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Over at the Cato Institute: Waving a Magic Wand for Economic Growth: Daily Focus

NewImageOver at the Cato Institute:

Waving a Magic Wand

J. Bradford DeLong :: U.C. Berkeley

Brink Lindsey asked me what I would do to the U.S. economy to increase economic growth if I could just "wave a magic wand".

The problem I have with such questions--with such "magic wands"--is that I am never sure just how powerful they are supposed to be.

Let me propose three, all of which are small scale in terms of policies but larger scale in that in order to become durable policies they do require, as John Adams said, changes "in the hearts and minds of our countrymen [and women]...":

(1) A Federal Reserve committed to nominal GDP level targeting, with a trend growth rate in nominal GDP of 7%/year: In my view the question of the origin of "general gluts"--demand-side business cycles characterized by (i) insufficient demand for pretty much every currently-produced good and service, and (ii) positively- rather than negatively-correlated fluctuations relative to trend of prices and employment--was decisively and correctly answered by John Stuart Mill back in 1829. A general glut arises when if there is full employment workers, savers, and managers wish to hold more in the way of liquid cash and readily-collateralizable safe savings vehicles than the economy is supplying. READ MOAR

The private sector then cannot produce cash and savings vehicles believed to be safe by any means short of deploying huge amounts of labor and capital to the Witwatersrand to dig rocks, and cannot produce large quantities of cash and safe savings vehicles quickly in any event. Only those organizations whose solvency is not just certain, but of which it is common knowledge of the solvency is certain, can issue cash and safe savings vehicles. Others can only issue assets that are almost as good as cash until the tide goes out and you see how naked they are. And in a crisis of which institutions is it common knowledge that it is common knowledge that they are solvent?

When, if there is full employment, workers, savers, and managers wish to hold more in the way of liquid cash and readily-collateralizable safe savings vehicles than the economy is supplying everyone tries to build up their holdings by cutting their spending below their income. But since everyone's income is other people's spending that does not work. Employment, production, and incomes drop until workers, savers, and managers feel so poor that they no longer wish to build up their stocks of cash and safe savings vehicles. And the economy undergoes a "general glut".

A well-functioning free-market economy thus requires more than just property rights cut at the joints to minimize externalities, Pigovian taxes and bounties levied to compensate for remaining externalities, tort laws, contract laws, police, and judges. It also requires a "neutral" monetary policy--i.e., one that matches the economy's supply of liquid cash and readily-collateralizable safe savings vehicles to the demand if there is full employment from workers, savers, and managers. The hope is that a central bank that has the power to target and does target a simple nominal GDP level-feedback rule--if nominal GDP is below the target, do more in the way of standard open-market operations, lending at the discount window on collateral that is good in normal times at a penalty rate, quantitative easing, and social-credit operations--will finally accomplish a properly "neutral" monetary policy.

A look back at previous ideas for what a "neutral" monetary policy--Newton's fixed price of gold, Hayek's fixed nominal GDP level, Fisher's fixed price-level commodity basket, Friedman's stable M2 growth rate, the NAIRU targeting of the 1970s, Bernanke's inflation-targeting--leads immediately to the conclusion that anybody who claims to have uncovered the Philosopher's Stone of a proper "neutral" monetary policy is a madman. But it is worth trying. Full employment is a very powerful boost to economic growth. And so is the elimination of future risks that businesses face as they try to calculate the chances that the profits to amortize investments will not be there because they will find themselves trying to sell into a "general glut".

(2) State and local governments committed to raising salaries of K-12 public-school teachers relative to median salaries by 50%, in exchange for severe reductions in teacher tenure: As Eddie Lazear tirelessly points out, our state and local governments still substantially set public-school teachers' salaries following a sociological pattern set generations ago, when the occupations open to women were (a) housekeepers, (b) laundresses, (c) waitresses, (d) telephone switchboard-operators, (e) secretaries, (f) nurses, and (g) teachers. Those days are long gone: women who would have become teachers and nurses in the 1950s are now becoming doctors, lawyers, managers, and bankers. School boards across the country have responded to the difficulties of hiring as the coming of feminist liberties has allowed their captive female labor pool to escape by offering tenure in order to attract the risk-averse to teaching without having to require their taxpayer principals to face reality. But this is, at most, a second-best solution.

A nationwide network of good schools is both one of the very best ways to build productive capital--human capital--and a powerful step toward turning equality of opportunity in America from a sick and cynical joke to something not that far moved to reality.

How to actually wave this magic wand, however, is beyond me. My reading of the evidence is that charter schools have been disappointing in ways somewhat similar to those in which 401(k)s have been disappointing--too-high rewards to flash and marketing and too-little repetition for successful social learning about true quality to take place. Teachers will fight attempts to disrupt security of employment unless they have confidence that the grand bargain by which they trade security for higher salaries will be kept--which they do not have. Fiscal conservatives will fight teacher-salary increases unless they are confident that the Democratic Party-public sector union complex will then disarm itself of its weapons--which they are not. And the very smart Jesse Rothstein in the building next door thinks that eliminating teacher tenure is in no wise low-hanging fruit--that it substantially boosts the salary needed to acquire good teachers as it leads the risk-averse to exit the profession, and that nearly all who should not be teachers as identified as such before they gain tenure.


(3) Increasing the number of legal immigrants from roughly one million per year to 2.5 million per year--0.75% of the population per year: Everywhere else in the world, those who want stasis are totally and completely terrified of our culture. They may admire American culture and attitudes or they may despise them. But they all are--if they want to keep their ownterrified of us, and of our culture's enormous absorptive power. They do not want their young talking about going to Mt. St. Michel for le weekend or making hip-hop videos for Youtube.

Yet we, somehow, fear that raising legal immigration above its current 0.3% of the population per year will in some way disrupt our culture? And we, somehow, fear that our politics is sufficiently broken that we cannot figure out a way to make increased immigration win-win for all current residents? Already for a 20 year old to crawl through a storm sewer from Tijuana to San Diego boosts the present value of future world GDP by $200 thousand. Give each one a green card too as he or she emerges and that number is boosted to about $400 thousand.

And let me note that I am not that big a fan of selling immigration licenses.

It strikes me that the kind of people who, illiterate, make it across the U.S. border from Chiapas on foot--well, they are likely to be at least as large as political and economic assets as the princelings of the Chinese Communist Party and the others who would buy their way in, eager and able as the latter are to pay.

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