right now? The answer is that the Obama administration and Congress have to get serious about long-run fiscal sustainability. Large budget deficits naturally occur during severe recessions when tax revenue undergoes a substantial decline. In addition, fiscal stimulus to promote economic recovery when the economy is in a severe recession is a sensible prescription. However, the failure to take steps to get future budgets under control is a recipe for disaster.... [I]t may even make the fiscal stimulus package less effective... if you know that the government is issuing a lot of debt that has to be paid back someday you can expect to pay much higher taxes in the future. With the prospect of higher taxes, you will be less likely to spend today.

How can the Obama administration and Congress help the Fed do its job and help the fiscal stimulus package work? It needs to address exploding spending on entitlements -- Social Security and particularly Medicare -- which are causing future deficit projections to be so bleak. One possibility is to establish a nonpartisan commission on entitlement reform, along the lines of the National Commission on Social Security in the early 1980s.... Another is taxing health-care benefits as part of any package to reform health care.... There are surely many other ways to promote more fiscal responsibility. The Fed can assist this process. It could indicate that implementing measures that would promote fiscal sustainability will be rewarded with Federal Reserve actions to bring long-term Treasury rates down. Deals like this have been successfully made in the past. In the current extremely difficult economic environment, we surely need such a deal now.

I think pieces like Ric Mishkin's are much less useful than they could be, because Mishkin talks in a peculiar kind of code:

• When Mishkin writes: "[t]he Fed... could indicate that implementing measures that would promote fiscal sustainability will be rewarded with Federal Reserve actions to bring long-term Treasury rates down. Deals like this have been successfully made in the past..." he means: "Alan Greenspan and Bill Clinton and the Democratic Party did a very good thing back in 1993 when--over unanimous Republican opposition--they coordinated action to raise taxes, cut the future growth path of spending, and ease monetary policy."

• When Mishkin writes: "nonpartisan commission on entitlement reform, along the lines of the National Commission on Social Security in the early 1980s..." he means: "the Democratic Party then did a good thing in giving Republican President Ronald Reagan bipartisan cover to raise taxes and so reduce the damage to long run fiscal stability that he had done in his first year..."

• When Mishkin writes: "budget deficits naturally occur during severe recessions when tax revenue undergoes a substantial decline... fiscal stimulus to promote economic recovery when the economy is in a severe recession is a sensible prescription..." he means: "Republican root-and-branch opposition to Obama's stimulus plan is stupid and harmful to the country..."

Everyone who was around in 1982, or 1993, or 2001-3 (when Republicans were welcoming and expanding deficits as recession-fighting measures understands the code that Mishkin is talking in: that Republican politicians behaved badly and Democratic politicians behaved well, and it would be good for the country if the Democratic politicians were to step up to the plate and once again do the right thing for the country. But for some reason Mishkin won't say that in anything but the most elliptical of implicatory sentences.

It matters, I think, because until senior Republican presidential appointees like Ric Mishkin will call Republican politicians on their misdeeds--and cross the aisle in response--Republican politicians will continue to misbehave. And it is not clear the country can afford that.

Another One from Paul Krugman: (Slightly) Rising Interest Rates a Sign of Improvement

What Paul said:

What’s moving interest rates?: I’ve written recently about applying the Engel-Frankel method to making sense of interest rate movements: ask what else moves when rates move, and you get a clue to what’s driving the changes. I’ve previously argued that the behavior of commodity prices suggests that the big rise in interest rates this spring was driven by economic optimism, not fear of deficits.

Here’s another indicator: which way do rates move when we get good or bad news about the economy? If you believed that deficits were the driver, bad news about the economy should push rates up, good news push them down. After all, a weaker economy means lower revenues, a stronger economy higher revenues. But if you believe that interest rates are being driven by changing expectations about when the Fed will be able to come off the zero-rate policy, you’d expect the opposite correlation.

And there’s no question about which way things work in practice. Late last week, for example, a couple of new figures — a better-than-expected Philadelphia manufacturing survey, a decline in continued claims for unemployment insurance — made investors more optimistic about the economy; long-term rates bounced. This morning, a gloomy World Bank Report is weighing on the market; long-term rates are down.

It’s not deficits. It’s the economy, stupid.

In My Inbox: Public Economic Argument

A corresopondent writes:

Dear Professor DeLong:

This fall I am teaching a section of the required freshman writing course at Malefactor of Great Wealth University, a course that emphasizes the analysis of argument and other related rhetorical skills, as well as instruction and practice in academic writing. All sections are organized around a single issue, and I have chosen to focus on public argument on the economy leading up to and following the events of late 2008.

I have been enjoying your blog and the fine array of links. My main question for you is this: can you recommend any good, short primers that can provide my students with enough economic literacy to be able to follow the public arguments made by, say, Alan Greenspan or Paul Krugman?

I would also be curious to know your answer to the following: What would you as an economist say to a member of the public who did not have an extensive economic education but nevertheless was trying to decide, say, what public economic policies to support? Is it a matter of picking the right experts to trust?

Thanks very much for your time and consideration!

Candidate for MA in Rhetoric and Freshman Writing Instructor
Malefactor of Great Wealth University
Sunny City, USA

My answer:

Oyyyy...

The problem is that everything I can think of takes a side (the fact that I think one side is clearly right is not of much help for your purposes)...

I can think of three things to do:

1. Set them to read, as preliminary background, one nineteenth-century book, Walter Bagehot's Lombard Street, and one early twentieth century book, John Maynard Keynes's Tract on Monetary Reform. There is a possibility of some confusion: when people today say "Keynesian" they mean late Keynes, and the Tract is early Keynes. But if that is made clear, it should work well: those two lay out pretty much all the issues and do so in a historical context divorced from today...

2. Set them to read, as preliminary background, the paperback macroeconomics half of Krugman and Wells's introductory economics textbook...

3. Set them to read, as preliminary background, the macroeconomics half of Cowen and Tabarrok's forthcoming introductory economics textbook...

As to your second question, all I can say is that I am trying as hard as I can in lots of different forums, with as best as I can see no success...

Better suggestions, guys?

Yours,

Brad DeLong

Asymmetric Loss Functions and Fiscal Policy Planning

Fiscal policy planning should assume a bad case scenario. So says Mark Thoma:

Romer roundtable: Assume the worst: WHEN deciding between two alternatives such as whether the government should intervene in the economy with a fiscal stimulus or not, the choice of the null and alternative hypotheses influences the type of errors we are likely to make.... Which is the bigger error, to deficit spend when it's not needed, or to fail to do so when it is? I think the bigger risk is doing nothing when it's needed...

So say we all!

More on the Romer Symposium at the Economist

I confess that I think Alan Meltzer's contribution to the Christie Romer symposium at the Economist ill-advised for two reasons. Meltzer writes:

Romer roundtable: Think, plan, and tell us the plan: CHRISTINA ROMER... like generations of policymakers before her... counsels "trust us"... [I]t was they who allowed banks to circumvent the Basel regulations, that permitted Fannie and Freddie to expand beyond any reasonable standard, that brought us too big to fail and, as John Taylor has shown, abandoned a policy that brought us almost 20 years of the Great Moderation....

[L]ike most other defenders of this inflationary, low productivity policy, Christina puts the choice as whether we act against recession now or against inflation now. That leaves out a multitude of options.... [Y]es, stimulate now to reduce unemployment, but avoid creating a big inflation in a year or two. And even announce in advance how you propose to reduce the high money growth rate and the excessive deficits. Don't just say you'll do it, think, plan, and tell us the plan.

The first reason that it is ill-advised is that Meltzer really should not be claiming that Christina Romer is one of the "they" who "allowed banks to circumvent the Basel regulations... permitted Fannie and Freddie to expand... abandoned a policy that brought us almost 20 years of the Great Moderation..." Christie has not been doing any of these things. She has been sitting in her southeast corner office on the sixth floor of Berkeley's Evans Hall lecturing about monetary policy before, during, and since the Great Depression. If Meltzer wants to blame the actions of the American conservative politicians he has consistently voted for and the officials they appointed for our current mess, fine. But to say that Christie Romer = Phil Gramm because both are "policymakers" is simply wrong.

The second reason that it is ill-advised is that Meltzer misleads when he implies that the Obama administration and the Federal Reserve have not "announce[d] in advance how [they] propose to reduce the high money growth rate and the excessive deficits..." The Obama administration wants, as OMB Director Peter Orszag explains every hour on the hour, to balance America's long-run budget by reducing the extraordinary economic inefficiency of the American health-care system via health care reform. The fact that the people staffing the executive branch are in large part those who in the Clinton administration did such great work at bringing America's public sector back toward fiscal balance in the 1990s (but whose work was then largely undone by the American conservative politicians Alan Meltzer has consistently voted for and the officials they appointed) should give observers some confidence that they will at least try to reduce excessive deficits. At the very least Alan Meltzer should not be claiming that they have not told us how they intend to do so.

The same applies to the Federal Reserve, which Meltzer implies needs to "tell us the plan." I have found the Federal Reserve extremely eager and anxious to explain how it intends to unwind the large increase in the money supply when monetary velocity starts to recover. The basic problem, I learned back in my first year of graduate school, is that the central bank's ability to soak up excess liquidity in an economy and reduce the supply of "monnaie" is limited by its balance sheet: it needs to be able to induce banks to part with their cash by offering them something else to hold, and the Fed cannot offer what it does not itself have to trade. The solution the Federal Reserve is proposing is to allow it to create additional kinds of liabilities on its balance sheet. If congress grants the Federal Reserve the power to accept not just interest-free but interest-paying reserve deposits (which it has) and the power to issue and sell its own interest-bearing bonds (which I hope it will), then the Federal Reserve will have no trouble reducing the transactions balances that make up our monetary base when it wishes to do so. Once again, we have already been told the plan--and it is unfair to claim that Bernanke and company have not told us.

The Lessons of 1937

Christie Romer is live at the Economist:

Economics focus: The lessons of 1937.

And myComment for the Economist on Christina Romer (2009), "The Lessons of 1937"? For now it is now not yet live...

http://www.economist.com/blogs/freeexchange/romer_roundtable/

Comment for the Economist on Christina Romer (2009), "The Lessons of 1937"

Five Lessons from 1937 and Otherwhen

J. Bradford DeLong
U.C. Berkeley and NBER
delong@econ.berkeley.edu

June 17, 2009

Comment on Christina Romer (2009), "The Lessons of 1937":

Let me make five points to eliminate or refute or at least to fight against or lay down a marker that there is--well, call it "confusion" about what the right state of American macroeconomy should be.

Last December’s Unemployment-Rate Forecast and Outcome to Date

Source: Romer and Bernstein (2009).

My first point is that over the past six months the economy has been a severe disappointment. Output and employment have fallen much faster than people were projecting last December. Romer and Bernstein (2009) projected at the very start of this year that unemployment in the U.S. would reach a peak of 7.9% in the summer of 2009. But unemployment now in mid-June is about 9.7%, with 10% baked in the cake and the possibility existing that it might go much higher. The signs that the cliff-dive of employment has come to an end are very few. The level of new unemployment claims is still consistent with a rapidly-collapsing labor market nationwide.

New Weekly Unemployment Claims (Red, Right Scale, Four-Week Average) and Monthly Fall in Payroll Employment (Blue, Left Scale, Thousands)

Source: Paul Krugman.

Six months ago a net federal fiscal stimulus of about $1 trillion--$400 billion each year for about 2.5 years--seemed appropriate: that seemed to balance the benefits of filling-in the hole in aggregate demand without running too great a risk of triggering worrisome inflationary fever further down the road. Now the hole in aggregate demand is greater than was thought likely last December--about twice as great--and the likelihood of heightened future inflation is less. Thus if it was appropriate to set a $1 trillion federal fiscal stimulus in motion last December given what we knew then, if we had known then what we know now it would have been appropriate to set a roughly $2.4 trillion fiscal stimulus--$800 billion for 3 years--in motion back then.

My first point is thus that the Obama administration's federal fiscal stimulus programs are on the low side of what is appropriate by a substantial margin: this is the largest economic downturn since the Great Depression and the standard tools of expansionary monetary policy are tapped out and broken right now.

My second--related--point is that the need for federal-level fiscal expansion is reinforced by what state governments are doing right now. The federal government's discretionary actions are expanding aggregate demand by about $400 billion over fiscal year 2010, but state governments are right now cutting their spending and raising their taxes in order to offset this federal fiscal expansion more or less completely. On net, the government sector will be on autopilot as far as discretionary policy moves to stimulate the economy are concerned: federal-level expansion is offset and neutralized by state-level fiscal contraction. This is not an appropriate macroeconomic policy stance: this is the largest economic downturn since the Great Depression.

My third--unrelated--point is that the policy innovations of the past year have created a potentially dangerous weakness in the Federal Reserve system. The Federal Reserve's balance sheet has more than doubled over the past year, as it has acquired an enormous and bizarre menagerie of assets. On the liability side, it has funded this acquisition by expanding the monetary base, and has increased private-sector willingness to hold this monetary base by paying interest on reserves. This has added a fourth motive--profit--to the three traditional motives for holding reserve deposits at the Fed: the transactions demand, the emergency liquidity demand, and the speculative demand.

As long as the dollar remains the safest currency in the world, as long as the dollar remains the linchpin of the global financial system, there is no problem in the Federal Reserve's funding by what is essentially overnight borrowing the expansion of its balance sheet and the purchase of private securities that will vary up or down in market price with an eye toward holding them to maturity.

However, at some future time the dollar will cease to be the linchpin of the world financial system, in which case the Federal Reserve's financing its balance sheet via overnight borrowing will leave it vulnerable to the mother of all bank runs. It would be very good to fix this now: to give the Federal Reserve now the option to borrow not in what are essentially demand but rather in time deposits--to grant the Federal Reserve the power to issue its own bonds. This diminishes the chance of a great financial crisis in 2050 or so, with no downside that I can see.

My fourth point is the obvious one that health care is the only thing tht matters for the long run budget. The other points that the Hon. Dr Christina Romer raises, are--as is almost always the case--accurate and important. America's long-run fiscal problems are caused by health care, and will not be appreciably made worse by this half-decade's federal fiscal stimulus. If restructuring the health care system can bend the curve on the rise in overall (and hence public as well as private) health care costs, then America has ample debt capacity to borrow whatever we wish in this crisis--and to borrow it at extraordinarily favorable rates as well. If the curve of rising health-care costs is not bent, then the government's long-term finances are in trouble and so is the growth of private-sector non-health living standards: health care costs that rise as fast as CBO is projecting in the baseline cause lots of long-run economic problems, of which government fiscal bankruptcy is not the worst. Health care reform to bend the long-run curve of costs is now just what it was back in 1993: the most important issue for the American political system to deal with.

Fifth, I have the sense that the Obama administration's economic policymakers have forgotten one of the most basic lessons taught by Robert Rubin during his stewardship of economic policy during the 1990s. The lesson is to think probabilistically: to project yourself forward into the possible futures, to ask in each one what would be the actions that you would then wish you hd undertaken today, and then to actually take the appropriate action today. Looking forward into the future, (a) I see a 10% chance that something happens to create renewed cliff diving--a recession that bottoms out not with an unemployment rate in the 10-12% range that we currently anticipate but an unemployment rate that blows through 12% and keeps on rising. (b) I see a 30% chance of a rapid recovery as confidence and asset prices recover, and firms take advantage of high unemployment to hire new workers in droves at wage levels that make increasing production very profitable. But (c) I see a 60% chance of the end of the current cliff-dive in employment being followed by what happened in Japan in the 1990s, in the U.S. after 1991, in the U.S. after 2001, and to some extent in the U.S. after 1933--a recovery that does not see the market exert sufficient upward pressure on employment to return the unemployment rate to normal levels in two or three years, but that instead sees a jobless or low-job recovery during which the unemployment rate continues to drift upward for years, or falls only then to rise again.

The Obama administration's policies appear to me to be the ones that would be adopted if we believed that there was a 75% chance of scenario (b) and a 25% chance of scenario (a). But I don't think those are the probabilities. And I wonder what the Hon. Dr. Christina Romer thinks the probabilities are. For she is the one who warns of how:

[t]he 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy following an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently [than in normal times]. If the government withdraws support too early, a return to economic decline or even panic could follow...

The blunt fact is that the economic recoveries that have been rapid and seen fast growth in employment are those that ended when a Federal Reserve following strongly restrictionary policies to fight inflation eased off and significantly lowered interest rates. No such lowering of interest rates is possible this time--interest rates are already as low as they can possibly go at the short end. So I can see no reason to anticipate a rapid recovery and employment when the cliff-diving stops. And I do not understand why the Obama administration is following policies that presume such a rapid recovery--a V rather than an L for the shape of the recession--is not just possible but probable.

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Posted via email from http://braddelong.posterous.com/comment-for-the-economist-on-christina-romer at Brad DeLong's Scrapbook

Mitch Daniels Did Not Do His Job

Oh dear. Only 52 hours in working for National Review, and the brainrot has gotten to Reihan Salam:

The Agenda on National Review Online: Daniels for Rushmore: Like NR's Mark Hemingway, I'm a slightly fanatical admirer of Indiana Governor Mitch Daniels...

One of the threads of Ron Suskind's The Price of Loyalty is that Mitch Daniels simply did not do his job as Bush's OMB Director. The OMB Director is the principal--indeed, the only--voice inside the White House for fiscal prudence, for trying to ensure that the money the government spends is spent well and that the resources the government raises are adequate for the spending plans the White House evolves. While he was Bush OMB Director, Daniels simply did not do his job.

Page 219:

Mitch Daniels became agitated. He blurted out, "Well, yes, but if you can't do the right thing when you're at 85 percent approval, then when can you do the right thing? I think it's time to say no." Everyone looked with surprise at Daniels--he has a way of expressing what others are thinking but don't say. Often, he'd find himself doubling back when he got an arched brow from Cheney or Rove...

And page 296:

The Commerce Secretary echoed much of what had been said.... As usual, not a real discussion, O'Neill thought as he looked over at [Mitch] Daniels.... He knew Daniels was focused on the perils of rising deficits, but it would take gumption to air those concerns in a room full of tax cut ideologues. "I think we need to balance concerns," Daniels said.... "You need to be out front on the economy, but I am concerned that this package may not do it. The budget hole is getting deeper... we are projecting deficits all the way to the end of your second term." From across the table came glares from the entire Bush political team. Daniels paused.... "Ummmm. On balance, then, I think we need to do a [tax cut] package... accelerate the rate cuts and the double taxsation of dividends..." O'Neill looked with astonishment at Daniels... turn 180 degrees in midsentence...

Surely we can do better? Surely we can find a Republican who has (a) held high federal office and (b) actually done his job?

We Hicksian Economists Should Be Confident that We Know Something...

Looking at forthcoming U.S. Treasury bond issues:

I do understand why people who think about supply-and-demand expect this tsunami of bonds to push down the prices and push up the interest rates on Treasury bonds a lot.

The argument that it will not do so but will instead boost spending is an old argument--more than three-quarters of a century old--but it is somewhat subtle.

The fact that U.S. Treasury bond prices did not collapse the moment the magnitude of the U.S. government's 2009 and 2010 fiscal deficits became clear is the one thing that gives me substantial confidence that we Hicksian economists do actually know something about how the world really works.

A Sokratic Dialogue: Liquidity Preference, Loanable Funds, and European Hedge Funds that Fear the Collapse of U.S. Treasury Bond Prices

Meno: I haven't seen you since spring classes ended.

Adeimantos: I have been away: Paris. London. Frankfurt.

Meno: Oh. Pleasant? Interesting?

Adeimantos: Not really interesting--too jet-lagged, so I sit in my hotel room in my underwear, read the Economist and Financial Times,, and reflect on how if in my 20s I had been in a fancy hotel in central Paris with someone else paying I would have thought I was in heaven, but that now I am just tired. Thus not too pleasant either.

Meno: Middle age is a shipwreck?

Kephalos: It gets worse...

Adeimantos: However, it was somewhat lucrative: talking to European hedge funds.

Meno: And what do European hedge funds think?

Adeimantos: They look at things like this:

Then they demand that I tell them why U.S. Treasury bond prices have not already collapsed (and Treasury interest rates risen) in anticipation of this forthcoming tsunami of bond issues. Given that Treasury bonds have not yet collapsed they are very very bearish about U.S. Treasury bond prices and interest rates. Supply and demand. The supply of U.S. Treasury bonds is about to become huge, and when supply goes up price should go down.

Sokrates: But if that argument is correct, then rational profit-seeking traders should already have sold U.S. Treasury bonds and already have pushed their prices down in anticipation of the sudden increase in supply...

Meno: Are you Sokrates or Milton Friedman?

Kephalos: There are two supply-and-demand arguments that can be made here. The first is that the supply of U.S. Treasury bonds is about to jump enormously--and so by supply-and-demand the price will be low once the extra bond issues hit the market, and should be low now in anticipation of this low-price Treasury bond market equilibrium. The second is that the inverse of the price of U.S. Treasury bonds--the Treasury nominal interest rate--is the price of liquidity: the amount of interest income you forego by keeping your wealth in cash rather than in securities. According to this second argument, the supply-and-demand is the supply and demand for cash: when the supply of cash is high, the price of liquidity is low, and since the price of liquidity is the short-term Treasury interest rate the short-term Treasury interest rate should be very low.

Adeimantos: Which it is...

Kephalos: And the long-term Treasury interest rate is the average of expected short-term future Treasury interest rates. Since the Federal Reserve has flooded the economy with cash and will keep flooding it with cash for the foreseeable, Treasury interest rates should be low which means Treasury bond prices should be very high--which they are--and stay high.

Adeimantos: Loanable funds vs. liquidity preference.

Sokrates: So, Kephalos, with your impeccable logic and deep wisdom derived from a long career financing expeditions to the shores of the Black Sea, you have presented us with two different supply-and-demand arguments, one saying that Treasury bond prices should be low and hence are about to collapse, and the other saying that Treasury bond prices should be high and are likely to stay more-or-less where they are for some time to come.

Meno: Which argument is right? Is the price of bonds the price that balances the supply and demand for bonds in the bond market? Or is the price of bonds the inverse of the interest rate which balances the supply and demand for cash in the money market? Both cannot be true, can they?

Adeimantos: Ah. But both arguments are true...

Meno: Why do I get the feeling that I am being cast as the dumb straight man in this dialogue?

Sokrates: Because you are a sophist and we are philosophers. We write the dialogues, and we write them to make ourselves look good so that everyone thinks that philosophers are the roxxor and sophists are lame...

Meno: What have I ever done to you?

Glaukon: Tried to take our students and their fees, perhaps?

Sokrates: And we have won. There are now departments of philosophy everywhere. But when was the last time you saw a department of sophistry?

Meno: OK. I will take up my role: Kephalos: Can you explain to me how two perfectly-coherent supply-and-demand arguments lead to opposite conclusions? And if both arguments are coherent, why do European hedge funds all believe the first?

Kephalos: I can answer the second question but not the first: European hedge funds live in the bond market and they see the supply and demand of bonds all day, so that is the market they believe is most important...

Adeimantos: That is true about European hedge funds. But, Meno, the way you have posed the issue is somewhat misleading. It is not which supply-and-demand argument is correct--for both are: the price/interest rate on Treasury bonds clears both the bond and the money market, both loanable funds and liquidity preference. It is how does the economy adjust in order to make the Treasury bond price/interest rate clear both these markets.

Meno: And I have the feeling that you are about to tell me...

Adeimantos: Let's start with an economy in equilibrium--where Treasury bond prices are such as to satisfy both loanable funds and liquidity preference, so that everyone is happy to hold the bonds given their current price and everyone is happy to hold the economy's cash supply given the current interest rate. Now suppose the Treasury issues a huge honking tranche of bonds (and Obama spends the money hiring the unemployed to give people cholesterol screenings on the street and hand out statins). Now the supply of bonds is greater than demand at current bond prices. So what happens?

Kephalos: The prices of Treasury bonds fall--interest rates rise...

Adeimantos: And what happens in the money market as interest rates rise?

Kephalos: People are no longer happy holding the economy's cash--it's too expensive; it's burning a hole in their pocket. So they start spending it faster...

Adeimantos: And as they start spending it faster?

Kephalos: This puts upward pressure on prices and employment, as businesses find that they can charge more and make hire profits and so hire more people...

Adeimantos: Incomes rise, and as incomes rise savings rise because people don't spend all of their increased incomes, do they?

Sokrates: Very true, Adeimantos.

Adeimantos: And what happens as savings rise?

Kephalos: People want to park those savings somewhere. They want to park those savings in Treasury bonds. And so demand for Treasury bonds rises...

Adeimantos: And the economy settles back at its new equilibrium, with (a) somewhat higher interest rates and (b) higher spending and income so that (c) people are happy holding the economy's cash at the current interest rates and rate of spending, and (d) people are happy holding the bonds at the current bond prices and level of income.

Kephalos: So both supply-and-demand arguments are true...

Meno: And the way that they can both be true is that there isn't just one quantity--the bond price--that adjusts to match supply and demand in the bond and the money markets...

Sokrates: But there are two quantities that adjust: the bond price and the level of spending...

Adeimantos: Yes. You have just derived things that were well-known 72 years ago. See John Hicks (1937), "Mr. Keynes and the 'Classics': A Suggested Interpretation."

Sokrates: But which adjusts more?

Adeimantos: Once again back to Hicks (1937). When the unemployment rate is high and the nominal interest rate on Treasury bonds is very very slow, adjustment comes in the form mostly of changes in spending and only slightly in changes in interest rates--the world is then "Keynesian." But when the unemployment rate is normal or low and the nominal interest rate on Treasury bonds is near its normal levels, adjustment comes in the form mostly of changes in interest rates and only slightly in changes in spending--the world is than "Classical." That's why the title of the article is "Mr. Keynes and the 'Classics'."

Meno: So when European hedge funds predict the collapse of U.S. Treasury bond prices as the new issues hit the market and ask where is the extra demand to hold all these new bonds come from, the answer is...?

Adeimantos: That even as the government issues the bonds it is also spending the money, and as the money it spends is parked in the bank accounts of the businesses the government is buying things from, the banks in which the money is parked take it and use it to buy Treasury bonds.

Meno: That sounds like sophistry...

Sokrates: You should talk...

Glaukon: Actually, it's just general equilibrium...

Meno: But is this doctrine--that the government's issuance of a fortune in bonds and spending of a fortune in money will show up primarily not as a collapse in bond prices and a spike in interest rates but as an expansion of spending--true?

Sokrates: We will see. Keynesian--or maybe I should say Hicksian--economists would say that bond prices/interest rates and spending/income levels are the two quantities that together adjust to jointly clear the bond and the money markets, to satisfy both loanable funds and liquidity preference equilibrium; that sometimes the principal movement is in interest rates; that sometimes the principal movement is in spending levels; and that right now it is likely that spending will adjust by much more than interest rates.

Adeimantos: And there is a little bit of empirical evidence that the Hicksian economists are right. Tim Fernholz http://www.prospect.org/csnc/blogs/tapped_archive?month=06&year=2009&base_name=compare_and_contrast_economic sends us to Nelson Schwartz, who writes:

Europe Lags as U.S. Economy Shows Signs of Recovery - NYTimes.com: There was more evidence Thursday that the United States economy might be stabilizing, if not rebounding, even as economic reports in Europe remained gloomy. The American news — showing slight growth in retail sales and a dip in first-time jobless claims, as well as rising stocks — was not enough to end the disagreement between bulls and bears over how soon the economy would improve. But the apparent divergence of fortunes between America and Europe highlighted the different approaches to solving the financial crisis, and why some economists say the more aggressive American strategy may be working better, at least for now. It is a debate that is likely to be one of the issues dominating discussions when finance ministers from the eight largest economies meet in Italy this weekend.

Some private economists are even predicting that the American economy will resume growth in the fourth quarter, while Europe’s economy is expected to remain in recession well into 2010, after contracting an estimated 4.2 percent this year compared with an expected 2.8 percent decline in the United States. “The shock originated in the U.S., but Europe is paying a higher price,” said Jean Pisani-Ferry, a former top financial adviser to the French government who is now director of Bruegel, a research center in Brussels. Almost from the beginning of the crisis, the United States and Europe chose largely different paths to aiding their economies. The most stark was Washington’s willingness to commit hundreds of billions of dollars to stimulus spending — in addition to moving aggressively to shore up banks and keep credit flowing — versus Europe’s worry that similar spending would increase inflation in the future. Just as the policies pursued during the Great Depression have been dissected ever since by economists, the fate of the United States and Europe as the two regions emerge from the global crisis will be analyzed for decades to come.....

One crucial concern about America’s increased deficit spending — that it would lead investors to demand higher interest rates on United States debt, making it far more expensive to borrow and slowing the economy — has been allayed, for now. An auction on Thursday of $11 billion in 30-year Treasury bonds found enthusiastic buyers, helping to push the Standard & Poor’s 500-stock index to a seven-month high...

Meno: And the Chicago School economists who say that government borrow-and-spend logically cannot increase overall spending? The Robert Lucases who say: "[W]ould a fiscal stimulus somehow get us out of this bind...? I just don't see this at all. If the government builds a bridge... by taking tax money away from somebody else, and using that to pay the bridge builder... then it's just a wash.... [T]here's nothing to apply a multiplier to. (Laughs.)... [And] taxing them later isn't going to help, we know that..."? And the John Cochranes who said: "[W]hile Tobin made contributions to investing theory, the idea that spending can spur the economy was discredited decades ago. 'It’s not part of what anybody has taught graduate students since the 1960s. They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false.'" To borrow money to pay for the spending, the government will issue bonds, which means investors will be buying U.S. Treasuries instead of investing in equities or products, negating the stimulative effect, Cochrane said. It also will do nothing to unlock frozen credit..."?

Sokrates: I, at least, find myself unable to understand them. They say they believe in the quantity theory of money--that spending is equal to the economy's cash times its velocity. And they say that they believe that velocity is interest elastic--that people respond to incentives and spend the cash in their pockets more rapidly when nominal interest rates are high. They say that they believe that bond prices/interest rates are such as to balance saving and investment and make people willing to hold the stock of bonds. That's all you need to be a Hicksian. Yet they also claim that Hicks is wrong, somehow--without giving arguments. I can trip up and make foolish anybody who makes an argument, but if they don't make an argument I cannot make them look any more foolish...

Net Treasury Bond Issues to Be Held by the "True' Public, since 1980 and Projected

Bonds held by the Federal Reserve are not part of debt held by the public, no matter what OMB may say.

It's really too bad that I don't have to give a lecture on liquidity preference vs. loanable funds right now...

(Small) Interest Rate Increases Are Good News, Not Bad News (Washington Post Crashed-and-Burned-and-Smoking Watch)

Over at the Financial Times, the careful, insightful, and highly intelligent Martin Wolf writes:

FT.com / Columnists / Martin Wolf - Rising government bond rates prove policy works: Is the US... on the road to fiscal Armageddon? Are recent jumps in government bond rates proof that investors are worried about fiscal prospects? My answers to these questions are: No and No.... [T]here are... right now and strong reasons for welcoming recent moves in the bond markets....

The jump in bond rates is a desirable normalisation after a panic. Investors rushed into the dollar and government bonds. Now they are rushing out again. Welcome to the giddy world of financial markets.... What has happened is a sudden return to normality.... [W]hat about the other concern caused by huge bond issuance: crowding out of private borrowers? This would show itself in rising real interest rates. Again, the evidence is overwhelmingly to the contrary.... [A]s confidence has grown, spreads between corporate bonds and Treasuries have fallen (see chart). One can also use estimates of expected inflation derived from government bonds to estimate real rates of interest on corporate bonds. These have also fallen sharply (see chart). While riskier bonds are yielding more than they were two years ago, they are yielding far less than in late 2008. This, too, is very good news indeed.....

[T]he last concern: the fear of inflation.... People need to believe that the extraordinarily aggressive monetary and fiscal policies of today will be reversed. If they do not believe this, there could well be a big upsurge in inflationary expectations long before the world economy has recovered. If that were to happen, policymakers would be caught in a painful squeeze and the world might indeed end up in 1970s-style stagflation. The exceptional policies used to deal with extreme circumstances are working.... It is irresponsible to insist either on immediate tightening or on persistently loose policies. Both the US and the UK now risk the latter. But their critics risk making an equal and opposite mistake. The answer is both clear and tricky: choose sharp tightening, but not yet.

Over at the Washington Post, the , , and _ Neil Irwin writes:

Spike in Interest Rates Could Choke Recovery: Rising long-term interest rates are making it more expensive for home buyers, corporations and the U.S. government to borrow money, threatening to further stifle an already weak economy. In just the past two weeks, the rate on a 30-year, fixed-rate mortgage has risen to 5.6 percent from 4.9 percent, ending a boom in refinancing and working against a budding recovery in the housing market. Rates on corporate borrowing have also risen, making it more expensive for companies to expand. And the government has been forced to pay more to finance its deficit.

Since the beginning of the year, historically low mortgage rates have had a twin benefit for the economy: They have allowed homeowners to refinance about $1.5 trillion worth of mortgages, thus lowering monthly payments and leaving people with more money to spend on goods and services. Low rates have also created greater incentive for people to buy homes, despite continuing troubles in the housing market. The abrupt rise in rates has removed that key stimulant for the economy.

The rise has many causes, some of which reflect good news. As investors have grown more confident about the future, for example, they have become more inclined to put money in risky investments, such as the stock market, rather than lending it to the U.S. government and to government-backed mortgage companies. But other causes give more reason for worry. Investors around the world are increasingly fearful that Congress and the Obama administration will be unwilling to bring taxes and spending in line in the years ahead. That makes the U.S. government appear to be a riskier borrower, leading those who lend to it to demand higher interest payments.

The Federal Reserve now finds itself in a box. It could try to lower rates by buying government debt. It has already said it would buy $1.5 trillion in U.S. Treasuries and mortgage-related securities this year to try to stimulate growth. But doing so would likely only deepen fears that the Fed will print money to fund government deficits in the future. That possibility -- while rejected by Fed officials and many mainstream economists -- means that expanding purchases might not have the intended effect of lowering rates. It could even drive them up further...

General equilibrium. Long-term interest rates have risen because banks expect that four or five years from now the economy will be stronger than they thought two months ago and so they will be able to lend their money out more profitably then--even with higher interest rates. The rise in interest rates is the result of a stronger anticipated recovery, not the cause of a weaker one.

Neil Irwin's economist sources are:

• Scott Anderson, a senior economist at Wells Fargo: "Households really have no capacity to afford higher rates at this point.... It affects the cost of any long-term borrowing a consumer or business might do, whether it's auto loans, mortgages or business credit..."
• Jay Brinkman, chief economist of the MBA, who says "The increase so far has not really been enough to choke off home buying..."

In short, Neil Irwin did not find an economic forecaster who would agree with his headline--"Spike in Interest Rates Could Choke Recovery"--yet he wrote the article anyway.

Think about that.

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

The Debt and the Deficit in Historical Perspective...

Debt-to-GDP Graphs:

Note: Debt held by the public, excluding debt held by the Federal Reserve.

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Change in Truly-Public-Held Federal Debt, Divided by GDP

Note: Not the change in the debt-to-GDP ratio; rather, the change in debt, then scaled by GDP.

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http://tinyurl.com/de20090611b

Robert Reich Writes About the Debt Scare

Reich:

Robert Reich's Blog: The Great Debt Scare: Why Has It Returned?: It’s the kind of thing I expect to hear from deficit hawks and chicken littles -- from the self-described "fiscally responsible" right, from the scolds Ross Perot and Pete Peterson, from my former cabinet colleague Bob Rubin.... The Great Debt Scare is back. Odd that it would return right now, when the economy is still mired in the worst depression since the Great one. After all, consumers are still deep in debt and incapable of buying. Unemployment continues to soar. Businesses still are not purchasing or investing, for lack of customers. Exports are still dead, because much of the global economy continues to shrink. So the purchaser of last resort -- the government -- has to create larger deficits if the economy is to get anywhere near full capacity, and start to grow again.

Odder still that the Debt Scare returns at the precise moment that bills are emerging from Congress on universal health care, which, by almost everyone’s reckoning, will not increase the long-term debt one bit because universal health care has to be paid for in the budget.... Even odder that the Debt Scare rears its frightening head just as the President’s stimulus is moving into high gear with more spending on infrastructure. Every expert who has looked closely at the nation’s crumbling infrastructure knows how badly it suffers from decades of deferred maintenance -- bridges collapsing, water pipes bursting, sewers backed up, highways impassable, public transit in disrepair. The stimulus, along with the President’s long-term budget, also focus on the nation’s schools, as well as America’s capacity to reduce emissions of greenhouse gases. These public investments are as important to the nation’s future as are private investments.

First, some background: Deficit and debt numbers mean nothing in and of themselves. They take on meaning only in relation to something else.... Pay close attention, in particular, to the debt/GDP ratio. True, that ratio is heading in the wrong direction right now. It may reach 70 percent by the end of 2010. That’s high, but it’s not high compared to the 120 percent it was in 1946, after the ravages of Depression and war. Over time, the basic way America has reduced the debt/GDP ratio is by growing the U.S. economy.... That growth path, by the way, will be faster and stronger if the nation invests in our infrastructure, our schools, and our environment -- which is exactly what Obama aims to do. In this respect, national budgets are like family budgets. It’s dumb for an indebted family to borrow more money to take a world cruise. But it’s smart even for an indebted family to borrow money to send their kids to college.... Don't get me wrong. I'm not saying there's nothing to worry about when it comes to long-term deficit and debt projections. I'm just saying now's not the time to worry, and we ought to temper our worries by understanding the larger context...

Back in 1992 the real interest rate on a ten-year U.S. Treasury bond was 5% per year. Right now the real interest rate on a ten-year U.S. Treasury bond is more or less zero. Borrow back in 1992 thinking that the government is going to repay its borrowings ten years down the road and ten years down the road you find yourself paying back $1.65 in real purchasing power for each dollar you borrowed in 1992. Today you find yourself paying back just $1 in real purchasing power ten years from now for each dollar you borrow today. As Commander Whorf would say if he were an economist rather than a Klingon professional practitioner of coercive violence: "Today is a good day to borrow," for the government at least.

There are worries about the long-run deficit to the extent that we are unable to bend the curve on government health-care expenditures, but those demand policy actions to raise taxes or change the medical-care system not today but in the 2012 time frame and beyond.

And of course there is the real way to cure destructive long-term deficits: stop electing Republicans like George W. Bush and Ronald Reagan who don't care about the quality of the economic policies they pursue. Elect Democrats like Bill Clinton and Barack Obama who do care about the quality of their economic policies instead.

A Pretty Good but Not Excellent Story from David Leonhardt on the Deficit

David writes:

Economic Scene - How the U.S. Surplus Became a Deficit: There are two basic truths about the enormous deficits that the federal government will run in the coming years. The first is that President Obama’s agenda, ambitious as it may be, is responsible for only a sliver of the deficits, despite what many of his Republican critics are saying. The second is that Mr. Obama does not have a realistic plan for eliminating the deficit, despite what his advisers have suggested. The New York Times analyzed Congressional Budget Office reports going back almost a decade, with the aim of understanding how the federal government came to be far deeper in debt than it has been since the years just after World War II. This debt will constrain the country’s choices for years and could end up doing serious economic damage if foreign lenders become unwilling to finance it.

Mr. Obama — responding to recent signs of skittishness among those lenders — met with 40 members of Congress at the White House on Tuesday and called for the re-enactment of pay-as-you-go rules, requiring Congress to pay for any new programs it passes. The story of today’s deficits starts in January 2001, as President Bill Clinton was leaving office. The Congressional Budget Office estimated then that the government would run an average annual surplus of more than $800 billion a year from 2009 to 2012. Today, the government is expected to run a $1.2 trillion annual deficit in those years...

There are two things wrong with the story. First, David doesn't say what part of the $1.2 trillion deficit is a problem. My estimate is that the U.S. could run a $500 billion annual deficit in an average year without incurring any chance of getting into any serious economic problems (although I would wish that the cyclically-adjusted deficit were smaller), and that an additional $400 billion of annual deficit is justified by the recessionary state of the business cycle over Obama's first term. So the serious deficit problem seems to me to be, today, at $300 billion a year.

Of course, it will grow unless taxes are raised by 2012 or health-care costs contained...

Second, this "[the deficit] could end up doing serious economic damage if foreign lenders become unwilling to finance it..." needs to be balanced by the observation that a worry that foreigners will prove unwilling to buy U.S. Treasury bonds at reasonable prices is, like, worry #927 on our list of worries. It's just not up there...

DeLong Smackdown Watch (Reconciliation Bill Version)

Apropos of Fiscal Policy in the Second Half of 2009, Stan Collender emails:

FYI…Reconciliation can’t be used to increase the deficit. The Democrats passed a rule when this Congress began that says it can only be used to decrease the deficit.

Ooops.

Fiscal Stimulus: Second Round

The Wall Street Journal picks up my draft call for more fiscal expansion:

Making the Case for Another Fiscal Stimulus: Although President Obama’s $787 billion fiscal stimulus is still working its way through the pipeiline, Berkeley economist — and former Clinton Treasury official — Brad Delong makes the case for another round. In a draft of a letter he says he may send Obama next week, he said:

At the end of 2008, when your incoming administration was preparing your recession-fighting strategy, your forecasts were that the recession would bottom out in August of 2009, with a peak unemployment rate of 7.9%. The unemployment rate in May was already 9.4%. 10% unemployment this year is a nearly foregone conclusion. 11% unemployment — a recession twice as deep as the one your incoming administration was forecasting at the end of 2008 — is not unlikely …. Even had the fiscal expansion plans of your administration not been cut back by roughly a quarter in their employment-generating effectiveness by the Congress, fiscal stimulus plans that appeared to be adequate and appropriate at the turn of the year now appear to be inadequate. Compounding the problem of inadequate fiscal expansion at the federal level is the problem of inappropriate and substantial fiscal contraction at the state level...

Delong’s proposal:

• Seek from the Congress for authority to guarantee the debt of states that, in response to the current recession, (a) seek to conduct their own state-level fiscal expansions, and (b) devise plans and strategies for the long-term repayment of the debt the federal government guarantees that the Secretary of the Treasury certifies as prudent and sustainable.

• Seek an additional $500 billion of federal aid to states for the federal fiscal year that begiins Oct. 1, 2001, to be distributed per capita and conditioned on their maintaining effort at the provision of public services — on their not repeating the mistake of Herbert Hoover of cutting government employment and spending in a downturn.

But then the WSJ hints that I am yet another self-interested lobbying group:

Delong, of course, works for the state university system in California, where Gov. Arnold Schwarzenegger and the state legislature are struggling with a colossal budget deficit.

I reply:

Making the Case for Another Fiscal Stimulus - Real Time Economics - WSJ: report offensive comments email blogsadmin@wsj.com: Brad DeLong wrote:

Truth to tell, the possibility that an additional round of fiscal expansion targeted at aid to the states might trickle down and help pay for my forthcoming master bathroom renovation literally never crossed my mind over the past week…

What did cross my mind was (a) memories of Paul Krugan last fall warning about this, (b) running the numbers on the deterioration of the forecast over the past six months, (c) Peter Schrag’s recountings of Sacramento politics over lunch, and Gene Smolensky’s and John Ellwood’s repeated pointings-out that California is only the worst case as far as fiscal contraction by state governments are concerned, and (d) my eighteen-year-old Michael’s summer job, which involves going to California budget conference committee hearings and taking notes…

Brad DeLong

Fiscal Policy in the Second Half of 2009

A DRAFT of a letter I might send next week:

Dear President Obama--

At the end of 2008, when your incoming administration was preparing your recession-fighting strategy, your forecasts were that the
recession would bottom out in August of 2009, with a peak unemployment rate of 7.9%. The unemployment rate in May was already 9.4%. 10% unemployment this year is a nearly foregone conclusion. 11% unemployment--a recession twice as deep as the one your incoming administration was forecasting at the end of 2008--is not unlikely.

An 11% unemployment rate would carry along with it an underemployment rate--a U-6--that would kiss 20%.

Even had the fiscal expansion plans of your administration not been cut back by roughly a quarter in their employment-generating effectiveness by the Congress, fiscal stimulus plans that appeared to be adequate and appropriate at the turn of the year now appear to be inadequate.

Compounding the problem of inadequate fiscal expansion at the federal level is the problem of inappropriate and substantial fiscal contraction at the state level. Last fall Nobel Prize-winning Princeton economist Paul Krugman feared "fifty Herbert Hoovers"--fifty states each trying to balance its budget year-by-year and each one delivering a substantial drag on employment and income in its and its neighbors' economies.

I therefore believe:

• That it is past time for you to seek from the Congress for authority to guarantee the debt of states that, in response to the current recession, (a) seek to conduct their own state-level fiscal expansions, and (b) devise plans and strategies for the long-term repayment of the debt the federal government guarantees that the Secretary of the Treasury certifies as prudent and sustainable.

• That it is time for you to seek from the Congress an amended Budget Resolution: to include in this year's forthcoming Reconciliation process an additional $500 billion of federal aid to states, distributed per capita and conditioned on their maintaining effort at the provision of public services--on their not repeating the mistake of Herbert Hoover of cutting government employment and spending in a downturn.

Sincerely yours,

J. Bradford DeLong

Washington Post Crashed-and-Burned-and-Smoking Watch (Robert Samuelson Edition)

Jesus weeps every day that the Washington Post prints another edition.

Publius:

Obsidian Wings: Robert Samuelson's Dishonest Jihad Against Social Security: If the country ever gets around to ending life tenure for Supreme Court Justices, I hope we add a provision ending it for Washington Post columnists too.  Or at least ending it for Robert Samuelson.  Today, again, we see another extremely misleading op-ed from him on the fiscal health of Social Security. Here’s a good rule of thumb – anytime you see an op-ed whining about entitlements that uses the phrase “Medicare and Social Security,” it’s safe to stop reading.... To lump Social Security together with the more problematic Medicare shortfall (which should be addressed through national health care reform) is blatantly misleading.  It’s like saying the combination of a Big Mac and a jelly bean is an extremely high-calorie meal. But that’s exactly what Samuelson is doing.  In fact, Michael Lind had a Salon column a while back outlining all the rhetorical tricks that dishonest Social Security skeptics make.  It’s as if Samuelson read that column, and decided to use them all.

For instance, here’s Lind:

In order to frighten gullible Americans, anti-Social Security crusaders conflate Social Security with Medicare and talk about the "entitlement crisis" in general. This masks the fact that Social Security's projected shortfalls are minor, compared to those of Medicare.

And Samuelson:

It's increasingly obvious that Congress and the president (regardless of the party in power) will deal with the political stink bomb of an aging society only if forced. And the most plausible means of compulsion would be for Social Security and Medicare to go bankrupt.

And Lind:

About a decade ago, conservative and libertarian economists who oppose Social Security, Medicare and other entitlements came up with a clever rhetorical strategy. They would calculate the gap between the payroll taxes that pay for these programs and estimated costs over time. But there was one problem: The gap isn't all that scary, at least in the near future. So in order to frighten the American people and their elected leaders, deficit hawks cite the sum total of Social Security's "unfunded liabilities" over 75 years. But even this -- a paltry $4.3 trillion over three-quarters of a century, according to the 2008 report -- isn't sufficiently terrifying.  [So they combine Medicare and SS].  [This] produces a suitably spooky 75-year shortfall of $42.9 trillion. And if this is not alarming enough, deficit hawks can cite the truly apocalyptic figure of $101.7 trillion in combined "entitlement" spending over an infinite time horizon. The anti-Social Security lobby always presents the "unfunded liabilities" of "entitlements" in scary dollar terms, rather than as percentage points of GDP. Here's why: Over the next 75 years, the Social Security shortfall at most hovers around 1 percent of total U.S. GDP over that same period.

And Samuelson:

That the programs will ultimately go bankrupt is clear from the trustees' reports. On Pages 201 and 202 of the Medicare report, you will find the conclusive arithmetic: Over the next 75 years, Social Security and Medicare will cost an estimated $103.2 trillion, while dedicated taxes and premiums will total only $57.4 trillion. The gap is $45.8 trillion. (All figures are converted to "today's dollars.")

The Chicago School on Dealing with Depression in 1933 I

Milton Friedman in "A Comment on the Critics" approvingly quotes Jacob Viner's (1933) "Balanced Deflation, Inflation, or More Depression":

Even more pertinent is a talk Viner delivered in Minneapolis of February 20, 1933, on "Balanced Deflation, Inflation, or More Depression"....

[I]t woul dhve been sound policy on the part of the federal government deliberately to permit a deficit to accumulate during depression years, to be liquidated in prosperity years.... The outstanding though unintentional achievement of the Hoover Administration in counteracting the depression has in fact been its deficits of the last two years....

[...]

I will use the term 'inflation' to mean an inrease in the total amount of spendable funds.... It is often said that the federal government and the Federal Reserve system have practiced inflation during this depression and that no beneficial effects resulted from it. What in fact happened was that they made mild motions in the direction of inflation.... At no time... since the beginning of the depression has there been for so long as four months a net increase in the total volume of bank credit....

Assjming for the moment that a deliberate policy of inflation should be adopted, the simplest and least objectionable procedure would be for the federal government to increase its expenditures or decrease its taxes, and to finance the resultant excess of expenditures over tax revenues either by the issue of legal tender greenbacks or by borrowing from the banks...

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From J. Rennie Davis (1968), "Chicago Economists, Deficit Budgets, and the Early 1930s," American Economic Review 58:3,1 (June), pp. 476-481:

Frank H. Knight to Senator Robert F. Wagner (May 8, 1932): As far as I know, economists are completely agreed that the Government should spend as much and tax as little as possible at a time such as this--using the expenditure in ways to do the most good in itself and also to point toward relieving the depression...

Jacob Viner (1931): [T]he public works or other useful services so financed [by deficit spending] during a period of economic depression are from the national economic point of view almost costless...

Andrew Samwick on Republicans and Taxes

Andrew writes:

Libertarians and Taxes: From David Boaz of the Cato Institute, who visited Dartmouth yesterday:

Too many advocates of small government still have this lingering attachment to the Republican party,” Boaz said. “It’s like being a battered wife — how long do you wait to leave?

Perhaps the more interesting part of the analogy is, Where do you go when you leave?  Typically, it is not to another partner, but to a period in which you are not in a relationship until you can recover from what just happened and make the changes that are needed so it never happens again. Are the Libertarians doing that?  I'm not so sure.  Consider more of what Boaz said: Boaz described the recent Republican tea parties in protest of tax day as “the revival of a freedom movement.” He also referenced a recent advertisement run by the Cato Institute in several major U.S. newspapers, including The New York Times. The advertisement discussed perceived flaws in the economic stimulus package. “Someday, this ad is going to be remembered as the revival of the free market movement,” Boaz said.

At moments like this, we go back to Milton Friedman's adage, "To spend is to tax."  I cannot really come up with a better word than juvenile for the tea parties -- don't protest the taxes unless you can identify the specific cuts in expenditures that you would make to bring the budget into balance.  If you think taxes are bad, then you should think deficits are worse, because they raise the taxes of people who were not represented in the decisions to spend the money. That's the real lesson from the Revolutionary War period that should be drawn.  And the danger for the Libertarians is that if they don't put the reduction in expenditures ahead of the reduction in taxes on their agenda, they are destined for another abusive relationship down the road.  This title of an Economix post [by David Leonhardt] had it right, "Where Were the Medicare Tea Parties?" 

This Is Getting Damned Annoying: Will I Ever Be Allowed to Disagree with Paul Krugman Again About Anything? (Niall Ferguson Edition)

There have been two annoying things about the past decade. The first is that I feel like I have been living in a Ken Macleod novel--and one of the more dystopic ones too, at least up until January 21, 2009 (I am glad he has stopped: Ken: please don't get cranky again). The second is that the best way to understand the world is through these two rules:

1. Paul Krugman's analysis is correct.
2. If you think that Paul Krugman's analysis is incorrect, see rule number 1.

Most recently, I thought that Paul Krugman must be being too harsh on Niall Ferguson. Ferguson could not really have forgotten so much economics as to believe that when interest rates are zero deficit spending is inherently contractionary, could he? But Paul said he did:

Liquidity preference, loanable funds, and Niall Ferguson (wonkish) - Paul Krugman Blog - NYTimes.com: Joe Nocera... fails to mention... the most depressing aspect... further confirmation that we’re living in a Dark Age of macroeconomics, in which hard-won knowledge has simply been forgotten. What’s the evidence? Niall Ferguson “explaining” that fiscal expansion will actually be contractionary, because it will drive up interest rates. At least that’s what I think he said....

[I]t might be useful to re-explain why [in] our current predicament... fiscal deficits won’t drive up interest rates unless they also expand the economy.... I imagine Niall Ferguson was thinking... of... the “loanable funds” model.... Keynes pointed out was that this picture is incomplete if... the economy is not at full employment.... [S]upply and demand for [loanable] funds... tells you what the interest rate would be conditional on the level of GDP... defines a relationship between the interest rate and GDP....

So what determines the level of GDP, and hence also ties down the interest rate?... [A]dd “liquidity preference”, the supply and demand for money. In the modern world... the central bank adjusts the money supply so as to [try to] achieve a target interest rate.... [But r]ight now the interest rate that the Fed chooses is essentially zero [and cannot go any lower], but that’s not enough to achieve full employment... the interest rate the Fed would like to have is negative... the Fed’s own economists estimate the desired Fed funds rate at -5 percent....

So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending... until the excess supply of savings has been sopped up... [and the interest rate consistent with full employment rises above zero].

Now, there are real problems with large-scale government borrowing — mainly, the effect on the government debt burden. I don’t want to minimize those problems; some countries, such as Ireland, are being forced into fiscal contraction even in the face of severe recession. But the fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.

And Krugman reiterated his judgment:

China and the liquidity trap - Paul Krugman Blog - NYTimes.com: By the way, I’ve had a chance to see the transcript of the PEN/ NY Review event, and I don’t think I was misrepresenting Niall Ferguson’s position...

Sure enough, now that I have taken a look at the transcript, I have to once again agree that Paul Krugman's analysis is correct. This is annoying. This is damned annoying. In fact, this is beyond annoying:

Niall Ferguson: Now we are in the therapy phase, and what therapy ar we using? Well, it is very interesting because we are using two quite contradictory courses of therapy. One is the prescription of Dr. Friedman, Milton Friedman, that is, that is being administered by the Federal Reserve: massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the 1930s. I am fine with that. That is the right thing to do. But thre is qnother course of therapy that is simultaneously being administered, which is the therapy prescribed by Dr. Keynes, John Maynard Keynes, and that therapy involves the running of massive fiscal deficits in excess of 12 percent of gross domestic product this year and the issuance therefore of vast quantities of freshly-minted bonds.

There is a clear contradiction between these two policies, and we are trying to have it both ways. You cannot be a Keynesian and a monetarist simultaneously, at least I cannot see how you can, because if the aim of the monetarist policy is to keep interest rates down to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.... [T]here is going to be... a very painful tug-of-war between our monetary policy and our fiscal policy...

A real monetarist--like Milton Friedman's teacher Jacob Viner, say--would argue (in fact, did argue during the Great Depression) that when the interest rate is near zero monetary expansion and deficit spending do not offset but reinforce each other, for essentially the reasons set out by Krugman. As Paul said in rebuttal to Ferguson: "There is... no contradiction between the Federal Reserve's actions and... fiscal stimulus. It is very much necessary to do both..."

Normally the banking system buys bonds from corporations which then spend the money investing in plant and equipment. Right now that process has broken down, and until the banking system gets fixed the second-best is to have the government step into the role. As Krugman writes:

By buying a lot of private securities, the Federal Reserve is... playing the role the private banking system is no longer playing properly... debt-financed spending on infrastructure by the Obama administraiton is filling the hole left by the collapse in business investment....

Conclusion? Once again:

There is not an excess demand for savings that is going to drive up interest rates...

Niall Ferguson does indeed know a lot less than economists knew in the 1920s. Back then when R.G. Hawtrey was laying out the Treasury View he claimed that fiscal policy was ineffective--and was wrong. Niall Ferguson's belief that fiscal policy is destructive shows that he has not even got that far.

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UPDATE: As a "friend" points out, Ferguson spent considerable time trying to bait Krugman into losing his cool:

• As d² points out, the references to "Dr. Keynes" appear for some reason to work like a red flag to a bull on status-conscious Englishmen--for Keynes never got a Ph.D.--but it doesn't work on Dr. Krugman.
• "I rather fear that, at the risk of provoking the man sitting on the other side of me, that it says 1936 on the bottle of Dr. Keynes’ medicine..."
• "[I]if you listened carefully to what Paul Krumgan said, he actually agreed with me [laughter]..."
• "So, I hate to teach arithmetic to a Nobel laureate, it doesn’t quite add up..."
• Madrick: "Let’s let Paul speak..." Krugman: "Oh, Dear..." Ferguson: "Oh Dear indeed..." Krugman: "Let’s talk national income accounting offstage..."
*

David Leonhard and Bruce Bartlett on Fiscal Policy

David Leonhardt:

Where Were the Medicare Tea Parties?/a>: Bruce Bartlett, the economist and former Reagan administration official, has been pounding the drum to get people to be more realistic about taxes. His case, in short, is that taxes will have to go up to cover the cost of government that Americans want. Referring to this week’s tea parties — the protests against taxes — Mr. Bartlett writes on Forbes.com:

[P]protesters... assume that the deficit has increased solely as a result of Barack Obama’s policies. But... the Congressional Budget Office was projecting a deficit of more than $1 trillion this year back in January, before any of Obama’s policies had been enacted, and a cumulative deficit of $4.3 trillion through 2019.... [P]rojected deficits have gotten larger since January. But much of this resulted from deteriorating economic conditions.... [M]any of those that loudly denounced the Obama stimulus package for its impact on the deficit would have cheered the McCain stimulus package even though it would have increased the deficit by about the same amount.

Proof of this proposition is that there were no tea parties during the years when George W. Bush was turning the surpluses of the Clinton years into massive deficits. Indeed, if concerns about deficits are the primary motivation for this week’s tax protests, then these same people should have been holding demonstrations of support for Bill Clinton in 2000 when the federal government ran a budget surplus of 2.4% of the gross domestic product–equivalent to a surplus of $336 billion this year.... [T]he greatest addition to national indebtedness occurred in 2003 when Bush rammed through the Republican Congress a massive expansion of Medicare to provide drug benefits even though the system was already broke...

Why Is Marty Feldstein Worrying About Whether Tax Increases Kill The Recovery?

Conor Clarke worries about Martin Feldstein's fears. I would say that it is an argument from the permanent income hypothesis rather than Ricardian equivalence--RE is that tax-law changes have no effect, while the PIH says that taxes matter not because current taxes affect current income but rather because the the long expected stream of future taxes affects the long expected stream of future income:

Will Tax Increases Kill The Recovery? : Martin Feldstein's Wall Street Journal op-ed... the argument he makes ("Tax Increases Could Kill the Recovery") is one that comes up a lot and I want to say one brief -- if slightly wonkish and tedious -- thing about it. When I read Feldstein's headline I thought, "But none of the tax increases take effect until 2011!" And while Feldstein anticipates that argument, I'm not sure his response makes a lot of sense:

Even if the proposed tax increases are not scheduled to take effect until 2011, households will recognize the permanent reduction in their future incomes and will reduce current spending accordingly.

[But] Feldstein supported a deficit-financed fiscal stimulus... when I went back and checked Feldstein's op-ed on the subject of fiscal stimulus I found that he has this to say....

Under normal circumstances, I would oppose this rise in the budget deficit and the higher level of government spending. When an economy is closer to full employment, government borrowing to finance budget deficits can crowd out private investment that would raise productivity and the standard of living. Budget deficits automatically increase government debt, requiring higher future taxes to pay the interest on that debt. The resulting higher tax rates distort economic incentives and thus weaken future economic performance.... Nevertheless, I support the use of fiscal stimulus in the US, because the current recession is much deeper than and different from previous downturns. Even with successful countercyclical policy, this recession is likely to last longer and be more damaging than any since the depression of the 1930's...

I prefer the Marty Feldstein of three months ago. Which one does Feldstein prefer?

My reading is that Marty has two things in mind:

• Trying to make sure that the current recovery is not derailed by the possibility that lots of press about coming tax increases causes consumers to cut back even more.
• Setting up the pins for three years from now, when we turn back to worrying about the long-run deficit, with the aim of starting from as low a level of taxes as possible when we start raising taxes and cutting spending to cut the deficit.

DeLong: Policies that Might Work I: Fiscal Policy

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Posted via email from http://braddelong.posterous.com/delong-policies-that-might-work-i-fiscal-poli at Brad DeLong's Scrapbook

Notes and Handouts for Berkeley Physics Colloquium, May 11, 2009

Audio: http://www.j-bradford-delong.net/2009_mov/20090511_physics.m4a

• The fall in the adult employment-population ratio
• The increase in risk and the collapse in risk tolerance
• The fall in monetary velocity
• What determines monetary velocity?
• Policy to fix it 1: dump money into the economy
  • Unjust enrichment
  • Inflationary overhang
  • Might not work when i<<1
• Policy to fix it 2: raise Treasury bond interest rates
  • By making Treasury bonds less attractive to hold--flood the zone
    • But then you have to spend the money you have earned by selling the Treasury bonds
  • By making corporate bonds more attractive to hold
    • Guarantees
    • Asset repurchases
    • Bank recapitalizations
• How did we get here?
  • Herd behavior
  • Short horizons
  • Limits to arbitrage
• What do we do for the long term?

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What is happening to employment?...

Increasing risk and collapsing risk tolerance...

Are the banks about to fail?...

Increasing risk and collapsing risk tolerance affect all asset prices...

Why asymmetry? The fall in monetary velocity...

Asymmetry arising from deflation...

Flight to safety produces a collapse in monetary velocity...

Normally we deal with collapsing velocity via monetary policy...

But may not work if interest rates are very low...

Guess where we are now?

Time to try alternative policies to try to raise the short-term interest rate on Treasury bonds...

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How did we get here?

What do we do to improve the system?

Obama's First 100 Days

And the four timescales on which he must act:

• The three-year time-scale: the economic crisis.
• The fifteen-year time scale: the health cost crisis.
• The seventy-five-year time scale: the global power crisis.
• The 375-year time scale: the global climate crisis.

http://www.j-bradford-delong.net/2009_mov/20090507_100_days.m4a

DeLong: Econ 202b Lecture May 7, 2009: Trying (and Failing) to Understand the "Modern Chicago" View of the Financial Crisis

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• Audio

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Posted via email from http://braddelong.posterous.com/delong-econ-202b-lecture-may-7-2009-trying-an at Brad DeLong's Scrapbook

Cryptic Note to Self: I Will Never Understand Chicago Today...

"But monetary policy can still be very effective: you just have to buy things other than Treasury bonds in your open-market operations..."

So you grow the money stock: what does that do? Unless your expansionary monetary policy raises short-term interest rates--in which case it is not what I at least think of as expansionary monetary policy--it moves you by the little red line--and it creates a huge excess demand-inflation problem whenever interest rates return to their normal (black) levels as shown by the big black arrow.

By contrast, fiscal policy--or perhaps flow-of-funds policy: fiscal and banking policy--that sops up the flow of savings and raises short-term safe nominal interest rates gets you quickly to the blue arrow--with no long-run monetary-overhang problem to produce a big burst of inflation later.

More to follow...

The Effects of Fiscal Policy in 2009 and Beyond: A Discussion of Cogan-Cwik-Taylor-Wieland

STANFORD INSTITUTE FOR ECONOMIC POLICY RESEARCH ANNUAL POLICY FORUM 2009

The Effects of Fiscal Policy in 2009 and Beyond:

A Discussion of Cogan-Cwik-Taylor-Wieland

J. Bradford DeLong

University of California at Berkeley and NBER

brad.delong@gmail.com; http://delong.typepad.com/; +1 925 708 0467

May 1, 2009

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Last March I got a note from Ward Hanson asking me to come down today and talk about:

the impact of the Stimulus Bill on jobs creation… the contrast between the Romer/Bernstein estimates of the benefits of the stimulus plan versus… Cogan, Taylor et. al. that estimate/argue that there will be very little benefit…. I've got agreement from the "Taylor group" to present, as well as Martin Giles of the Economist Magazine to serve as a moderator…

So I said yes. And Tuesday afternoon I sat down to reread Romer and Bernstein (2009), which I had read before, and Cogan, Cwik, Taylor, and Wieland (2009), which I had not, and I ran into a problem.

On page 2 Cogan et al. write that their Figure 1 shows how Romer and Bernstein think government spending affects the economy alongside:

exactly the same policy change… in another study… by one of us [John Taylor]… the results are vastly different…. [T]he Romer-Bernstein estimates apparently fail a simple robustness test, being far different from existing published results of another model…

Source: Cogan et al. (2009).

This surprised me. I had talked to Christy. I had talked to Jared. I knew that their intention had been to pull standard models off the shelf and use them--not to push the envelope in economic modeling in any way.

So I dug--and found that Cogan et al.’s claim of “exactly the same policy change” was simply wrong. Romer-Bernstein model an increase in government spending with the Federal Reserve expanding and keeping on expanding the money supply in order to keep the short-term Treasury Bill interest rate the same. Taylor (1993) models an increase in government spending with the Federal Reserve contracting the real money supply to push the short-term Treasury Bill interest rate up over time as unemployment falls and inflation creeps up. There is no “robustness” problem with Romer-Bernstein at all: the results are different because the policy changes are different. Expanding the money supply on the one hand, contracting it on the other.

“Geez,” my first thought was, “this is embarrassing—none of four coauthors of Cogan actually read Romer-Bernstein. Sloppy.” Then I got to page 5 of Cogan: “Romer and Bernstein assume that the Federal Reserve pegs the interest rate—the federal funds rate—at the current level of zero…” Cogan et al. know perfectly well that the policy changes are not “exactly the same.” They just say they are.

I am sorry. In Europe, that gets you four red cards. In America, that gets you sent to the showers. The first intellectual responsibility of critique is to accurately present what you are critiquing. When Cogan et al. learn that they can come back into the game. But not until then.

Cogan is simply not what it is being sold as--a critique of the argument of Romer-Bernstein. It should not be taken as such.

I could stop here.

But I have extra time.

I think the best way for me to spend the rest of my time is to lay out why right now at this moment someone like Christy Romer--fundamentally a monetarist, a believer in monetary policy, author of papers on how it was monetary expansion that substantially alleviated the Great Depression in the late 1930s--is now a believer in, a designer of, and an advocate for Barack Obama’s plan to give the U.S. economy a fiscal boost to try to cushion the current fall in employment.

The analysis I am going to give is essentially that carried out nearly eighty years ago by one of Milton Friedman’s teachers, Jacob Viner, in his analysis of the Great Depression when he called for “large and continuous deficit budgets to combat the mass unemployment and deflation of the times.” Friedman applauded Viner’s analysis and saw it as superior to those of others like John Maynard Keynes: “so far as policy was concerned,” Friedman wrote in the early 1970s, “Keynes had nothing to offer those of us who had sat at the feet of [Henry] Simons, [Lloyd] Mints, [Frank] Knight, and [Jacob] Viner…”

Start with Robert Lucas’s observation that in a modern economy you cannot deflate--you cannot have the total nominal volume of spending fall--without having production, sales, and employment falls as well.

And also start with the quantity theory of money:

PY = MV

The total flow of spending in the economy--the amount produced and sold Y times the prices at which goods and services are sold P--is equal to the stock of money in the economy M--bank reserves, cash, checking-account balances, other liquid assets--times the velocity of money V. If PY threatens to fall--threatening a fall in production and sales and a rise in unemployment—then the standard policy Jacob Viner, Milton Friedman, and Christy Romer would recommend would be to boost M. Provided that V does not move in the opposite direction to offset the increase in M, nominal spending will stabilize and deflation and depression and high unemployment will be averted.

The loose end is V--how fast households and businesses spend their cash balances. Milton Friedman in Studies in the Quantity Theory of Money maintained that the key determinant of velocity is the (nominal) interest rate: the higher are nominal interest rates, the higher is velocity because the faster you want to spend your money. Holding purchasing power in cash rather than in bonds is expensive when interest rates are high: you would rather either spend it and buy something or move it back into bonds that pay interest rather than keep it around idle. The velocity of money of money is low when interest rates are low because delaying purchases while you comparison shop is not costly: you lose little in foregone interest that you could have been earning.

This dependence of velocity on the interest rate puts a limit on the effectiveness of monetary expansion. When you expand the money stock you increase the ratio of money to bonds. By simple supply and demand raise the price of bonds in terms of money—and the price of bonds in terms of money is the inverse of the interest rate. So when you raise the money stock, you lower velocity.

This matters when interest rates on assets like Treasury Bills get very low, like zero, like they are now. If you hold your money in a six-month Treasury Bill you get essentially no interest--0.3% per year Monday afternoon--and you run the small risk that interest rates might rise over the next month and your Bill might lose a little value. If you hold your money in cash you get exactly no interest and it is safe--FDIC insured. Thus there is no economic incentive pushing you to spend your cash when interest rates are very low. And so there is no economic reason for the velocity of money to be any particular value. When the central bank tries to boost nominal spending through standard monetary expansion it might prove ineffective: interest rates will drop even closer to zero as the ratio of money to bonds rises, and the velocity of money might well drop to offset the boost to the money stock.

Guess where we are now? The Federal Reserve is boosting the money supply with extraordinary force, and the velocity of money is dropping like a stone.

In order to ensure that monetary expansion is effective, you need to do something to boost interest rates. What can you? Here is where “large and continuous deficit budgets” comes in. When the government runs a deficit it floods the market with bonds. Once again by simple supply and demand more bonds means a lower price of bonds which is the same thing as higher interest rates. The government cannot hold on to the money it gets from selling bonds for that would reduce the money stock, and the whole point of the exercise is to make the increase in the money stock effective. It has to return the money to the private sector by spending it. And it can spend it in four ways:

• By buying up assets like mortgage-backed securities.
• By buying up companies like Fannie Mae, Freddie Mac, AIG, GM, Citigroup, and more to come.
• By refunding the money to taxpayers by cutting taxes.
• By spending the money directly--boosting government purchases.

Which of these ways would be most effective at keeping the velocity of money from falling further to offset expansionary monetary policy? The answer is that we really do not know which of the ways would be most effective--and that is the reason that we are trying them all right now, with Tim Geithner buying GM and mortgage-backed securities with the government’s money and Peter Orszag directing the flow of spending and tax cuts that is the American Recovery and Reinvestment Plan.

Will it work? It is hard to see how it could not work. Nobody disputes that in normal times monetary expansion boosts spending, demand, production, and employment. But the worry is that these times right now appear to be not-normal. Nobody disputes that in not-normal times when interest rates are very low--as they are now--there are no strong incentives to spend cash working to keep monetary velocity from falling to offset increases in the money supply. Purchasing insurance against this eventuality--which appears to be a reality outside the building--seems a reasonable thing to do.

Is this a good use of the government’s money? It does, after all, saddle us with additional government debt. If we did not spend money on the stimulus program now, we could use that debt capacity for some other, different purpose in the future. But as of 4 PM EDT on Monday, the U.S. government could borrow for seven years at a real interest rate I estimate at –0.5% per year. Government expenditures on national security, on Medicare, on the Center for Disease Control, on the Interstate Highway System, on research and development into green energy technologies would have to be extraordinarily and uniquely inefficient right now for them not to be worth doing right now when they come with the extra bonus of making monetary policy effective in the current situation.

Will it be big enough, or will in two years we wish we had done more? I think the odds are one-in-three that in two years we wish we would have done more, and that the odds are close to zero that in two years we wish we would have done less.

Thus my analysis of the stimulus program is quite positive. And this analysis, remember, is not mine alone. It is modeled on the analysis of Milton Friedman’s teachers at the University of Chicago in the 1930s--men of whom he highly approved as having left him nothing to learn at the feet of John Maynard Keynes, men who called for a two-handed approach to the Great Depression:

• “the Federal Reserve banks systematically pursue open-market operations with the double aim of facilitating necessary government financing and increasing the liquidity of the banking structure…”
• “the use of large and continuous deficit budgets to combat the mass unemployment and deflation of the times…”

That two-handed strategy is the approach we are pursuing now, in a situation that in its level of short-term interest rates has considerable similarities to the Great Depression.

It seems a wise and prudent bet.

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References

John Cogan, Tobias Cwik, John Taylor, and Volker Wieland (2009), “Old Keynesian versus New Keynesian Government Spending Multipliers” < http://www.volkerwieland.com/docs/CCTW%20Mar%202.pdf>.

Milton Friedman (1972), “Comment on the Critics of ‘Milton Friedman’s Monetary Framework’,” Journal of Political Economy.

Milton Friedman, ed. (1956), Studies in the Quantity Theory of Money.

Christina Romer and Jared Bernstein (2009), “The Job Impact of the American Recovery and Reinvestment Plan” http://otrans.3cdn.net/45593e8ecbd339d074_l3m6bt1te.pdf.

John Taylor (1993), Macroeconomic Policy in a World Economy: From Econometric Design to Practical Operation.

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DeLong: Discussion of Romer-Bernstein and Cogan-Cwik-Taylor-Wieland (Stanford SIEPR Conference, May 1, 2009)

Bad Banks Are Not an Adverse Supply Shock

Nick Rowe asks a question:

Worthwhile Canadian Initiative: Banks, Aggregate Demand, and Aggregate Supply: can understand how bad banks could affect the AS curve. Long-run growth comes from the Long Run Aggregate Supply curve moving slowly rightward over time as savings create investment that adds to the stock of capital and increases productivity. A good banking and financial system will encourage savings and investment, make sure the investments are the most productive ones, and make the LRAS curve move rightwards more quickly over time.

Even in the short run a good banking and financial system will be important in re-allocating capital between growing and declining sectors, if there are shifts in relative demand. If people want fewer cars and more restaurant meals, but banks cannot shift loans from car manufacturers to restaurants, the Short Run Aggregate Supply curve may shift left, because the restaurants won't be able to expand to meet demand, and car manufacturers' prices or wages may be sticky downwards. If you see the financial crisis as causing the recession by shifting the SRAS curve left, then monetary and fiscal policies, which shift the AD curve right, are not the appropriate cure...

But if bad banks have shifted the AS curve inward, then right now we should have stagflation: depression and inflation, as output falls and prices rise. We don't. The argument that fiscal and monetary policies won't reduce unemployment to normal levels because we have a supply side problem is completely incoherent in an AS-AD framework.

DeLong: The Current Situation (as of April 24, 2009): Econ 196 Lecture

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http://www.j-bradford-delong.net/2009_mov/20090426_196_lecture/

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Posted via email from http://braddelong.posterous.com/delong-the-current-situation-as-of-april-24-2 at Brad DeLong's Scrapbook

Britain Is Off the Euro

And Paul Krugman thinks that is a very good thing:

A quick note on Britain: Paul Krugman Blog: The Darling budget is basically a confession that Britain doesn’t dare do any significant discretionary fiscal stimulus. But it should be pointed out that Britain is getting a serious monetary expansion — much more than other troubled European economies.... Britain has, despite worries about its budget, managed to cut rates significantly vis-a-vis the core eurozone countries... the fall in the pound has made British products a lot more competitive.

I think the Spanish comparison is instructive. Like Britain, it’s had a major housing bust. But Spain has basically had nothing happen to offset that shock.

So I’m actually fairly hopeful about Britain; right now, the fact that it’s not on the euro is serving it well.

Samuel Brittan Worries About Secular Stagnation

He writes:

A long cool look at budget deficits: it would have been much better if the UK could have entered the [current] recession with much lower initial deficit and borrowing ratios – if only because the financial markets do not understand the very good arguments for fiscal deficits in depressed times.... What fundamentally is wrong with a budget deficit? The basic argument is that if borrowing is too high the government can get into a debt trap, having to borrow more and more simply to pay the interest on past borrowings.... Keynes in his General Theory maintained, however, that the propensity to save was much greater than the private propensity to invest, not just at the bottom of a recession but more or less permanently – a state known as secular stagnation.... We could easily have a good few years in which secular stagnation might seem to prevail again, if only because of the near destruction of the world financial system. If we are in such a state then an attempt to adhere rigidly to a fiscal rule could lead to a permanent and unnecessary loss of output outweighing any welfare loss from the debt trap risk itself.

I have sympathy with those economists who favour a mainly monetary approach to sustaining demand. But I fear that the present dangers are great enough to require a belt and braces – monetary and fiscal – approach. I go back to an early suggestion of Milton Friedman... tax rates should be set to balance government spending at a hypothetical level of national income corresponding to “reasonably full employment at a pre-determined price level”... the beauty of the suggestion is that, should the economy go back to a recognisable trend growth rate, then the budget would automatically achieve the target balance. Yet should there really be secular stagnation then deficits would run on as long as necessary...