Princeton economics prof Alan Blinder argues that we shouldn't repeat the mistake FDR made in 1936:
From its bottom in 1933 to 1936, the G.D.P. climbed spectacularly (albeit from a very low base), averaging gains of almost 11 percent a year. But then, both the Fed and the administration of Franklin D. Roosevelt reversed course.
In the summer of 1936, the Fed looked at the large volume of excess reserves piled up in the banking system, concluded that this mountain of liquidity could be fodder for future inflation, and began to withdraw it. This tightening of monetary policy continued into 1937, in a weak economy that was ill-prepared for it.
About the same time, President Roosevelt looked at what seemed to be enormous federal budget deficits, concluded that it was time to put the nation’s fiscal house in order and started raising taxes and reducing spending. This tightening of fiscal policy transformed the federal budget from a deficit of 3.8 percent of G.D.P. in 1936 to a surplus of 0.2 percent of G.D.P. in 1937 — a swing of four percentage points in a single year. (Today, a swing that large would be almost $600 billion.)
Thus, both monetary and fiscal policies did an abrupt about-face in 1936 and 1937, and the consequences were as predictable as they were tragic. The United States economy, which had been rapidly climbing out of the cellar from 1933 to 1936, was kicked rudely down the stairs again, and America experienced the so-called recession within the depression. Real G.D.P. contracted 3.4 percent from 1937 to 1938; the total G.D.P. decline during the recession, which lasted from mid-1937 to mid-1938, was even larger.
The moral of the story should be clear: Prematurely changing fiscal and monetary policies — from stepping hard on the accelerator to slamming on the brake — can be hazardous to the economy’s health.
As it casts about for a rebranded political identity, the GOP has lurched into the pose of fiscal responsibility at the worst possible time. A policy that would have made sense over the last eight years -- and will make sense again a year or two from now -- has no place in the worse recession since the Great Depression. There will come a time when we need to restore some fiscal balance, but that time isn't here yet.
The unemployment rate rose to 8.9 percent in April, but "only" 539,000 people lost their jobs. (Over 3.3 million jobs have been lost in the last five months.) Good thing the centristy centrists made sure the stimulus wasn't too big.
OMB Director Peter Orszag gives a shout out to Emmanuel Saez, who just won the prestigious John Bates Clark Medal, which is awarded to the best American economist under 40. Two things stand out. First, income inequality has been growing rapidly since the late 1970s, and those whose incomes place them in the top 10 percent now earn 50 percent of our national income, a share even higher than the previous record -- which occurred on the brink of the Great Depression.
Emmanuel's work on income inequality has helped to point the way for the Administration in its pledge to rebalance the tax code, with a tax cut going to 95 percent of working Americans while asking those at the very top to contribute more. The inequality that has arisen over the past three decades is not going to go away overnight, and it has been driven by many factors—including a decline in the growth rate of college-educated workers. But where the prior administration used changes in the tax code to exacerbate these trends, this Administration thinks that the tax code should be used to mitigate them because an economy in which all can enjoy success is one that is strong for us all.
One little noticed but vitally important component of the new Geither plan: It doesn't require Congressional approval. The new bailout plan doesn't appropriate any new money, so Congress is out of the loop, but it does include non-recourse loans. Unless the toxic assets we're buying are worth a lot more than any sane person thinks, some of these non-recourse loans aren't going to be paid back. This means that what are in appearance loans are in many cases going to turn out to be subsidies. And when that happens, Congress will have to appropriate money to retire the Treasury's debt. This means that the Treasury is engaged in what is in effect deficit spending.
The big policy news this week has been the Fed’s decision to buy $1 trillion of long-term bonds, going beyond the normal policy of buying only short-term debt.
. . . Now, the Fed isn’t taking on any serious default risk — Treasuries are backed by the full faith etc of the US government, and agency debt is de facto backed by the same, although the market doesn’t seem to believe that. Anyway, the Fed is for these purposes a government agency itself, so all this is debt between different parts of USG.
The Fed is, however, creating a new liability: the monetary base it creates to buy these bonds. In effect, it’s printing $1 trillion of money, and using those funds to buy bonds.
. . . The problem may come when the economy recovers, and inflation starts to become a problem rather than a hoped-for outcome. Basically, there will come a time when the Fed wants to withdraw that extra $1 trillion of money it created. It will presumably do this by selling the bonds it bought back to the private sector.
But here’s the rub: if and when the economy recovers, it’s likely that long-term interest rates will rise, especially if the Fed’s current policy is successful in bringing them down. Suppose that the Fed has bought a bunch of 10-year bonds at 2.5% interest, and that by the time the Fed wants to shrink the money supply again the interest rate has risen to 5 or 6 percent, where it was before the crisis. Then the price of those bonds will have dropped significantly.
And this also means that selling the bonds at market prices won’t be enough to withdraw all the money now being created. So the Fed will have to sell additional assets; if the rise in interest rates is at all significant, it will have to get those assets from the Treasury. So the Fed is, implicitly, engaged in a deficit spending policy right now.
This may all be good, and I hope it is, but no one seems to be paying any attention to it.
Both Paul Krugman and Simon Johnson (here and here) are sharply critical of Europe's timid response to the financial crisis, which they say presents an even bigger threat to Europe than it does to us. Krugman has the nastiest shot, comparing the Europeans to [gasp!] Republicans.
In response to criticism from South Carolina Rep. James Clyburn of his decision to reject $700 million in stimulus money, South Carolina Gov. Mark Sanford evoked Zimbabwe:
"What you're doing is buying into the notion that if we just print some more money that we don't have and send it to different states, we'll create jobs," he said. "If that's the case, why isn't Zimbabwe a rich place?"
Zimbabwe has been in the throes of an economic meltdown ever since the southern African nation embarked on a chaotic land reform program. Its official inflation rate topped 11 million percent in 2008, with its treasury printing banknotes in the trillion-dollar range to keep up with the plummeting value of its currency.
After Clyburn said Sanford's Zimbabwe reference was "beyond the pale", Sanford explained that he hadn't intended to bring race into it -- that he merely intended to refer to a country with hyperinflation, regardless of race. Regardless of his intentions, David Kurtz points out, Zimbabwe was an unfortunate choice:
If you're the governor and a prominent black congressman from your state says refusing to take stimulus money will disproportionately hurt black citizens of your state, would you turn around and compare the stimulus plan to the economic policy of ... Zimbabwe?
The more fundamental problem, though, is that Sanford's comparison reveals that he has no idea what's actually going on. Our problem isn't an overheated economy. Our problem is that spending has fallen off a cliff, causing the economy to plunge into a recession. Unlike Zimbabwe, the United States is at no risk of hyperinflation. Indeed, there's virtually no inflation at all here. There is, however, a very serious risk of deflation, which we're trying to prevent by increasing government spending to stimulate the economy.
A couple months ago I linked to some excellent media criticism by NYU journalism professor Jay Rosen.
The "Sphere of Legitimate Controversy" defines the scope of "acceptable" debate. . . At the heart of what's "acceptable" is the "Sphere of Consensus" -- the stuff that's deemed self-evidently true and is never questioned. . . Outside the Sphere of Legitimate Controversy is the "Sphere of Deviance" -- the crackpot notions that serious, sensible, sober-minded people don't take seriously. Opinions that fall into this zone don't get bad coverage, they get no coverage.
With this in mind, WaPo reported today that economists are increasingly coming around to the opinion that the recently-passed stimulus bill is probably too small. As Paul Krugman notes, the media consigned this possibility to the Sphere of Deviance during the debate on the stimulus bill:
One major sin of news coverage, especially on TV, is the way certain points of view just get excluded from consideration — even if many of the best-informed people hold those views. Most famously and disastrously, the case against invading Iraq was just not heard in the months before the war.
And still it happens. According to the invaluable Media Matters, the idea that the Obama stimulus plan might be too small — a view held by many well-known economists — basically went unreported on broadcast news during the stimulus debate. Out of 59 broadcasts addressing the plan, only 3 mentioned concerns that the plan was inadequate. And it’s actually even worse than that: one of those three involved Harry Reid talking about longer-term goals on health and education — and one of the other two was me.
Meanwhile, it’s rapidly becoming clear that yes, the plan was too small.
Notwithstanding WaPo's suggestion that economists are only now coming around to this view, lots of economists (including Krugman) said the stimulus bill was too small while it was being debated. This was so obvious that even I could see it:
People who are shocked by the size of the stimulus ought instead to be shocked by the magnitude of the problem it’s intended to address. There’s an excellent argument that the stimulus ought to be twice as large as the one being contemplated.
Unfortunately, this got no publicity at all, and coverage was instead dominated by Republican claims that the stimulus was much too large. In this media environment, centristy centrists won undeserved media acclaim for making the stimulus smaller and less effective in exchange for the three Republican votes that were necessary to secure its passage. Today's WaPo report suggests that the establishment media may be incorporating more economic reality into what it considers the Sphere of Legitimate Controversy. Perhaps this will affect coverage of the insane spending freeze House Republicans are pushing.
As I posted below, Republican claims about fiscal responsibility have been baseless since Ronald Reagan decided that deficits don't matter. But like Otter in "Animal House", House Republicans have decided that "this situation absolutely requires a really futile and stupid gesture be done on somebody's part." For their futile and stupid gesture, House Republicans have decided to combat the recession with . . . a spending freeze:
“We’re advocating that Congress freeze all federal spending immediately,” said Rep. Mike Pence (R-Ind.), the chairman of the House Republican Conference, during a Tuesday luncheon at the conservative Heritage Foundation. “People out there are hurting, and they understand what you do when times are tough. You make hard choices. Today House Republicans are urging the Democrats to do the same. We think it’s time that the Democrats put our money where their mouth is.”
. . . Pence’s argument for a spending freeze is widely accepted within the Republican conference. On Monday, House Minority Leader John Boehner (R-Ohio) asked Democrats to “abandon their plans” to push through an omnibus bill “and instead pass a clean bill that freezes spending at current levels.” Gov. Mark Sanford (R-S.C.) has decried the economic stimulus package because, in his words, “when times go south you cut spending.” In a conversation on Monday, freshman Rep. Jason Chaffetz (R-Utah) concurred with party leaders.
This is really, really stupid, even by the standard of House Republicans. Of course it makes sense for financially strapped consumers to cut back on their own spending, but that doesn't mean that the government should also cut back its spending. In fact, it's precisely because consumers have cut back their spending that the government should increase its spending to make up for the lost demand.
Republican claims that the government should take whatever actions would be prudent for individual consumers exhibit the fallacy of composition:
In Keynesian macroeconomics, the "paradox of thrift" illustrates this fallacy: increasing saving (or "thrift") is obviously good for an individual, since it provides for retirement or a "rainy day," but if everyone saves more, it may cause a recession by reducing consumer demand.
Similarly, the government's decision to freeze its spending during a recession would make everyone worse off by exacerbating the recession. This is true even though it makes sense for individuals to cut back on their own spending. The lesson, once again, is that it's best to ignore what Congressional Republicans say about the economy. The odds are it's wrong.
Once upon a time Republicans were fiscal conservatives, but those days ended with the election of the GOP's modern political hero, Ronald Reagan:
During the 2008 election John McCain admitted that economics wasn't his strong suit. His post-election statements demonstrate that this was a vast understatement. Unfortunately, he's now one of the leading voices in the GOP's opposition to Barack Obama's economic policies.
"During the Senate debate, 36 of the Senate Republicans voted for an alternative that would have cut taxes over the next decade by $2.5 trillion, [and] reduced the top marginal race to 25 percent," said the's Ron Brownstein on "Meet the Press." "For John McCain -- who voted for that alternative of a $2.5 trillion tax cut over the next decade -- to talk about generational theft, I mean, pot meet kettle."
And, of course, this is the same John McCain who argued during the 2008 campaign that the Bush tax cuts should be made permanent, which would cost $4.4 trillion -- more than five times the cost of the stimulus bill. So much for McCain's worries about "generational theft".
It is easy to see that the national debt is not really a measure of intergenerational burden. While the taxpayers collectively can be seen as owing the debt, taxpayers (or at least some of them) also own the debt. This is not a payment across generations; it is a payment within generations.
If the United States let the debt rise to $10 trillion and then left the debt at $10 trillion for 100 years, just paying the interest, then in 2108 some of our children, grandchildren and great grandchildren would be collecting the interest on the $10 trillion, which would be paid from the taxes that the government collects.
This flow of money from taxpayers to bond holders doesn’t on net make people better or worse off 100 years from now. It is simply a redistribution from some members of future generations to other members of future generations.
The important thing, Baker emphasizes, is what we do with the amount we borrowed:
Whether or not the debt has made future generations poorer will depend on how it was incurred. If we ran up debts so that we could finance schools and colleges, and make sure that our children and grandchildren were well educated, then we probably made them richer than if we didn’t run up debt but left them illiterate. Similarly, if we ran up the debt to construct a modern physical and information infrastructure, then we probably made future generations much wealthier than if we had handed them a country that was debt free, but had no Internet and no computers.
In short, the debt is not an accurate measure of whether we have been generous to or short-changed the generations that come after us. The answer to that question depends on the economy and society that we pass on. There are many scenarios in which we would have impoverished future generations, even if we were to hand them a government that is free of debt or alternatively left them very wealthy, even if there is a substantial government debt.
Despite demagogic Republican complaints about "pork" -- which in the aggregate never amounted to more than a few percent of the $800 billion total -- the stimulus bill includes huge investments in infrastructure that will benefit future generations. Fundamentally, though, the stimulus is intended to avert a deflationary spiral which would leave the next generation with a shattered, lifeless economy that would cost vastly more to resuscitate than our economy does today.
Below I posted former IMF chief economist Simon Johnson's argument that major US banks are insolvent and will have to be nationalized, broken up, and re-privatized. After reviewing a new estimate of the amount necessary to keep the banks afloat, Paul Krugman argues that it will be all but impossible to avoid that result:
Focus just on the big four money center banks: Citi, B of A, Wells Fargo, JPMorgan. According to this estimate, they need around $450 billion. Meanwhile, their combined market cap is only about $200 billion — and part if not all of that market cap surely represents the “Geithner put,” the hope that stockholders will in effect get a handout from the feds.
Given these numbers, it’s extremely hard to rescue these banks without either (a) giving a HUGE handout to current stockholders or (b) effectively taking ownership on the part of we, the people. Of these, (a) would be politically unacceptable as well as bad policy — but the Obama administration isn’t ready to go for (b), because it’s not in our “culture”.
Hence the perplexity of policy. Our best hope right now is that the “stress test” will make (b) inevitable — that Treasury will declare itself shocked, shocked to find that the banks are in such bad financial shape, leaving government receivership unavoidable.
Maybe Team Obama is ready to go for option (b), but it just isn't ready to say so. I'd like to think that's what's going on.
Harvard economist Jeff Frankels asks whether the $800 billion stimulus is too big or too small. The answer, he says, is both.
My feeling is that if the current stimulus package were to break the $1 trillion mark, it might truly alarm international financial investors, who would in that case stop acquiring dollar assets, thus precipitating the hard landing of the dollar that so many of us have feared for so long. In those circumstances, the Fed would lose the ability to keep interest rates low, and we could be in even worse trouble than today.
Let's just run a highlighter over that point:
Everything would be different if we had spent the last 8 years preserving the budget surpluses that Bill Clinton bequeathed to George Bush. Then we would have paid down a big share of the national debt by now, instead of doubling it. We would be in a strong enough fiscal position to undertake the expansion today that we really need.
In that light it is ironic, to say the least, that the politicians who are warning against the size of the stimulus bill (”generational theft”), particularly the Congressmen who are voting against it, are mostly the same Republicans who supported the original fiscal policies that gave us the doubling of the national debt: the huge long-term tax cuts of 2001 and 2003 and the greatly accelerated rate of government spending. What we need now is a fiscal policy that maximizes short-run demand stimulus relative to long-run damage to the national debt. Lots of bang for the buck. The Republicans supported fiscal policies that did the opposite. Lots of buck for the bang. They are still doing it today when they argue that tax cuts give stimulus and spending does not. One doesn’t even hear them give an economic argument in support of this proposition. They just close their eyes and endlessly repeat their “tax cut” mantra, like a religious cult that can’t even remember why.
There are reasonable people who oppose the stimulus bill, including a minority of economists. But there is nothing reasonable about the opposition of Congressional Republicans. For the good of the country, I hope that Barack Obama has learned a lesson about the limited utility of bipartisanship when the opposition is disconnected from reality.
That's where you go and you check the bank's books, and you say, okay, not only do we use market prices, not pretend prices, not what you wished things were worth, what they're really worth, okay, in the market today. We use that to value your loans and the securities that you have, your assets, right?
And we also assess what will happen to the value of the things you own if there's a severe recession. So that's the idea, it's a stress test, like when you go to see the doctor, they put you on a treadmill, and make you run to see how your heart is going to behave under stress.
So you're looking at how the bank's balance sheets will look under stress. And then you say to them, "This is our assessment of the amount of capital you need to cover your losses, and to stay in business, and be able to make loans, through what appears to be a severe recession."
And, as the president said, we may lose a decade. So we've got to be very hard headed, and all the officials forecasters are still too optimistic on that. This is the amount of capital you need. Now you have a month, or two, to raise this amount of capital privately.
And when this was done in Sweden, by the way, in the early 1990s, they did it to three big banks. One of the three was able to go to its shareholders, raise a lot more capital, and stay in business as a private bank, same shareholders. That's an option. Totally fine. However, the ones that can't raise the capital are in violation of the terms of their banking license, if you like.
. . . You say, "You haven't raised the capital privately. The government is taking over your bank. You guys are out of business. Your bonuses are wiped out. Your golden parachutes are gone." Okay? Because the bank has failed.
This is a government-supervised bankruptcy process. It's called, in the terminology of the business, it's called an intervention. The bank is intervened. You don't go into Chapter 11 because in that's too messy. Too complicated. There's an intervention, you lose the right to operate as a bank. The FDIC takes you over.
. . [Y]ou set up the government intervention, and there's various technical ways to do this, so that you re-privatize very quickly.
Now, it might take three months, it might take six months. It'll depend on the overall macro economy turning around. But there's a lot of private money out there. Let's call it private equity.
These people would like to come in and buy these re-privatized banks. You would attach antitrust provisions to this, so the banks are broken up as part of this transaction. Senator Sanders has a great saying. He says, "Any bank that is too big to fail is too big to exist."
And he's exactly right. So, in this transformation, you're bringing in private equity. You're using, I think this is, to me, the right idea, and what we've learned in our country, is you're using part of the powerful financial lobby against another part. You're using private equity, that would do very well in this, against the inbred insider big bankers. And you're doing this in a way so that the taxpayer decides who the new owners are.
The new owners come in and do a lot of the restructuring. They're going to fire all of these managers. I can honestly assure you that. They're going to put in new risk management systems. They're going to have to make the banks smaller. And the taxpayer is going to retain a substantial equity interest. So as these banks recover the value of our investment goes up. And that's how we get upside participation.
. . . That is classic oligarchy breaking strategy. Now I do admit that once you've done that, you have to worry about the new oligarchs. That's why you're breaking up the banks. You don't want to just change the owners of banks that are too big to fail, because they'll be coming around in five years for another handout.
The structure or banking system, the concentration of power in big financial institutions has to change. There's a lot of appeal to FDR and what he did in the Great Depression.
I would go back to Teddy Roosevelt 100 years ago, and think about trust busting. Okay? Now, the banks don't violate existing antitrust laws. That's 'cause our antitrust laws are 100 years old and need to be changed, okay? We need to break them up for exactly the same reason that Rockefeller and the oil interests, standard oil, at the end of the 19th century, was too powerful, economically and politically. And it had to be broken up. And breaking it up was the right thing to do. That's where we are with the banks today.
It's at this point that I start wishing that tax troubles had knocked out Tim Geithner instead of Tom Daschle. Daschle actually seemed like the perfect guy to head up health care reform, but Geithner increasingly seems like the wrong guy to clean up the financial sector. That's alarming, because this is probably more important than the stimulus.
The examples of Republican stupidity keep piling up. On Sunday's Meet the Press, for example, Barney Frank slammed the Senate's "centrist" cuts to the proposed stimulus:
“That’s the wasteful spending that my colleagues are talking about,” Frank said. “Money to go to the states to stop them from laying off cops and firefighters, money to help keep teachers going. Those are jobs.”
In response, Sen. John Ensign (R-NV) called that "fearmongering", denying that any jobs would be lost:
To get back to what Congressman Frank said, is that we’re going to be laying off teachers and firefighters. You know, that’s just fearmongering. We’re not going to be doing that in any of the states. … [The states’] budgets are bloated, the federal government’s budget is bloated. What we should be doing is cutting back.
Here's the video:
They have plundered reserves, enacted hiring freezes and engaged in all manner of budgetary voodoo to shield us from the pain.
But now state governments -- reeling from a historic free fall in tax revenue -- have run out of tricks. And Americans are about to feel it.
In some cases, they already have.
Nevada resident Margaret Frye-Jackman, 71, was diagnosed in August with ovarian cancer. She had two rounds of chemotherapy at University Medical Center, the only public hospital in the Las Vegas area.
Soon after, she and her daughter heard the news on TV: The hospital's outpatient oncology services were closing because of state Medicaid cuts. Treatment for Frye-Jackman and hundreds of other cancer patients was eliminated.
Luckily, Frye-Jackman's gynecological oncologist, Dr. Nick Spirtos, decided to open a tiny chemotherapy center in his office's empty storage room.
Today, he treats Frye-Jackman there, along with about 20 more cancer patients who were dumped by the hospital. Frye-Jackman's care is paid for with Medicare and supplemental insurance, but other patients can't cover the cost of full treatment. The doctor has considered putting donation boxes in the lobby.
"If this is what it's like in Nevada, with cancer stuff closing, is it like that everywhere?" said Frye-Jackman's daughter, Margaret Bakes, accompanying her mother to the doctor's recently. "Are all the other states closing stuff too?"
The answer, in at least 39 states, is "yes" -- or "soon." With personal, sales and corporate income tax revenue plummeting, state governments -- which recently trimmed their budgets to cover a cumulative $40.3-billion shortfall for the current fiscal year -- are now watching in horror as a $47.4-billion gap opens for 2009.
And for fiscal year 2010, they will face a $84.3-billion hole, according to the National Conference of State Legislatures. The total shortfall through fiscal 2011 is estimated at $350 billion, according to the Center on Budget and Policy Priorities, a nonpartisan think tank in Washington.
Unlike the federal government, nearly all states must balance their budgets. So legislatures either have to raise taxes, borrow money from dwindling rainy-day funds, or cut. The last option is becoming increasingly common.
"The easy budget fixes are long gone," Corina Eckl, fiscal program director for the National Conference of State Legislatures, said in a statement. "Only hard and unpopular options remain."
I'm getting more than a little tired of hearing Republican politicians say, "That's not a stimulus, it's just spending." This is moronic. It's like saying, "That's not a dessert, it's just a chocolate sundae."
The stimulus debate makes my head explode.
Republican ideology rules out what textbook macroeconomics says is the right thing to do. That makes compromise impossible:
[N]egotiating with people detached from reality is fundamentally impossible. Obama came to the table stating a simple truth: given the circumstances and exhausted options, the economy needs a government stimulus. He was prepared to have good-faith discussions over how much should be spent, where it should be invested, how quickly, etc.
In response, 90% of the Senate Republican caucus rejected the very idea of a government stimulus, while a leading House Republican said it was time for the failed minority party to emulate the "insurgency" tactics of the "Taliban." For weeks, their ideas fell on deaf ears because they didn't make any sense at all.
To keep the most conservative Democrats in line and pick off the couple Republican votes necessary to defeat a filibuster, the new Senate bill eliminates many expenditures that would clearly be stimulative, including $40 billion in aid to states that are cutting services and laying off employees to comply with balanced budget laws. But since the bill is now smaller than it was, it feels more centristy:
[T]o appease the centrists, a plan that was already too small and too focused on ineffective tax cuts has been made significantly smaller, and even more focused on tax cuts.
According to the CBO’s estimates, we’re facing an output shortfall of almost 14% of GDP over the next two years, or around $2 trillion. Others, such as Goldman Sachs, are even more pessimistic. So the original $800 billion plan was too small, especially because a substantial share consisted of tax cuts that probably would have added little to demand. The plan should have been at least 50% larger.
Now the centrists have shaved off $86 billion in spending -- much of it among the most effective and most needed parts of the plan. In particular, aid to state governments, which are in desperate straits, is both fast -- because it prevents spending cuts rather than having to start up new projects -- and effective, because it would in fact be spent; plus state and local governments are cutting back on essentials, so the social value of this spending would be high. But in the name of mighty centrism, $40 billion of that aid has been cut out.
My first cut says that the changes to the Senate bill will ensure that we have at least 600,000 fewer Americans employed over the next two years.
This earns congratulations from the supposedly liberal Washington Post, which doesn't know what the facts are but is nevertheless certain that measures that seem centristy and bipartisan are to be preferred, no matter what the facts may be.
While economists remain divided on the role of government generally, an overwhelming number from both parties are saying that a government stimulus package -- even a flawed one -- is urgently needed to help prevent a steeper slide in the economy.
Many economists say the precise size and shape of the package developing in Congress matter less than the timing, and that any delay is damaging.
"Most of the things in the package, the big dollar amounts, are things that are pretty quick stimulus and need to be done," said Alice Rivlin, who was former president Bill Clinton's budget director and who criticized aspects of the proposed stimulus in congressional testimony two weeks ago. "Is it a perfect package? Of course not. But we're past that. Let's just do it."
. . . In Hawaii on Friday, San Francisco Federal Reserve Chairman Janet Yellen added her voice to the supporters of quick action on a stimulus measure.
"In ordinary circumstances, there are good reasons why monetary, rather than fiscal, policy should be used to stabilize the economy," she said, citing lags in adopting and implementing government spending programs. "The result is that fiscal stimulus sometimes kicks in only after the need has passed. However, the current situation is extraordinary, making the case for fiscal action very strong."
Yellen said, "There is -- and there should be -- vigorous debate about the form it should take and about the likely effectiveness of particular fiscal strategies. However, it is critical that decisions on these matters be made on a timely basis so that the economy's downward spiral is not allowed to deepen."
Congress needs to enact a big fiscal stimulus with a lot of spending in it, and it needs to do this yesterday. Ideological Republicans and clueless centrists are a major impediment.
We’ve been in a recession for over a year, and during the last quarter of 2008, GDP fell at an annualized rate of 3.8 percent, which means we haven’t bottomed out yet. Things are still getting worse. The greatest fear isn’t merely that the recession will be unusually severe, but that the economy will enter a deflationary spiral, in which a sustained drop in the aggregate demand for goods and services drives down wages and employment, which in turn further depresses demand, which drives wages and employment down further still, and so on. In this environment consumers quit spending, businesses quit investing, and unemployment goes up and up and up. We don’t really know how to get out of a deflationary spiral, so no one wants to get into one, but we’re now at the edge of that precipice. That’s why a lot of economists are freaking out.
The debate among economists is much more complicated than this, but here’s a very basic macroeconomic description of the economy:
GDP = C + I + G + X, where
(1) GDP is our gross domestic product;
(2) C is consumer spending;
(3) I is business investment;
(4) G is government spending; and
(5) X is net exports.
Let’s look at each of those components.
First, consumer spending has fallen off a cliff, and with unemployment rising, it’s going to keep falling. Anxiety over economic conditions induces people to save more of what money they have, which further reduces consumer spending. (This is referred to as the “paradox of thrift” – although increased savings is good in the long run, it makes a recession worse.)
Business investment is also falling, and it’s easy to see why. Since consumers aren’t buying, businesses find themselves with excess capacity and unsold inventory. They respond by laying people off, canceling their own purchases of supplies, and discontinuing any capital expansions. All of this further reduces aggregate demand and makes the recession worse. (It should also be clear that business tax cuts won’t fix this – businesses that already have excess capacity won’t respond to a tax cut by spending more when consumers aren’t buying the stuff that’s already stacking up in their warehouses.)
Since we have a persistent trade deficit, X is a negative number for us. That makes the recession worse. The recession should drive down the value of the dollar relative to other currencies, causing our trade imbalance to improve, which would be a silver lining. In this global economic downturn, however, Treasury bills that earn a zero rate of return still look like a good investment, so the dollar isn’t falling as much as it ought to. No help there.
So, we want to increase GDP, but three of its components (C, I, and X) are falling. That leaves only G – government spending – to make up the lost capacity. Simple arithmetic reveals the magnitude of the problem. The current stimulus bill totals about $900 billion, divided roughly 70/30 between spending and tax cuts. The CBO says about 80 percent of that amount will be “spent” (including both spending and tax cuts) by the end of 2010. To simplify my arithmetic and make my point more conservatively, I’ll assume that (1) it’s all spending and no tax cuts; and (2) 50 percent will be spent this year and another 50 percent will be spent next year. (Again, this overstates the additional spending, because I’m treating tax cuts as spending, and because about 20 percent of the stimulus would be “spent” after 2010.) This would mean a total expenditure of about $450 billion this year and another $450 billion next year. But the CBO estimates that the recession will reduce aggregate demand by about $1 trillion in each of 2009 and 2010. This means that, even under my very conservative assumptions, the stimulus will make up less than half of the annual shortfall.
People who are shocked by the size of the stimulus ought instead to be shocked by the magnitude of the problem it’s intended to address. There’s an excellent argument that the stimulus ought to be twice as large as the one being contemplated.
On Sunday ABC's "This Week" featured what the so-called liberal media considers a balanced panel (two CEOs, a Republican Senator, and a Democratic Congressman) to discuss the stimulus. Happily the Democrat was Barney Frank, who wiped the floor with the Republican, Sen. Jim DeMint (R-SC). This exchange is an excellent example:
DEMINT: And so it really comes down to a basic argument: Do you want a government-directed plan or do you want the free markets to work?
FRANK: Well, yes, I do want -- I want highways. I want better medical care for people laid off. This notion -- and the one thing I would most disagree with is you say we overregulated. It was the complete absence of regulation in the financial area that led to the crisis we're in today.
. . . FRANK: The policy was, yes, to put no restrictions on people outside the banking system who are extending themselves in the financial area into instruments which they couldn't back up. It was even within the banking system, letting people go with things that were off the balance sheet.
The complete absence of regulation in the financial area has, I think, been a disaster. And I think we're back to where we were when Theodore Roosevelt and Woodrow Wilson stepped in or Franklin Roosevelt.
But beyond that, the notion that everything is solved by a tax cut, of course there are sensible tax policies you could have. But there are public needs we have in this society...
FRANK: ... that cannot be accomplished by a tax cut. No tax cut builds a road. No tax cut puts a cop on the street. No tax cut educates a child in -- in the way that it ought to be done.
So this -- only tax cuts, at a time when I think we have a deficiency in some areas that are important for the quality of our life is a big disagreement.
DEMINT: But, George, we -- we have programs. I mean, we're reauthorizing our highway bill this year.
FRANK: At too low a level.
DEMINT: And -- well -- well, let's talk about making it a higher level, but let's don't say it's a stimulus when it's a government spending plan. And all of these things, the needs in our society, education, these are things we debate every year.
FRANK: Spending can be stimulus. I don't understand what you think stimulus is.
DEMINT: But this is the largest spending bill in history, and we're trying to call it a stimulus when it's just doing the things that...
FRANK: Well, let me tell you what I think is the largest...
DEMINT: ... you wanted to do anyway.
FRANK: The largest spending bill in history is going to turn out to be the war in Iraq. And one of the things, if we're going to talk about spending, I don't -- I have a problem when we leave out that extraordinarily expensive, damaging war in Iraq, which has caused much more harm than good, in my judgment.
And I don't understand why, from some of my conservative friends, building a road, building a school, helping somebody get health care, that's -- that's wasteful spending, but that war in Iraq, which is going to cost us over $1 trillion before we're through -- yes, I wish we hadn't have done that. We'd have been in a lot better shape fiscally.
. . . FRANK: That's the problem. The problem is that we look at spending and say, "Oh, don't spend on highways. Don't spend on health care. But let's build Cold War weapons to defeat the Soviet Union when we don't need them. Let's have hundreds and hundreds of billions of dollars going to the military without a check." Unless everything's on the table, then you're going to have a disproportionate hit in some places.
DeMint's fatuous definition of the question ("Do you want a government-directed plan or do you want the free markets to work?") captures what's wrong with the Republicans' view. According to Republicans, there's this magical "free market" that will solve all our problems if only we get out of its way. I've written previously about this inanity, and that applies here. There's no such thing as the "free market" -- at least as DeMint imagines it -- and it's appalling that someone could live to DeMint's age and still believe in the equivalent of the tooth fairy.
Conservatives are railing against the stimulus bill now moving through Congress because, they say, it's loaded up with wasteful "pork". For example, the Wall Street Journal's editors call it "A 40-Year Wish List", arguing that only about 12 percent of the bill's expenditures would be stimulus, and the rest would be pork. An excerpt:
Most of the rest of this project spending will go to such things as renewable energy funding ($8 billion) or mass transit ($6 billion) that have a low or negative return on investment. Most urban transit systems are so badly managed that their fares cover less than half of their costs. However, the people who operate these systems belong to public-employee unions that are campaign contributors to . . . guess which party?
Here's another lu-lu: Congress wants to spend $600 million more for the federal government to buy new cars. Uncle Sam already spends $3 billion a year on its fleet of 600,000 vehicles. Congress also wants to spend $7 billion for modernizing federal buildings and facilities. The Smithsonian is targeted to receive $150 million; we love the Smithsonian, too, but this is a job creator?
The Journal's editors presumably intend that as a rhetorical question (because they believe that the answer is obviously "No"), but in fact the answer is "Yes". That's because refurbishing the Smithsonian would create work for which people would be paid and then spend what they received. This is Econ 101, but the Journal can't see that because it's hung up on "pork". I'll let Mark Thoma explain:
It is hard to get people who are used to thinking about tradeoffs and opportunity costs to realize that when there are idle workers, idle financial capital, and unmet needs, putting these resources to work meeting those needs does not sacrifice other objectives, it enhances them.
. . . That is where the government comes in. It serves two roles here, one is to provide the funding (and also, by offering wages, giving people the incentive to do the work instead of watching sports), but it is also important for the government to coordinate activity as well, to bring people together to work on the highest value projects in the community in whatever sector - public or private- those projects might be in. The coordination role is important and often overlooked in these discussion, recessions and depressions are times when the normal coordinating factors such as price signals break down, and public goods won't be provided by the private sector in any case. It isn't completely overlooked of course - it's part of what people mean when they argue that government needs to be careful in selecting the projects that will be pursued with public money - but that discussion is generally stated in efficiency terms rather than as a need to coordinate idle resources into productive activity of some sort.
Keynesians also note that even if the government spending has zero value initially, e.g. paying half the idle workers to dig ditches, and the other half to follow behind and fill the ditches in again, as those workers spend their new income in the community it will generate productive private sector activity. Thus, even if the initial projects are of little or no value, it can still be the case that we are better off having the government intervene than we would be if we did nothing at all. The government should do everything that it can to pursue the highest value projects, but the fact that there may be some waste in the process does not, in and of itself, mean that we'd be better off leaving those resources completely idle and doing nothing at all.
So, it would be good stimulus policy to refurbish the Smithsonian even if we didn't care about the ceiling falling down on visitors. And it would be good stimulus policy to buy more cars for the government (particularly if they were hybrids or other highly efficient vehicles). And it would be good stimulus policy to invest in mass transit even though it doesn't currently produce a good return on investment. (Perhaps it might if we'd made the same level of massive public investment in mass transit that makes vehicular transportation so attractive.) These are all good stimulus measures because they pay people to do things, enabling them to spend money to buy things, which puts people to work making things, and so on.
Behind the political debate about a fiscal stimulus there's an academic debate among economists that's getting pretty sharp. On the one hand there are distinguished economists from the "Chicago school" (like Robert Barro, Eugene Fama, and John Cochrane) who argue that there's no such thing as a fiscal stimulus. On the other hand, there are distinguished economists like Paul Krugman, Brad DeLong, and Mark Thoma who respond that the Chicago Boys aren't just wrong, but are instead obviously and preposterously wrong about elementary economics. For example, here's DeLong trashing Fama:
Back in the 1920s and 1930s--in the days that overly-clever bisexual academic dilettante John Maynard Keynes was trying to persuade us that if only we got the government to spend more money the unemployment rate might go down--by far the silliest argument against his position was the one put forward by the staff of the Chancellor of the Exchequer: the so-called "Treasury View."
The Treasury View was that nothing could boost employment: not government spending, not tax cuts, not private business decisions to expand their capacity, not irrational exuberance on the part of entrepreneurs--for the level of output was what it was and the unemployment rate was what it was and no fiscal policies or private investment decisions could change it, for all they could do was move resources from one use to another without affecting the total flow of economic activity.
Back on Christmas Eve Paul Krugman whacked Caroline Baum of Bloomberg on the nose for rediscovering the Treasury View. Now Eugene Fama of the University of Chicago has rederived it from scratch (apparently without knowing anything of its history), claiming that the savings-investment national income identity proves that fiscal policy cannot have any effect on output and employment.This is a howler of such magnitude that it has pulled me from my grave to speak--because we went over and over this in the 1920s starting with R.G. Hawtrey (1925), "Public Expenditure and the Demand for Labour," Economica 5, pp. 38-48, and with F.W. Leith-Ross's various Treasury memos to P.J. Grigg, and thrashed this out to a conclusion that Fama appears not to know.
. . . These mistakes are, literally, elementary ones.
They were elementary when R.G. Hawtrey and the other staffers of the British Treasury made them in the 1920s.
They carry the implication not just that government cannot stimulate or depress the economy, but that no set of private investment or savings decisions can stimulate or depress the economy either, and thus that there can be no business cycle fluctuations from any source whatsoever--because every action that shifts savings or investment simply moves resources from one use to another.
What is extraordinary is that these mistakes are being rederived today, at the end of the 2000s--without any consciousness of their past or of the refutations of them made by past theory and history.
I think it is time to draw a line in the sand: no more economists who know nothing about the economic history of the world or the history of economic thought.
Krugman is equally harsh:
The answer, I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.
And that’s what seems to have happened to macroeconomics in much of the economics profession. The knowledge that S=I doesn’t imply the Treasury view — the general understanding that macroeconomics is more than supply and demand plus the quantity equation — somehow got lost in much of the profession. I’m tempted to go on and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t. Oh wait, I guess I just did.
For the most part this debate is politically irrelevant because there is absolutely going to be a stimulus package, no matter what Chicago thinks. I'm reassured, though, to see that the "serious" opponents of a stimulus must resort to such non-serious arguments. That doesn't mean that the proponents are right, but it does mean that the opponents are grasping at straws.
Economic debates too often proceed from the presumption that there is a "free market" into which the government can intervene only with great trepidation. But government writes and enforces the rules that are essential to what we think of as a "free" market. Without these rules, and the coercive power of government that stands behind them, a "free market" would involve nothing better than getting clubbed over the head for a handful of acorns.
The less-versus-more framing of regulation supports the premise that there is in principle an unregulated market out there and that some of us wish to rein in this unregulated market while others would leave it alone. This is consistent with the idea that large inequalities in income distribution just happen as a result of market forces. But as the above examples illustrate, no one is really talking about an unregulated market—rather we are all just talking about whom the regulation is designed to benefit. Distribution of income has never preceded the intervention of government.
The government is always present, steering the benefits in different directions depending on who is in charge. Accepting this view provides a political vantage point much better suited to the case for progressive regulation. After all, conservatives want the big hand of government in the market as well. They just want the handouts all to go to those at the top.
. . . Even so, the catastrophe produced by the one-sided deregulation of the financial industry, coupled with a long list of regulatory failures in other areas, will almost certainly lead to a serious rethinking of regulatory policy in the years ahead. It remains to be seen whether this rethinking will go beyond the familiar debate. We know that when we emerge from the current crisis the economy will be extensively regulated. The questions is, to whose benefit?
I hope the smart folks in the Obama administration are pondering just that question.
It's said that, whatever they may nominally be called from time to time, there are only two political parties: the Stupid Party and the Silly Party. Today the GOP is undoubtedly the Stupid Party, and as I've written before, ideologically blinkered Southern Republicans seem determined to make it the Even Stupider Party. As Exhibit A for that proposition, I give you South Carolina Gov. Mark Sandford:
Just hours before the unemployment benefits fund was to run out in South Carolina, the state with the nation’s third-highest jobless rate, Gov. Mark Sanford relented Wednesday and agreed to apply for a $146 million federal loan to shore it up, after weeks of refusing to do so.
The governor’s position had drawn rebukes even from fellow Republicans in the Legislature, one of whom denounced Mr. Sanford as “heartless,” and from newspaper editorial pages. On Wednesday, The State, the daily newspaper here in Columbia, accused the governor of playing “chicken with the lives of the 77,000” who are unemployed in South Carolina.
. . . “It’s absolutely unheard of, it’s insane, for a governor of any state not to request those funds,” State Senator Hugh K. Leatherman, a Republican who is chairman of the Senate Finance Committee, said last week. “I can’t believe anybody would be this heartless, and create such a heartless act on these people.”
On Wednesday morning, at nearly the last minute, Mr. Sanford relented and said at a news conference in his office at the State House that he would request the money. South Carolina is one of three high-unemployment states, along with Michigan and Indiana, to ask for a loan from the federal government to ensure the unemployed continue to receive benefits.
. . . Mr. Sanford, a wealthy real estate investor, is often mentioned as a potential Republican presidential candidate in 2012, in part because he is seen as an exemplary adherent of the party’s low-government, antispending philosophy. He recently wrote an op-ed article in The Wall Street Journal saying he was opposed to a “bailout” for states.
So, in the midst of the worst economic crisis since the Great Depression, Sandford has to be dragged kicking and screaming to accept federal funds to extend unemployment benefits in a state with the third-highest unemployment in the United States, because he's ideologically opposed to a federal "bailout" for states. As a matter of basic economics, this is utterly stupid. Here's Mark Zandi, chief economist and co-founder of Moody’s Economy.com, saying what every economist knows:
“The most efficacious spending includes extending unemployment benefits, expanding the food stamp program and increasing aid to hard-pressed state and local governments."
Sandford therefore opposes the very measures that would most cost-effectively improve the economy of his state. In this way (and in many others) ideologues like Sandford are doing everything in their power to drive the Republican Party off a cliff. We can only hope they aren't allowed to take the country with them.
On Christmas Eve Martin Feldstein published a piece in the Wall Street Journal arguing that increased military spending would be a great stimulus. To some extent he has a point. For example, this makes perfect sense:
Replacing the supplies that have been depleted by the military activity in Iraq and Afghanistan is a good example of something that might be postponed but that should instead be done quickly. The same is true for replacing the military equipment that has been subject to excessive wear and tear. More generally, replacement schedules for vehicles and other equipment should be accelerated to do more during the next two years than would otherwise be economically efficient.
Industry experts and DOD officials confirm that military suppliers have substantial unused capacity with which to produce additional supplies and equipment. Even those production lines that are currently at full capacity can be greatly expanded by going from a single shift to a two-shift production schedule. With industrial production in the economy as a whole down sharply, there is no shortage of potential employees who can produce supplies and equipment.
Military procurement has the further advantage that almost all of the equipment and supplies that the military buys is made in the United States, creating demand and jobs here at home.
This has to be done anyway, and the need for projects ready to go makes the repair or replacement of military equipment a good candidate for prompt action. So far, so good. But Feldstein takes his point much further.
Military planners must also look ahead to the missions that each of the services may be called upon to do in the future. Additional funding would allow the Air Force to increase the production of fighter planes and transport aircraft without any delays. The Army could accelerate its combat modernization program. The Navy could build additional ships to deal with its increased responsibilities in protecting coastal shipping and in countering terrorism. And all three services have significant infrastructure needs.
This is where I get off the bandwagon. It would be a tremendous mistake to build our future defense policy around the desire for a short term fiscal stimulus. As Andrew Bacevich has explained in his masterful book, The Limits of Power: The End of American Exceptionalism, our foreign policy is already excessively militarized -- to continue unsustainable domestic policies, we maintain a vast imperial presence abroad to insure (among other things) a reliable supply of cheap oil. We need to change those unsustainable domestic policies, and thereby obviate the burdens of empire that make our domestic situation even worse. In this context, the last thing we need are more aircraft carriers, littoral combat ships, advanced fighter/bomber aircraft, and nuclear submarines. If we build these things, policy will follow procurement. This would be a terrible idea.
Instead, we should enact a stimulus focused on measures that would produce sustainable domestic prosperity in the future. Instead of buying military aircraft we don't need, we should reinvest in our decaying transportation infrastructure with expenditures on both roads and bridges and the expansion of mass transit. Instead of a new aircraft carrier we should invest in a new "smart" electronic grid that allows alternative energy sources to be incorporated into our transmission system. Instead of a new submarine we should invest in green technologies that would conserve energy more cost-effectively than we could produce it. Instead of a littoral combat ship we should become the world's leader in the manufacture of electric, hybrid, and other highly efficient cars that would help us escape our addiction to imported oil. All of these measures would produce a larger and more enduring stimulus than the procurement of military equipment we don't need, and unlike the military equipment we don't need, these expenditures would produce a vast new infrastructure that would sustain our prosperity in the future.
We already spend more on what we euphemistically call "defense" than the rest of the world combined. This means we can cut our "defense" budget and still maintain massive military superiority. It is desperately necessary that we do so, in part because we have far more pressing domestic needs (see, for example, national health care) and also because we need to abandon the policies that require an imperial military abroad. Instead of expanding the military so we can keep on fighting in places like Iraq and Afghanistan, we should adopt more sensible domestic and foreign policies that don't make our security dependent on resolving intractable problems in dysfunctional regions where we have no real idea what we're doing.