Economist's View

What is the Role of the State?

When I teach the History of Economic Thought, one thing we focus on is how views on the role of the state have changed over time. It has a natural cycle to it, with eras such as the highly interventionist Mercantilist years followed by Physiocratic and Classical views stressing minimal government intervention. This is followed by a rebound in the other direction, and so it goes with a Keynes followed by a Friedman in the 50s, a rebound back to Keynes in the 60s, to classical ideas following the experience of the 70s, and so on, and so on. We are involved in the same debate, and a smaller version of the grand historical lurches in each direction, yet again today:

What is the role of the state?, by Martin Wolf: It is ... a good time to ask ... the biggest question in political economy: what is the role of the state? This question has concerned western thinkers at least since Plato (5th-4th century BCE). It has also concerned thinkers in other cultural traditions... The perspective here is that of the contemporary democratic west.

The core purpose of the state is protection. This view would be shared by everybody, except anarchists... Contemporary Somalia shows the horrors that can befall a stateless society. Yet horrors can also befall a society with an over-mighty state. ...

Mancur Olson argued that the state was a “stationary bandit”. A stationary bandit is better than a “roving bandit”, because the latter has no interest in developing the economy, while the former does. But it may not be much better, because those who control the state will seek to extract the surplus over subsistence generated by those under their control.

In the contemporary west, there are three protections against undue exploitation by the stationary bandit: exit, voice ... and restraint. By “exit”, I mean the possibility of escaping from the control of a given jurisdiction, by emigration, capital flight or some form of market exchange. By “voice”, I mean a degree of control over, the state, most obviously by voting. By “restraint”, I mean independent courts, division of powers, federalism and entrenched rights.

This, then, is a brief background to ... the problem, which is defining what a democratic state ... is entitled to do. ...

There exists a strand in classical liberal or, in contemporary US parlance, libertarian thought which believes the answer is to define the role of the state so narrowly and the rights of individuals so broadly that many political choices (the income tax or universal health care, for example) would be ruled out a priori. ... I view this as a hopeless strategy...

So what ought the protective role of the state to include? Again, in such a discussion, classical liberals would argue for the “night-watchman” role. The government’s responsibilities are limited to protecting individuals from coercion, fraud and theft and to defending the country from foreign aggression.

Yet once one has accepted the legitimacy of using coercion (taxation) to provide the goods listed above, there is no reason in principle why one should not accept it for the provision of other goods that cannot be provided as well, or at all, by non-political means.

Those other measures would include addressing a range of externalities (e.g. pollution), providing information and supplying insurance against otherwise uninsurable risks, such as unemployment, spousal abandonment and so forth. The subsidization or public provision of childcare and education is a way to promote equality of opportunity. The subsidization or public provision of health insurance is a way to preserve life, unquestionably one of the purposes of the state. Safety standards are a way to protect people against the carelessness or malevolence of others or (more controversially) themselves. All these, then, are legitimate protective measures. The more complex the society and economy, the greater the range of the protections that will be sought.

What, then, are the objections to such actions? The answers might be: the proposed measures are ineffective..; the measures are unaffordable...; the measures encourage irresponsible behavior; and, at the limit, the measures restrict individual autonomy to an unacceptable degree. These are all, we should note, questions of consequences.

The vote is more evenly distributed than wealth and income. Thus, one would expect the tenor of democratic policymaking to be redistributive and so, indeed, it is. Those with wealth and income to protect will then make political power expensive to acquire and encourage potential supporters to focus on common enemies (inside and outside the country) and on cultural values. The more unequal are incomes and wealth and the more determined are the “haves” to avoid being compelled to support the “have-nots”, the more politics will take on such characteristics.

What are my personal views on how far the protective role of the state should go? In the 1970s, the view that democracy would collapse under the weight of its excessive promises seemed to me disturbingly true. I am no longer convinced of this... Moreover, the capacity for learning by democracies is greater than I had realized. The conservative movements of the 1980s were part of that learning. But they went too far in their confidence in market arrangements and their indifference to the social and political consequences of inequality. I would support state pensions, state-funded health insurance and state regulation of environmental and other externalities. I am happy to debate details.

The ancient Athenians called someone who had a purely private life “idiotes”. This is, of course, the origin of our word “idiot”. Individual liberty does indeed matter. But it is not the only thing that matters. The market is a remarkable social institution. But it is far from perfect. Democratic politics can be destructive. But it is much better than the alternatives. Each of us has an obligation, as a citizen, to make politics work as well as he (or she) can and to embrace the debate over a wide range of difficult choices that this entails.

Update: Read Martin Wolf’s response to readers’ comments

Protection, justice, correction of externalities, social insurance, and the provision of public goods (which I would like to have seen emphasized more above) are, in my view, legitimate roles of the state. I have more trouble when it comes to redistribution, I prefer that everyone have an equal chance in life with the chips falling where they may (with insurance against outcomes where individuals end up with too few chips). But redistribution to correct problems associated with, say, uncorrected market failures that redistribute income unfairly, or to compensate for an unequal playing field more generally, is another matter.

"He is One of the Best Fed Watchers Out There"

I figured Tim Duy would be too shy to post this, so I posted it for him.

Krugman and Wells: The Slump Goes On: Why?

Having just said that "the idea of 'public goods' and the need for government to provide them has been lost in discussions over stimulus spending," I'm glad to see this:

Infrastructure, by Paul Krugman: Some bleary-eyed thoughts from Japan on the reported administration proposal for $50 billion in new spending:

1. It’s a good idea
2. It’s much too small
3. It won’t pass anyway — which makes you wonder why the administration didn’t propose a bigger plan, so as to at least make the point that the other party is standing in the way of much needed repair to our roads, ports, sewers, and more– not to mention creating jobs. Once again, they’re striking right at the capillaries.

Beyond all that, the new initiative is a chance for me to air one of my pet peeves: the stupidity of the claim, which you hear all the time — and you’ll hear again now — that it’s always better to provide stimulus in the form of tax cuts, because individuals know better than the government what to do with their money.

Why is this claim stupid? Because Econ 101 tells us that there are some things the government must provide, namely public goods whose benefits can’t be internalized by the market.

So suppose we’re going to put $50 billion of resources that would otherwise be idle to work. Is it better to use them to produce public goods like improved roads, or private goods like more consumer durables? That’s not at all obvious — and anyone who tells you that basic economics settles the question, that is says that devoting more resources to production of private goods is better, doesn’t understand Econ 101.

And there’s a pretty good argument to be made that we are, in fact, starved for public goods in this country, so that it would actually be a good idea to shift some resources to public goods production even if we were at full employment; in that case, we should definitely give priority to public goods when trying to put unemployed resources to work.

Anyway, it’s all academic right now. My response to the administration plan, at least as best as I can respond given a massive case of jet lag, is a big eh.

Looks like we agree on all three points, it's a good idea, but there's too little of it, and it's unlikely to pass. I would also add "much too late" to the "much too little" charge, but "too late" assumes the point of the proposal is to help people rather than play political games designed to influence the upcoming midterm elections.

But I've said all that before, many times, so let's move on to the actual reason for this post. In the NYRB, Paul Krugman and Robin Wells review Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram G. Rajan, Crisis Economics: A Crash Course in the Future of Finance by Nouriel Roubini and Stephen Mihm, and The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession by Richard C. Koo:

The Slump Goes On: Why?, by Paul Krugman and Robin Wells, NYRB: In the winter of 2008–2009, the world economy was on the brink. Stock markets plunged, credit markets froze, and banks failed in a mass contagion that spread from the US to Europe and threatened to engulf the rest of the world. During the darkest days of crisis, the United States was losing 700,000 jobs a month, and world trade was shrinking faster than it did during the first year of the Great Depression.

By the summer of 2009, however, as the world economy stabilized, it became clear that there would not be a full replay of the Great Depression. Since around June 2009 many indicators have been pointing up: GDP has been rising in all major economies, world industrial production has been rising, and US corporate profits have recovered to pre-crisis levels.

Yet unemployment has hardly fallen in either the United States or Europe—which means that the plight of the unemployed, especially in America with its minimal safety net, has grown steadily worse as benefits run out and savings are exhausted. And little relief is in sight: unemployment is still rising in the hardest-hit European economies, US economic growth is clearly slowing, and many economic forecasters expect America’s unemployment rate to remain high or even to rise over the course of the next year.

Given this bleak prospect, shouldn’t we expect urgency on the part of policymakers and economists, a scramble to put forward plans for promoting growth and restoring jobs? Apparently not: a casual survey of recent books and articles shows nothing of the kind. Books on the Great Recession are still pouring off the presses—but for the most part they are backward-looking, asking how we got into this mess rather than telling us how to get out. To be fair, many recent books do offer prescriptions about how to avoid the next bubble; but they don’t offer much guidance on the most pressing problem at hand, which is how to deal with the continuing consequences of the last one.

Nor can this odd neglect be entirely explained by the mechanics of the book trade. It’s true that economics books appearing now for the most part went to press before the disappointing nature of our so-called recovery was fully apparent. Even a survey of recent articles, however, shows a notable unwillingness on the part of the dismal science to offer solutions to the problem of persistently high unemployment and a sluggish economy. There has been a furious debate about the effectiveness of the monetary and fiscal measures undertaken at the depths of the crisis; there have also been loud declarations about what we must not do—warnings about the alleged danger of budget deficits or expansionary monetary policy are legion. But proposals for positive action to dig us out of the hole we’re in are few and far between.

In what follows, we’ll provide a relatively brief discussion of a much-belabored but still controversial subject: the origins of the 2008 crisis. We’ll then turn to the ongoing policy debates about the response to the crisis and its aftermath. Not to keep readers in suspense: we believe that the relative absence of proposals to deal with mass unemployment is a case of “self-induced paralysis”—a phrase that Federal Reserve Chairman Ben Bernanke used a decade ago, when he was a researcher criticizing policymakers from the outside. There is room for action, both monetary and fiscal. But politicians, government officials, and economists alike have suffered a failure of nerve—a failure for which millions of workers will pay a heavy price. ...[...continue reading...] ...

There's a lot in the article, but I do want to point to this section in particular:

The idea that the government did it—that government-sponsored loans, government mandates, and explicit or implicit government guarantees led to irresponsible home purchases—is an article of faith on the political right. It’s also a central theme, though not the only one, of Raghuram Rajan’s Fault Lines.

In the world according to Rajan, a professor of finance at the University of Chicago business school, the roots of the financial crisis lie in rising income inequality in the United States, and the political reaction to that inequality: lawmakers, wanting to curry favor with voters and mitigate the consequences of rising inequality, funneled funds to low-income families who wanted to buy homes. Fannie Mae and Freddie Mac, the two government-sponsored lending facilities, made mortgage credit easy; the Community Reinvestment Act, which encouraged banks to meet the credit needs of the communities in which they operated, forced them to lend to low-income borrowers regardless of risk; and anyway, banks didn’t worry much about risk because they believed that the government would back them up if anything went wrong.

Rajan claims that the Troubled Asset Relief Program (TARP), signed into law by President Bush on October 3, 2008, validated the belief of banks that they wouldn’t have to pay any price for going wild. Although Rajan is careful not to name names and attributes the blame to generic “politicians,” it is clear that Democrats are largely to blame in his worldview. By and large, those claiming that the government has been responsible tend to focus their ire on Bill Clinton and Barney Frank, who were allegedly behind the big push to make loans to the poor.

While it’s a story that ties everything up in one neat package, however, it’s strongly at odds with the evidence. And it’s disappointing to see Rajan, a widely respected economist who was among the first to warn about a runaway Wall Street, buy into what is mainly a politically motivated myth. Rajan’s book relies heavily on studies from the American Enterprise Institute, a right-wing think tank; he doesn’t mention any of the many studies and commentaries debunking the government-did-it thesis.⁵ Roubini and Mihm, by contrast, get it right:

They go on to detail some of the evidence against the Rajan view of the crisis.

"Being a Hegemon is a Thankless Task"

Harold James:

Recession Geopolitics: ...It is as if China’s leaders were the star pupils in one of Kindleberger’s courses. Throughout the crisis, the Chinese economy continued to grow at an amazing pace, in part as a consequence of massive fiscal stimulus. When anyone wants an example of how effective a Keynesian counter-cyclical strategy can be, internationally as well as domestically, they need look no further than China’s four-trillion-renminbi stimulus of 2008-2009.

Apart from a six-month period after the September 2008 collapse of Lehman Brothers, in which trade finance stopped and the world did look as if it was close to Great Depression circumstances, China and other emerging markets helped those export-oriented industrial economies to recover. The surprising strength of the German economy, with more vigorous growth than at any time in the past 15 years, is due to the dynamism of emerging-market – particularly Chinese – demand, not only for investment goods, engineering products, and machine tools, but also for luxury consumer products. Germany’s high-end automobile producers are now operating at full capacity.

China also followed Kindleberger’s financial lessons. For a moment, it looked as if a contagious crisis, driven by fears of government over-indebtedness, would destroy the politically fragile compromise that European countries had carefully constructed over a 50-year period. The turning point in this spring’s euro panic came when big holders of reserve currencies signaled that they saw the need for the euro as an alternative to the increasingly problematic dollar and the equally vulnerable yen. China started to buy European Union governments’ bonds, and a high-profile Chinese team even went to Greece to buy under-priced real assets.

It was not just Europe that benefited from China’s willingness to take on the mantle of “lender of last resort.” The new-found dynamism of African economies is a consequence of the Chinese drive to build up and secure sources of raw materials.

But there is a problem with Kindleberger’s argument. Kindleberger, a kind and well-meaning man, could never see that the world is never entirely grateful to the country that saves it. Being a hegemon is a thankless task. ...

Mostly just curious to see what reaction this will bring. Comments?

links for 2010-09-06

• A Bank for Macro Models - John Taylor
• Keynes’s conference and Morgenthau’s dream - Edge of the American West
• RA of The Economist gets it right - Richard Green
• Housing markets: Let the market crash? - Free Exchange
• Interview with Germany's Finance Minister - Spiegel
• Plan B for Obama on the economy - Thomas Palley
• EconoChat (Tom Keene's New Blog) - BusinessWeek
• It's not 1933, it's 1930 - Andrew Gelman
• Sweep economists off their throne - Gideon Rachman
• On the demand and the supply side: The stimulus debate - Models & Agents
• Liability and excessive risk taking: Historical evidence from Britain - voxeu
• Breakfast at Richard's - Worthwhile Canadian Initiative
• Q&A with economist Mark Zandi - CSMonitor.com
• Goffman's programme - UnderstandingSociety
• naked capitalism - links
• Abnormal Returns - links
• FT Alphaville - links
• Brad DeLong - links
• Free Exchange - links

"Now The Real Work Begins"

David Warsh:

Now The Real Work Begins, by David Warsh: ...The experts’ deciphering of the crisis is nearly complete. Now the real work begins.

The best account of what happened,..., still seems to me, as it did in April, is that of Gary Gorton, of Yale University, Slapped by the Invisible Hand: The Panic of 2007, which described the problem as the high-tech equivalent of an old-fashion nineteenth-century banking panic. Federal Reserve chairman Ben Bernanke shares my opinion, I was gratified to learn...

We can look forward to the report of the Financial Crisis Inquiry Commission, at whose hearings Bernanke was testifying last week. The FCIC’s investigation, undertaken in the spirit of various Congressional inquiries, including the Report of the 9/11 Commission and stretching all the way back to the 1932 Pecora Hearings (which led to the passage in 1933 of ... the Glass-Steagall Act), is due to be submitted to Congress on December 15. ...

[Most analysts agree that] the culmination of a thirty-year pulse of financial innovation simply swamped regulators’ abilities to cope with – or even at certain key points to understand – the nature of the unfolding crisis. This vast new infrastructure, known collectively as  the “shadow banking system,” consists principally of the proliferation of investment instruments known as “securitization,” on the one hand; and, on the other, the advent of  myriad other institutional investors including money market mutual funds. There is probably no reason to want to dismantle this system, or even to think any longer that it could be done. But new methods of regulation are definitely needed to prevent the industry from seizing up in panic again a few years hence.

Almost none of the structural problems involved are addressed in the Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Obama signed into law in July. Among a small circle of economists and market participants, the deciphering is nearly complete. But popular news media haven’t yet tackled the task of translating their findings of malfunctions into political discourse. That probably won’t begin in earnest before the FCIC report appears in December.

So perhaps the most interesting occasion on the calendar will be the meeting of the Brookings Panel on Economic Activity scheduled for September 16-17. Gorton and Andrew Metrick, also of Yale, are scheduled to present a paper there – “Regulating the Shadow Banking System” — that includes a concrete proposal to bring the securitization industry under the regulatory umbrella.

How? By chartering – and closely supervising – a new kind of bank (narrow-funding banks) whose sole business would be to buy asset-backed securities from their originators and use them to conduct the banking activities known as “repo” that were at the heart of the 2007-09 crisis.

Sound complicated? It is. Fanciful?  Probably not. It was strict standards for collateral that stabilized national banking in the nineteenth century. The new market will be designed by experts, as opposed to a popular reform. Even so, get ready for more stories  than you will want to read about the mechanics of big-league financial intermediation. ...

Finding ways to prevent runs in the repo market is an important component of financial market stabilization. [Note: There are citations to several accounts of the crisis in the article, including "the work of Markus Brunnermeier, of Princeton University, whose early article in the Journal of Economic Perspectives, “Deciphering the Liquidity and Credit Crunch of 2007-08” is, like the rest of that rejuvenated journal, now available free online.]

The Bush Tax Cuts and Infrastructure Spending

The Economist asks:

Should the Bush tax cuts be extended?

Here are the answers, including one from me:

Tom Gallagher Yes, but only for a short period
Michael Bordo Yes, their benefits outweigh their costs
Alberto Alesina Maintain the cuts and reduce spending to trim deficits
Guillermo Calvo Yes, as the rich will drive recovery
Mark Thoma Only some, and the saved revenue should be recycled
[All Responses.]

Given the reports this morning that the administration's is about to propose a six year plan to rebuild infrastructure, I may want to rethink this part of my answer on what to do with tax revenue gained from allowing high end tax cuts to expire:

There are other possibilities as well. For example, since it doesn't look like the recession is going to end anytime soon, there's still time for new infrastructure projects. And having them kick in down the road when other types of stimulus fade away would provide insurance against backsliding. But, as with most alternatives, it's very unlikely that anything like this could pass Congress.

I still think that Congress is unlikely to go along. As for the proposal itself, here are a few details:

Obama to unveil infrastructure plan, Reuters via FT: Washington – President Barack Obama will announce on Monday a six-year plan to revamp the United States’ road, railways and runways with a $50bn up-front investment to jump-start job creation, the White House said.

The plan is one of several economic initiatives that Mr Obama is due to unveil this week aimed at generating some desperately needed US job growth and limiting predicted Democratic losses in November 2 congressional elections. ...

The argument ... is this: Democratic policies have stopped the bleeding and produced some economic growth. Yes, more needs to be done, but Republicans would bring back ideas, he will argue, that propelled the country into the deepest recession in 70 years. ...

Administration officials said he will propose making permanent the business tax credits for research, which the White House projects will cost $100bn over 10 years and would be paid for by ending some corporate tax breaks.

Other items that could also be talked about by Mr Obama are a payroll tax holiday, extending tax cuts for the middle class and increasing money for clean energy. ...

It's a bit late, and it's much too small, but I see this as a positive evolutionary step in the administration's approach to these issues. It's good politics as well. In fact, since the small size means it won't do much on its own to improve the employment situation, and given the timing of the proposal (why not six months or a year ago instead of near an election?), gaining political advantage is likely the main thrust of the initiative.

But, while it may not do much in the short-run, it does have attractive features in the longer run. There's talk, for example, of an "infrastucture bank." It doesn't have the automatic stabilization properties I talked about here, but it provides a good institutional foundation for countercyclical infrastructure policy in the future either through an automatic mechanism that ramps up infrastructure spending when the economy turns downward, or using discretionary authority. And, as argued here, infrastructure is a good investment in any case. But, again, no matter the merits, it seems unlikely that this will be approved by Congress. But I won't mind at all if I'm wrong about that.

Paul Krugman: 1938 in 2010

In a deep recession, "the usual rules don’t apply":

1938 in 2010, by Paul Krugman, Commentary, NY Times: Here’s the situation: The U.S. economy has been crippled by a financial crisis. The president’s policies have limited the damage, but they were too cautious, and unemployment remains disastrously high. More action is clearly needed. Yet the public has soured on government activism, and seems poised to deal Democrats a severe defeat in the midterm elections.

The president in question is Franklin Delano Roosevelt; the year is 1938. ...

Now,... President Obama’s economists promised not to repeat the mistakes of 1937, when F.D.R. pulled back fiscal stimulus too soon. But by making his program too small and too short-lived, Mr. Obama did just that: the stimulus raised growth while it lasted, but it made only a small dent in unemployment — and now it’s fading out.

And ... the inadequacy of the administration’s initial economic plan has landed it — and the nation — in a political trap. More stimulus is desperately needed, but in the public’s eyes the failure of the initial program to deliver a convincing recovery has discredited government action to create jobs.

In short, welcome to 1938.

The story of 1937, of F.D.R.’s disastrous decision to heed those who said that it was time to slash the deficit, is well known. What’s less well known is the extent to which the public drew the wrong conclusions from the recession that followed..., voters lost faith in fiscal expansion. ... And the 1938 election was a disaster for the Democrats, who lost 70 seats in the House and seven in the Senate.

Then came the war. ... Over the course of the war the federal government borrowed ... the equivalent of roughly $30 trillion today.

Had anyone proposed spending even a fraction that much before the war, people would have said the same things they’re saying today. They would have warned about crushing debt and runaway inflation. They would also have said, rightly, that the Depression was in large part caused by excess debt — and then have declared that it was impossible to fix this problem by issuing even more debt.

But guess what? Deficit spending created an economic boom — and the boom laid the foundation for long-run prosperity. ... And after the war, thanks to the improved financial position of the private sector, the economy was able to thrive without continuing deficits.

The economic moral is clear: when the economy is deeply depressed, the usual rules don’t apply. Austerity is self-defeating: when everyone tries to pay down debt at the same time, the result is depression and deflation, and debt problems grow even worse. And conversely,... a temporary surge of deficit spending, on a sufficient scale, can cure problems brought on by past excesses.

But the story of 1938 also shows how hard it is to apply these insights. Even under F.D.R., there was never the political will to do what was needed to end the Great Depression; its eventual resolution came essentially by accident.

I had hoped that we would do better this time. But ... politicians and economists alike have spent decades unlearning the lessons of the 1930s, and are determined to repeat all the old mistakes. And it’s slightly sickening to realize that the big winners in the midterm elections are likely to be the very people who first got us into this mess, then did everything in their power to block action to get us out.

But always remember: this slump can be cured. All it will take is a little bit of intellectual clarity, and a lot of political will. Here’s hoping we find those virtues in the not too distant future.

links for 2010-09-05

• The Return of the Blue-Collar Blues - NYTimes.com
• Donald Kohn Says Fed Should Consider More Action - NYTimes.com
• A carbon border tax can curb climate change - FT.com
• Fears of a decline in bee pollination confirmed - EurekAlert
• Older Workers and Stock Market Returns - CBS MoneyWatch.com
• Time-shifting and demand - Nick Rowe
• Delusions Of Recovery - Paul Krugman
• Economic Policy and Politics - Stephen Williamson
• The surprising truth about what motivates us - YouTube
• Fiscal policy: Build America - The Economist
• The EU can be a boon for Greece - Paul Romer
• Can carbon labelling be development friendly? - voxeu
• Abnormal Returns - links
• naked capitalism - links
• Marginal Revolution - links
• Brad DeLong - links

Public Goods and Countercyclical Fiscal Policy

I don't have any grand, new points to make here, they've all been made before, I just want to point out that the idea of "public goods" and the need for government to provide them has been lost in discussions over stimulus spending.

A previous post quoting Richard Green makes the basic case that, recession or not, spending on public goods can have benefits that exceed costs:

...what if the cost to borrow for the bridge is 3 percent and the bridge's IRR is 5%? Then doesn't the bridge stimulate spending for the simple reason that it is a good investment? The federal government has made, it seems to me, some very good investments. Hoover Dam is one. Rural electrification is another. The interstate highway system. The Golden Gate Bridge. The New York City subway system. I could continue...

I do worry about bridges to nowhere. But many macroeconomists seem to believe in the hearts that public goods don't exist, and that there is nothing government can do better than the private sector. I think it is here that macro takes its cues more from religion than science.

When interest rates are low and resources such as labor are idle, costs are low, and the cost-benefit calculation is more favorable. Duncan Black has been banging this drum:

Beware Of The Bond Vigilantes, by Duncan Black:10-year Treasury at 2.51. As I keep saying, at rates this low it's a crime not to borrow crazy amounts and spend it on supertrains and fixing bridges and whatnot.

And

Hire People To Do Stuff, by Duncan Black: When I look around my hilariously flawed urban hellhole, I see infinite things that could use some work, both public infrastructure and dealing with a lot of deteriorated housing stock. That's even before we get to sexy ideas like weatherization. The idea that we might have "structural unemployment" because there are a bunch of laid off construction workers is absurd. Those people have skills which can be put to good use on obvious productive activities. Someone just needs to write them a check and tell them what to do. The possibilities are, as I said, infinite.

People have been making the argument for spending on public goods during recessions for a long time:

"We Were All Keynesians Then", by Mark Thoma: Though the idea is likely far older, using public works projects to stimulate employment goes back at least to the mercantilists. For example, Sir William Petty (1623-1687) believed the government should employ the idle to work on roads, dredge rivers, build bridges, that sort of thing, though he did say in A Treaties of Taxes and Contributions (1662) that "tis of no matter if it be employed to build a useless Pyramid upon Salisbury Plain, bring the Stones at Stonehenge to Tower-Hill, or the like," so it was more of a traditional Keynesian view on stimulating aggregate demand than one devoted purely to construction of infrastructure. Thomas Malthus (1766-1834) believed that:

It is also of importance to know that, in our endeavors to assist the working class in a period like the present, it is desirable to employ them in those kinds of labour, the results of which do not come for sale into the market, such as roads and public works, The objection to employing a large sum in this way, raised by taxes, would not be its tendency to diminish the capital employed in productive labour; because this, to a certain extent is exactly what is wanted... [Political Economy, 2nd Ed., 429-430]

And, from 80 years ago, Calvin Coolidge echoes this theme:

We Were All Keynesians Then, Journal of Political Economy, Back Cover, Vol. 104, No. 5 (Oct., 1996):  The idea of utilizing construction, particularly of public works, as a stabilizing factor in the business and employment situation has long been a plan of perfection among students of these problems. If in periods of great business activity the work of construction might be somewhat relaxed; and if in periods of business depression and slack employment those works might be expanded to provide occupation for workers otherwise idle, the result would be a stabilization and equalization which would moderate the alternations of employment and unemployment. This in turn would tend to favorable modification of the economic cycle. . . The first and easiest application of such a regulation is in connection with public works; the construction program which involves public buildings, highways, public utilities, and the like. Most forms of Government construction could be handled in conformity to such a policy, once it was definitely established. . . This applies not only to the construction activities of the Federal Government, but to those of states, counties and cities.

More than this, the economies possible under such a plan are apparent. When everybody wants to do the same thing at the same time, it becomes unduly expensive. Every element of costs, in every direction, tends to expand. These conditions reverse themselves in times of slack employment and subnormal activity, with the result that important economies are possible.

I am convinced that if the Government units would generally adopt such a policy, and if, having adopted it, they would give the fullest publicity to the resultant savings, the showing would have a compelling influence upon business generally. Quasi-public concerns, such as railroads and other public utilities, and the great corporations whose requirements can be quite accurately anticipated and charted, would be impressed that their interest could be served by a like procedure.

[Calvin Coolidge, address before the Associated General Contractors of America; quoted in L. W. Wallace, "A Federal Department of Public Works and Domain: Its Planning, Activities, and Influence in Leveling the Business Cycle," Proceedings of the Academy of Political Science 12 (July 1927): 108-9] (Suggested by David Laidler)

...Given the state of our infrastructure and the state of the economy, both of which have crumbling foundations, it's past time to start these projects. So what are we waiting for?

I've made this plea before. This was in January 2009, more than a year and a half ago, and I was trying to make the case that there's plenty of time to put more spending on public goods type infrastructure in place:

...right now, with so much of our infrastructure in need of attention, we need public goods.

We tried the tax cut approach to stimulating the economy once, we had no choice since Bush and the Republicans would not have passed any other type of stimulus package.

Guess what? It didn't work very well, and we have little to show for it. Had we, say, rebuilt water systems instead, at the very worst we'd have better water. That's not so bad in any case.

And it's been interesting, if that's the right word, to watch the same people who delayed fiscal policy for months and months and months as they insisted that we try tax cuts first now tell us that it will take too long to put the spending in place. They don't seem to realize the delay is because of their insistence on the use of tax cuts rather than spending. If we had started on these projects a year ago instead of enacting the tax cut package to appease the right, timeliness would not be such an issue - we might already be repairing sewage systems, rebuilding roads, and so on. I've even heard some who ought to know better argue that because forecasts say the recession will end soon, we can't possibly get the spending in place soon enough. That is, they argue that by the time the spending hits the economy, the economy will have already recovered (these are often the same people who reassured us that there was no housing bubble, and there was not worry anyway because the recession, if it hit at all, would be very mild and easily absorbed by our dynamic, flexible economy). Never mind that forecasts beyond around six months ahead are not much better than a coin flip, and they know it, some forecast somewhere says that the recession will end before spending is in place, and that's enough for them to take the argument public. What if the forecast is wrong?

It's not completely clear to me that the fact that the recession might end soon undercuts the case for government spending anyway. If the money is spent on large, socially beneficial projects - and lots of infrastructure comes under this heading - then so what if the economy recovers? These are things we very much need, and that won't change just because the economy is doing better. There will be net benefits no matter the state of the economy, but the net benefits will be higher if we pursue these projects when the costs are low. If we are lucky, and the economy recovers very fast, much faster than expected, then there will still be benefits, they just won't be as large.

We need to do these things, and right now, with so many idle resources in the economy, the opportunity cost of employing resources is low. For this reason, this is an opportune time to meet the challenges that we face in repairing the infrastructure and in meeting other needs that are critical to maintaining robust economic growth, and in maintaining our health and welfare.

The tax cuts are better than spending proponents generally ignore public goods when they argue that the private sector is always better at spending money, but it seems to me that leaves out an important part of the argument.

If the argument that the private sector is more efficient than government always prevailed, we wouldn't have any public goods at all, and that's not an economy I'd want to live in. Obviously, there are times when spending on public goods is justified economically, and I'd argue strongly that this is one of those times, i.e. that there are lots of places the government can spend money that have large social returns. Why would we want to wait until the opportunity cost is very high to reap these returns instead of pursuing these projects now when the cost is lower? If we are going to have to make these expenditures anyway, it doesn't make any sense to wait. ...

Let me end with this from Brad DeLong:

Department of "Huh?!": Obama Election Season Edition, by Brtad DeLong: Outsourced to Jackie Calmes, who wonders whether the Democratic establishment is insane:

On Economy, Democrats Face a Lack of Unity: Mr. Obama spoke Thursday with the House speaker, Nancy Pelosi, and the Senate majority leader, Harry Reid, to coordinate on proposals.... Among the ideas favored within the administration are tax incentives for clean energy jobs and credits for employers who increase their work forces. The president and his team have ruled out a broad-based payroll tax holiday to promote hiring, officials say. But they are still considering whether to propose making permanent a tax credit for businesses’ research and development; for three decades the costly credit has been repeatedly renewed rather than made permanent so the revenue loss does not show up in deficit projections.

Democrats say the list of stimulus ideas is mostly tax cuts because spending proposals would have no chance of Republican support.

Yet Republicans have opposed Democrats’ tax cutting ideas as well, so some Democrats argue that the new ideas could further demoralize party liberals, who want new spending for job-creating public works...

To put forward a weak, ineffective, Republican idea for further stimulus that then does not pass seems the worst of all possible worlds.

The forecasts are that employment could take years to fully recover. There's plenty of time for more spending on public goods, the need for such spending is large, and right now the cost of that spending is very, very low. And, repeating from above, even if the recession ends sooner than we expect, "these are things we very much need, and that won't change just because the economy is doing better. There will be net benefits no matter the state of the economy, but the net benefits will be higher if we pursue these projects when the costs are low."

[Update: Ryan Avent at The Economist's Free Exchange has more along these lines.]

"Making Social Security Less Generous Isn't the Answer"

Ezra Klein:

Making Social Security less generous isn't the answer, by Ezra Klein, Commentary, Washington Post: ...Raising the Social Security retirement age has become as close to a consensus position as exists in American politics. ... And for a while, I agreed... People live longer today, and so they should work later into life. But as I've looked at the issue, I've decided that I was wrong. ... We should leave the retirement age alone. In fact, we should leave Social Security alone...

Start with the basic rationale for raising the retirement age. As Rep. Paul D. Ryan (R-Wis.) has argued, when Social Security was signed into law, the retirement age was 65 and life expectancy was 63. "The numbers added up pretty well back then," he said on Fox News. But that's misleading. That figure was driven by high infant mortality. ...

Moreover,... averages conceal a lot of inequality. In 1972, a 60-year-old male worker who made less than the median income had a life expectancy of 78 years. By 2001, he had a life expectancy of 80 years. Meanwhile, workers in the top half of the income distribution shot to 85 years from 79. ...

Lurking beneath this conversation is an unquestioned assumption: We live longer, so we should work longer. That's pretty intuitive to members of Congress, who seem to like their jobs and don't seem to like the idea of retiring. It's also pretty intuitive to blogger/columnists, who spend their time in air-conditioned rooms opining about pension programs. But most people don't work in Congress or in the media. They work on their feet. They strain their backs. They're bored silly at the end of the day. By the time they're in their 60s, they want to retire.

You see that reflected in Social Security. Age 66 is when you get full benefits. But most people begin taking Social Security at age 62. They get less, but they can retire earlier. To them, the trade-off is worth it. ...

An August survey ... tested reactions to a variety of Social Security fixes. One of the options was raising the retirement age to 70. Two-thirds of respondents opposed it. Another option was eliminating the cap on payroll taxes so that well-off workers pay the tax on their full income, just as middle-income workers do now. A solid 61 percent supported it.

That's almost the reverse of the conversation in Washington, where affluent people who like their jobs propose cutting benefits for the poor (which is, after all, what raising the retirement age would do) rather than lowering benefits or increasing the payroll tax on, well, themselves. ...

The universally unpleasant options for reform are a testament to Social Security's efficiency. It's a simple transfer program, with administrative costs that amount to less than 0.9 percent of total spending. There's not much fat to cut.

That can't be said for much else in American public policy. Our health-care system costs twice as much as the German system and doesn't deliver better results. Our defense sector is wasteful and bloated. Our tax code could raise more money and do less to harm growth if we cleaned it out. Our home prices are driven upward by the mortgage interest tax deduction. Our health insurance premiums are goosed by the exclusion of employer-sponsored insurance from taxable income.

Reforming any of those sectors ... would be politically difficult, but would mean better policy. Reforming Social Security will be politically difficult and result in worse policy. ...

Here's what I argued in May of 2005:

1. An increase in life expectancy does not necessarily imply that people are healthier at age 65 or 70 than before. Suppose, for example, that medical advances are discovered that extend the end of life by several years, but have no effect on health prior to the last few years of life. In such a case there would be an increase in life expectancy, but no increase in the health of workers at the age of retirement. If people aren’t healthier, then increasing the retirement age imposes a hardship over and above that faced by current retirees.

2. It’s already difficult for elderly workers to find employment, and when they do they are often underemployed relative to their skill levels. Raising the retirement age will make this worse.

3. What about workers employed in physically demanding occupations? Is it reasonable to ask them to work until, say, age 72? If not, how equitable is it to have some workers work until 72, and others allowed to retire at a younger age depending on their occupation?

4. Will this distort occupational choice decisions? ... How will we decide when a worker is unable to work due to reasons associated with age?

5. The life expectancy of some groups of workers is lower than for others. If poorer workers die younger than richer workers on average, then raising the retirement age will have a larger impact on low income workers and thus, in essence, be regressive.

links for 2010-09-04

• Obama to Pitch Making Research Tax Credit Permanent - NYTimes.com
• Again with the Small Business Myth - Capital Gains and Games
• Snapshots of the Employment Situation - Econbrowser
• No Really, We Did Have A Huge House Price Boom - The Irish Economy
• Not Exactly Rocket Science - links
• Marginal Revolution - links
• naked capitalism - links
• Brad DeLong - links

The Fed Can Help, and Should Help, but Fiscal Policy Can Do Even More

The Fed has been under considerable pressure recently by those, me among them, who believe the Fed should use quantitative easing to lower long-term interest rates. 

However, a temporary investment tax credit can provide the same incentives for business investment as a Fed induced fall in the long term interest rate, and then some, and that's not the only thing fiscal policy can do.

The Fed can help, and should help, but fiscal policy can do even more.

How Illegal Immigrants are Helping Social Security

Illegal immigrants are helping to finance your retirement:

The contributions by unauthorized immigrants to Social Security ... are much larger than previously known... Stephen C. Goss, the chief actuary of the Social Security Administration and someone who enjoys bipartisan support for his straightforwardness, said that by 2007, the Social Security trust fund had received a net benefit of somewhere between $120 billion and $240 billion from unauthorized immigrants.  The cumulative contribution is surely higher now. Unauthorized immigrants paid a net contribution of $12 billion in 2007 alone... Somebody ought to say thank you.

Stiglitz and Bilmes: The True Cost of the Iraq War

Joseph Stiglitz and Linda Bilmes:

The true cost of the Iraq war: $3 trillion and beyond, by Joseph E. Stiglitz and Linda J. Bilmes, Commentary, Washington Post: Writing in these pages in early 2008, we put the total cost to the United States of the Iraq war at $3 trillion. This price tag dwarfed previous estimates, including the Bush administration's 2003 projections of a $50 billion to $60 billion war.

But today, as the United States ends combat in Iraq, it appears that our $3 trillion estimate (which accounted for both government expenses and the war's broader impact on the U.S. economy) was, if anything, too low. For example, the cost of diagnosing, treating and compensating disabled veterans has proved higher than we expected.

Moreover, two years on, it has become clear to us that our estimate did not capture what may have been the conflict's most sobering expenses: those in the category of "might have beens," or what economists call opportunity costs. For instance, many have wondered aloud whether, absent the Iraq invasion, we would still be stuck in Afghanistan. And this is not the only "what if" worth contemplating. We might also ask: If not for the war in Iraq, would oil prices have risen so rapidly? Would the federal debt be so high? Would the economic crisis have been so severe?

The answer to all four of these questions is probably no. ... [...continue reading...]

There are some costs -- the harm that something like torture does to our collective sense of morality for example -- that I have no idea how to evaluate.

Stephen Hawking's Big Bang Gaps

I probably should have posted this discussion of naked CDS from Yeon-Koo Che and Rajiv Sethi, but for some reason I felt like something different from the usual fare:

Stephen Hawking's big bang gaps, by Paul Davies, CIF: Cosmologists are agreed that the universe began with a big bang 13.7 billion years ago. People naturally want to know what caused it. A simple answer is nothing: not because there was a mysterious state of nothing before the big bang, but because time itself began then – that is, there was no time "before" the big bang. The idea is by no means new. In the fifth century, St Augustine of Hippo wrote that "the universe was created with time and not in time".

Religious people often feel tricked by this logic. They envisage a miracle-working God dwelling within the stream of time for all eternity and then, for some inscrutable reason, making a universe (perhaps in a spectacular explosion) at a specific moment in history.

That was not Augustine's God, who transcended both space and time. Nor is it the God favored by many contemporary theologians. In fact, they long ago coined a term for it – "god-of-the-gaps" – to deride the idea that when science leaves something out of account, then God should be invoked to plug the gap. The origin of life and the origin of consciousness are favorite loci for a god-of-the-gaps, but the origin of the universe is the perennial big gap.

In his new book, Stephen Hawking reiterates that there is no big gap in the scientific account of the big bang. The laws of physics can explain, he says, how a universe of space, time and matter could emerge spontaneously, without the need for God. And most cosmologists agree: we don't need a god-of-the-gaps to make the big bang go bang. It can happen as part of a natural process. A much tougher problem now looms, however. What is the source of those ingenious laws that enable a universe to pop into being from nothing?

Traditionally, scientists have supposed that the laws of physics were simply imprinted on the universe at its birth, like a maker's mark. As to their origin, well, that was left unexplained.

In recent years, cosmologists have shifted position somewhat. If the origin of the universe was a law rather than a supernatural event, then the same laws could presumably operate to bring other universes into being. The favored view now, and the one that Hawking shares, is that there were in fact many bangs, scattered through space and time, and many universes emerging therefrom, all perfectly naturally. The entire assemblage goes by the name of the multiverse.

Our universe is just one infinitesimal component amid this vast – probably infinite – multiverse, that itself had no origin in time. So according to this new cosmological theory, there was something before the big bang after all – a region of the multiverse pregnant with universe-sprouting potential.

A refinement of the multiverse scenario is that each new universe comes complete with its very own laws – or bylaws, to use the apt description of the cosmologist Martin Rees. Go to another universe, and you would find different bylaws applying. An appealing feature of variegated bylaws is that they explain why our particular universe is uncannily bio-friendly; change our bylaws just a little bit and life would probably be impossible. The fact that we observe a universe "fine-tuned" for life is then no surprise: the more numerous bio-hostile universes are sterile and so go unseen.

So is that the end of the story? Can the multiverse provide a complete and closed account of all physical existence? Not quite. The multiverse comes with a lot of baggage, such as an overarching space and time to host all those bangs, a universe-generating mechanism to trigger them, physical fields to populate the universes with material stuff, and a selection of forces to make things happen. Cosmologists embrace these features by envisaging sweeping "meta-laws" that pervade the multiverse and spawn specific bylaws on a universe-by-universe basis. The meta-laws themselves remain unexplained – eternal, immutable transcendent entities that just happen to exist and must simply be accepted as given. In that respect the meta-laws have a similar status to an unexplained transcendent god.

According to folklore the French physicist Pierre Laplace, when asked by Napoleon where God fitted into his mathematical account of the universe, replied: "I had no need of that hypothesis." Although cosmology has advanced enormously since the time of Laplace, the situation remains the same: there is no compelling need for a supernatural being or prime mover to start the universe off. But when it comes to the laws that explain the big bang, we are in murkier waters.

links for 2010-09-03

• Economic consequences of speculative side bets: naked CDS - voxeu
• “Low for long”: A risky but necessary interest rate policy - voxeu
• Payroll Tax Holiday with a Twist - David Beckworth
• The Real Lesson of Labor Day - Robert Reich
• Re-learning the New Keynesian IS curve - Nick Rowe
• The U.S. auto industry is smaller but healthi - Daniel Gross
• On Health Care, the Devil's in the Details - Uwe E. Reinhardt
• The Skills Deficit - Daniel Gros
• The Great Jobs Depression Worsens... - Robert Reich
• The public sphere - Daniel Little
• Market Talk - links
• New Deal 2.0 - links
• Free Exchange - links
• Marginal Revolution - links
• Economix - links
• Abnormal Returns - links
• Brad DeLong - links

"Optimism…Pessimism…and a Bit of Perspective"

Dennis Lockhart, president of the Atlanta Fed, makes it clear that presently he sees no need for more stimulus -- a slow, plodding recovery like we had in the previous two recession is the best we can expect. If we're on track to match those, there's no need to try to do better.

Here's David Altig of the Atlanta Fed discussing Lockhart's speech earlier today:

Optimism…pessimism…and a bit of perspective, by David Altig, macroblog: Here's how I'm tempted to summarize today's release of the August employment report from the U.S. Bureau of Labor Statistics: more of the same. That theme fits nicely with comments this morning from Atlanta Fed President Dennis Lockhart, in a speech at East Tennessee State University. Here he calls for a little perspective:

"Some commentators are reading recent economic data as suggesting the onset of a second recession and deflationary cycle. Quite naturally, business people and consumers aren't sure what to believe.

"At the last meeting of the Federal Open Market Committee (FOMC) in Washington, the committee made a decision that has been widely interpreted as signaling declining confidence in the strength and sustainability of the recovery….

"In my remarks today, I will provide a less alarmist interpretation of recent economic information and the Fed's recent policy decision. I will argue that, generally speaking, there was too much optimism in the early months and quarters of the recovery and now there may be excessive pessimism."

One point is that recoveries are not generally linear affairs:

"Growth at the end of last year and early part of this year was stronger than I anticipated while economic activity in the second and third quarters seems weaker than I expected.

"But such ups and downs are not unusual during a recovery. A little history: following the 2001 recession, gross domestic product (GDP) grew at the annualized rate of 3.5 percent in early 2002. Growth then decelerated to about 2 percent for the next two quarters then fell to almost zero in the fourth quarter. Entering 2003, growth edged up to a little over 1.5 percent and then accelerated from there to a sustained period of relatively strong growth for two years."

...Even in the rapid-growth, pre-1990 recoveries, there was generally a quarter or two of growth that underperformed. ...

But the better benchmarks will likely prove to be the slower-growth, low-employment recoveries post-1990. In addition to the 2001 experience noted by President Lockhart, the expansion that followed the 1990–91 recession stumbled along with quarterly growth rates of 2.7, 1.69, and 1.58 percent, before picking up to above-potential growth rates. Despite that, the eighth quarter after that recession's end clocked in at an anemic 0.75 percent.

So why are we content to match that performance instead of trying to improve? Why do we try to rationalize concerns instead (calling it "a bit of perspective")?:

What is more important is that there is a reasonably good explanation for why we might have hit a soft patch:

"Looking at the 2009–2010 recovery, it seems clear that some of the early strength was promoted by policies that pulled forward spending from the second and third quarters of this year. The recent sharp decline in housing-related indicators following the expiration of homebuyer tax credits is the most obvious example of this effect."

Given that expectation, wouldn't it have been nice to have someone, the Fed say, try to fill this hole until the private sector begins growing robustly on its own?

Back to David Altig:

Essentially, President Lockhart's is a simple message: don't ignore the short-term data, but be careful with getting too carried away with it as well.

"Simply stated, I was expecting a relatively modest recovery...

And he, along with other members of the Fed, is apparently content with that. Finally:

...with respect to that meeting, here is the main policy point:

"At the last meeting there were two important considerations as I saw it. First, as already discussed, some economic data came in weaker than expected, shifting the balance of risks to slower growth in the near term and further disinflation. Second, the Fed's holdings of MBS were projected to decline faster than previously thought because lower rates were generating heavy mortgage prepayments and refinancings.

"So, in the context of a softening economy, the FOMC was confronted with the prospect of unintended withdrawal of support for the recovery through a decline in the level of liquidity provided to the economy….

"That is how I interpret the decision announced following the August meeting—a small tactical change designed to preserve the level of liquidity provided to the system. I supported the committee's decision, but I do not view it as a fundamental change of outlook or strategy. I do not believe this change necessarily heralds the beginning of a period of further expansion of the Fed's balance sheet. Nor do I think the decision precludes a return to a policy of allowing the balance sheet to shrink on its own.

"I think the decision has been over-interpreted in some quarters."

...

So, again, the recovery is expected to plod along like we've seen in the past, at least that's the hope, and though the downside risk has increased and the Fed has the tools to try to help, it doesn't think it should use them.

My view is different.

Will a Payroll Tax Cut Stimulate the Economy?

Will a payroll tax cut stimulate the economy? I am going to answer this in the context of  Gauti B. Eggertsson' paper "What Fiscal Policy Is Effective at Zero Interest Rates?" where this question is addressed directly (the analysis begins on page 13). The model is New Keynesian.

The answer, in this model anyway, is that in normal times a payroll tax cut would be stimulative, but at the zero bound it's not so clear. Let me see if I can explain why.

When interest rates are positive, the framework is essentially a standard AS-AD model:

A payroll tax cut increases labor supply and shifts out the AS curve. The shift in the AS curve results in lower inflation and higher output/employment.

One thing that is left out of this model to simplify the analysis and keep it tractable is the demand-side effects of such policies. That is, a tax cut would also increase AD. If we add this effect, the graph then looks like:

Output goes up even more, but whether inflation goes up or down depends upon which shift is larger, the shift in the AS or the shift in the AD (based upon the evidence on how labor supply responds to changes in taxes, I would expect that the shift in the AD would be larger, but ultimately that is an empirical matter).

When the economy is at the zero bound for nominal interest rates things change. In particular, the AD curve slopes upward. This will be explained intuitively in a moment, but mechanically the effect of a positively sloped AD curve is as follows:

Thus, when we consider only the supply-side effects of a tax cut, it has a negative impact on output and employment. Why is this?

Figure 5 clarifies the intuition for why labor tax cuts become contractionary at zero interest rates while being expansionary under normal circumstances. The key is aggregate demand. At positive interest rates the AD curve is downward-sloping in inflation. The reason is that as inflation decreases, the central bank will cut the nominal interest rate more than 1 to 1 with inflation..., which is the Taylor principle... Similarly, if inflation increases, the central bank will increase the nominal interest rate more than 1 to 1 with inflation, thus causing an output contraction with higher inflation. As a consequence, the real interest rate will decrease with deflationary pressures and expanding output, because any reduction in inflation will be met by a more than proportional change in the nominal interest rate. This, however, is no longer the case at zero interest rates, because interest rates can no longer be cut. This means that the central bank will no longer be able to offset deflationary pressures with aggressive interest rate cuts, shifting the AD curve from downward-sloping to upward-sloping in (YL,πL) space...

The reason is that lower inflation will now mean a higher real rate, because the reduction in inflation can no longer be offset by interest rate cuts. Similarly, an increase in inflation is now expansionary because the increase in inflation will no longer be offset by an increase in the nominal interest rate; hence, higher inflation implies lower real interest rates and thus higher demand.

Once again, however, demand side effects are missing. Tacking those on gives:

Thus, the overall effect on employment depends upon the net effect of the AD and AS shifts. If the AD shift dominates, as I suspect it would, it's still possible for this policy to have positive effects on output and employment. But the size of the effect depends upon the strength of the demand side shift, and how strong the shift would be is an open question, particularly given the degree of household balance sheet rebuilding we are seeing which causes the tax cuts to be saved rather than spent.

Another way to think about this is the following. Supply is not the problem right now, it's lack of demand, and a policy that encourages more supply and threatens deflation is not helpful except to the extent that it increases aggregate demand in the process. Other types of policies can avoid this problem, see, for example the sales tax cut discussed on page 20 or the discussion of fiscal policy multipliers on page 17, but they may not have the same political feasibility as  tax cut for labor, which itself doesn't seem all that likely give the degree of opposition it will likely hit in Congress (the sales tax cut would be difficult to implement given that sales taxes are levied at the state level, and there's no chance that government spending increases will pass Congress right now; on the politics of a payroll tax cut, see the end of this post).

*****

[Note: The demand-side effects were left out of the paper to keep the mathematics tractable, and it may be that simply tacking on the demand-side effects as I've done (the red lines) isn't quite correct. I think it's okay, but if anyone can speak to this, that would be great. Also, the policy analyzed in the paper is best interpreted as a payroll tax cut on the worker side. I don't think it matters if the cut is on the employer side, and I hope the administration doesn't pursue this anyway since the employer side tax cut may not pass through to labor fully, or much at all in the very short-run, but, again, if that matters and someone can speak to this point, please do.]

The Employment Report: “We’ve Gone Essentially Nowhere in a Year”

Here's my somewhat cranky response this morning's employment report showing that the unemployment rate ticked up, and that the broader U-6 measure went up even more. There was some private sector job growth, but not nearly enough to keep up with population growth, and far from enough to make any inroads into reemploying the millions of people who have lost jobs:

The Employment Report: “We’ve Gone Essentially Nowhere in a Year”

My fear isn't a double dip as much as it is that job and GDP growth will remain stagnant. The central valley in California is a good metaphor. It's narrow east to west, but very long north to south (think of the shape of the state). We went down into the valley as we went into the recession, and the question for me has always been whether we are heading east to west so that we will climb out of the valley relatively quickly, or north to south as we trudge along at the bottom of the valley for considerable time before finally climbing slowly back to full employment. I've been warning for a long time that it looks like north to south, and the fact that we've had essentially no growth for a year now, and no hint of change any time soon, makes the north to south fear very real. The administration is supposed to propose new policies to try to help us reach the other side faster, but the timing of that effort -- way too late except as a political ploy -- is one of the thing's I'm cranky about.

Paul Krugman: The Real Story

When Obama announces his new measures to boost the economy next week, will he learn from the mistakes he made the first time?:

The Real Story, by Paul Krugman, Commentary, NY Times: Next week, President Obama is scheduled to propose new measures to boost the economy. I hope they’re bold and substantive, since the Republicans will oppose him regardless — if he came out for motherhood, the G.O.P. would declare motherhood un-American. So he should put them on the spot for standing in the way of real action.

But let’s put politics aside and talk about what we’ve actually learned about economic policy over the past 20 months.

When Mr. Obama first proposed $800 billion in fiscal stimulus, there were two groups of critics. Both argued that unemployment would stay high — but for very different reasons.

One group — the group that got almost all the attention — declared that the stimulus was much too large, and would lead to disaster..., skyrocketing interest rates and soaring inflation.

The other group, which included yours truly, warned that the plan was much too small given the economic forecasts then available...; an $800 billion program, partly consisting of tax cuts that would have happened anyway, just wasn’t up to the task...

Critics in the second camp were particularly worried about what would happen this year, since the stimulus would ... gradually fade out. Last year, many of us were already warning that the economy might stall in the second half of 2010.

So what actually happened? ... Start with interest rates. Those who said the stimulus was too big predicted sharply rising rates. When rates rose in early 2009, The Wall Street Journal ... declared that it was all about fear of deficits, and concluded, “When in doubt, bet on the markets.”

But those who said the stimulus was too small argued that temporary deficits weren’t a problem as long as the economy remained depressed; we were awash in savings with nowhere to go. Interest rates, we said, would fluctuate with optimism or pessimism about future growth, not with government borrowing.

When in doubt, bet on the markets. The 10-year bond rate was over 3.7 percent when The Journal published that editorial; it’s under 2.7 percent now.

What about inflation? Amid the inflation hysteria of early 2009, the inadequate-stimulus critics pointed out that inflation always falls during sustained periods of high unemployment... Sure enough, key measures of inflation have fallen ... to 1 percent or less..., and Japanese-style deflation is looking like a real possibility.

Meanwhile, the timing of recent economic growth strongly supports the notion that stimulus does, indeed, boost the economy: growth accelerated last year, as the stimulus reached its predicted peak impact, but has fallen off — just as some of us feared — as the stimulus has faded. ...

The actual lessons of 2009-2010, then, are that scare stories about stimulus are wrong, and that stimulus works when it is applied. But it wasn’t applied on a sufficient scale. And we need another round.

I know that getting that round is unlikely... And if, as expected, the G.O.P. wins big in November, this will be widely regarded as a vindication of the anti-stimulus position. Mr. Obama, we’ll be told, moved too far to the left, and his Keynesian economic doctrine was proved wrong.

But politics determines who has the power, not who has the truth. The economic theory behind the Obama stimulus has passed the test of recent events with flying colors; unfortunately, Mr. Obama, for whatever reason — yes, I’m aware that there were political constraints — initially offered a plan that was much too cautious given the scale of the economy’s problems.

So, as I said, here’s hoping that Mr. Obama goes big next week. If he does, he’ll have the facts on his side.

"What Role Did the Fed Play In the Housing Bubble?"

David Beckworth pushes back against some posts that have appeared here and elsewhere recently (my view is that low interest rates played a role, as did regulatory failures, but these were not the only causes of the crisis):

What Role Did the Fed Play In the Housing Bubble?, by David Beckworth: I really did not want to revisit this question since I have already covered it here many times before. Folks, however, are talking about it again given its coverage at the Fed's Jackson Hole conference. Mark Thoma, for example, has posted several pieces on it in the past few days. Most of this renewed discussion has taken a less critical view of the Fed's role during the housing boom, specifically the role played by the Fed's low interest rate policy. I feel compelled to rebut this Fed love fest since there are compelling reasons to believe the Fed did play an important role in creating the housing boom. To be clear, I do not see the Fed as the only contributor--far from it--but it does appear to be one of the more important ones. Here is my list of reasons why:

(1) The Fed kept its policy interest rate, the federal funds rate, below the natural or neutral interest rate for an extended period. It is not correct to say the Fed kept interest rates very low and thus monetary policy was very loose. Interest rates can be low because the economy is weak, not just because monetary policy is stimulative. Interest rates only indicate a loosening of monetary policy if they are low relative to the neutral interest rate, the interest rate level consistent with a closed output gap ( i.e. the economy operating at its full potential). There is ample evidence that the Fed during the 2002-2004 period pushed the federal funds rate well below the neutral interest rate level. For example, see Laubach and Williams (2003) or this ECB study (2007). Below is graph that shows the Laubach and Williams natural interest rate minus the real federal funds rate. This spread provides a measure on the stance of monetary policy--the larger it is the looser is monetary policy and vice versa. This figure shows that monetary policy was unusually accommodative during this time. This figure also indicates an important development behind the large gap was that the productivity boom at that time kept the neutral interested elevated even as the Fed held down the real federal funds rate.

(2) Given the excessive monetary easing shown above, the Fed helped create a credit boom that found its way--via financial innovation, lax governance (both private and public), and misaligned incentives--into the housing market. Housing market activity was further reinforced by "the search for yield" created by the Fed's low interest rates. The low interest rates at the time encouraged investors to take on riskier investments than they otherwise would have. Some of those riskier investments end up being tied to housing. Thus, the risk-taking channel of monetary policy added more fuel to the housing boom.

(3) Given the Fed's monetary superpower status, its loose monetary policy got exported across the globe. As a result, the Fed helped create a global liquidity glut that in turn helped fuel a global housing boom. The Fed is a global monetary hegemon. It holds the world's main reserve currency and many emerging markets are formally or informally pegged to dollar. Thus, its monetary policy was exported to much of the emerging world at this time. This means that the other two monetary powers, the ECB and Japan, had to be mindful of U.S. monetary policy lest their currencies becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. As as result, the Fed's loose monetary policy also got exported to some degree to Japan and the Euro area. From this perspective it is easy to understand how the Fed could have created a global liquidity glut in the early-to-mid 2000s. Inevitably, some of this global liquidity glut got recycled back into the U.S. economy and further fueled the housing boom (i.e. the dollar block countries had to buy up more dollars as the Fed loosened policy and these funds got recycled via Treasury purchases back to the U.S. economy). Below is a picture from Sebastian Becker of Deutsche Bank that highlights this surge in global liquidity:

For these reasons I believe the Fed played a major role in the credit and housing boom during the early-to-mid 2000s. Let me close by directing you to Barry Ritholtz who gives more details on how the Fed's policy distorted incentives in financial markets.

links for 2010-09-02

• Comparing the High-Income Tax Cuts and the Social Security Shortfall - CBPP
• A Push on Tax Cuts? - NYTimes.com
• Macro and Financial Policies Before and After the Crisis - Barry Eichengreen
• Texas A&M System Will Rate Professors - The Chronicle of Higher Education
• Do low rates make house prices more volatile? - Richard Green
• The housing bubble reconsidered - FT Alphaville
• The Big Lie at the Core of the GOP's Economic Argument - Simon Rosenberg
• Europe's economy: Driving Germany - The Economist
• Bernanke Changes Story on Lehman Collapse - Rational Irrationality:
• Where the Monetary Debate Is Happening - Capital Gains and Games
• Walking Away From a Win-Win-Win - CBPP
• Weekly Initial Unemployment Claims Decline Slightly - Calculated Risk
• The Inflation Cure - Paul Krugman
• A moderate and pragmatic proposal for monetary stimulus - TheMoneyIllusion
• Gov’t Now Pays 30 Cents Of Every $1 in Income - Jed Graham
• The Stock Market Rally Versus the Economic Fundamentals - Robert Reich
• Marginal Revolution - links
• Economix - links
• FT Alphaville - links
• naked capitalism - links
• New Deal 2.0 - links
• Abnormal Returns - links
• Credit Writedowns - links
• Brad DeLong - links

Measuring the Output Responses to Fiscal Policy

Using a model that allows multipliers to vary over the business cycle, Alan Auerbach and  Yuriy Gorodnichenko find that the fiscal stimulus multiplier is greater than one in recessions:

The return from a fiscal stimulus – the fiscal multiplier – remains one of the most controversial topics in economics today. This column considers the influence of expectations, of variation in recessions and expansions, and of different components of government spending. It finds that the size of the multiplier varies considerably over the business cycle: between 0 and 0.5 in expansions and between 1 and 1.5 in recessions.

"Companies Already Lobbying Fed on Financial Rules"

I don't like to steal other people's catch phrases (just their posts), but, well, quelle surprise!:

Companies Already Lobbying Fed on Financial Rules, by Michael Crittenden, WSJ: U.S. firms eager to shape newly-passed financial laws have wasted no time in lobbying the Federal Reserve and other agencies, according to new details released Thursday by the central bank.

Summaries of 11 meetings involving Fed staff and outside corporations and advocacy groups highlight the high-stakes rulemaking that will occur as U.S. regulators seek to implement the wide-ranging financial overhaul legislation. The meeting log shows representatives from Visa Inc. met with Fed staff just two days after President Barack Obama signed the Dodd-Frank bill into law on July 21.

The topics of conversation at that meeting: debit cards and interchange rates charged to merchants. ... The records show Bank of America Corp., J.P. Morgan Chase & Co. and American Express Co. have all met with Fed staff at least once since mid-July to discuss the interchange issue.

Firms such as Goldman Sachs Group Inc. and Citigroup Inc. have also discussed tough new rules for derivatives with Fed officials, among others. ...

It isn’t just financial firms seeking to discuss the potential changes. The Fed on Aug. 20 hosted a discussion with a group representing firms that use derivatives to hedge risks, so-called “end users”. Those present included executives from Safeway Inc. and Boeing Co., as well as representatives from the American Petroleum Institute and U.S. Chamber of Commerce. ...

Notice any interest that aren't being represented here?

The phrase "If they're too big to fail, they're too big to exist" has been heard a lot recently, but I'd add that: "If they're too big for Congress and the Fed to say no to, they're too big to exist."

It appears to me that many firms lobbying Congress and the Fed are, in fact, this big, and the question is whether we will do anything about it. I'm not optimistic that those with the ability to change things will do so as it would involve going against the interests of major campaign contributors. I would love to write a post entitled "Quell Surprise" about how wrong I am about this, I just don't think it's going to happen.

"Too Much “Too Big to Fail”?"

Adair Turner, Chairman of Britain’s Financial Services Authority, on the too big to fail problem:

Too Much “Too Big to Fail”?, by Adair Turner, Commentary, Project Syndicate: Obviously, the global financial crisis of 2008-2009 was partly one of specific, systemically important banks and other financial institutions such as AIG. In response, there is an intense debate about the problems caused when such institutions are said to be “too big to fail.”

Politically, that debate focuses on the costs of bailouts and on tax schemes designed to “get our money back.” For economists, the debate focuses on the moral hazard created by ex ante expectations of a bailout, which reduce market discipline on excessive risk-taking – as well as on the unfair advantage that such implicit guarantees give to large players over their small-enough-to-fail competitors.

Numerous policy options to deal with this problem are now being debated. These include higher capital ratios for systemically important banks, stricter supervision, limits on trading activity, pre-designated resolution and recovery plans, and taxes aimed not at “getting our money back,” but at internalizing externalities – that is, making those at fault pay the social costs of their behavior – and creating better incentives.

I am convinced that finding answers to the too-big-to-fail problem is necessary... But we must not confuse “necessary” with “sufficient”; there is a danger that an exclusive focus on institutions that are too big to fail could divert us from more fundamental issues.

In the public’s eyes, the focus on such institutions appears justified by the huge costs of financial rescue. But when we look back on this crisis in, say, ten years, what may be striking is how small the direct costs of rescue will appear. Many government funding guarantees will turn out to have been costless...

All of this implies that the crucial problem is not the fiscal cost of rescue, but the macroeconomic volatility induced by precarious credit supply – first provided too easily and at too low a price, and then severely restricted. And it is possible – indeed, I suspect likely – that such credit-supply problems would exist even if the too-big-to-fail problem were effectively addressed. ...

There is therefore a danger that excessive focus on “too big to fail” could become a new form of the belief that if only we could identify and correct some crucial market failure, we would, at last, achieve a stable and self-equilibrating system. Many of the problems that led to the crisis – and that could give rise to future crises if left unaddressed – originated elsewhere.

I mostly oppose large banks due to the political power that they have, the market power that comes with size, the unfair advantage the implicit guarantee of a bailout gives large banks over small banks (since the large banks are perceived as less risky due to the guarantee, they can get funds at a lower cost), and the fact that the implicit guarantee induces large banks to take on too much risk. There's also a worry that size and connectedness amplifies the effects of a crisis. However, I don't think systemic risk falls much by simply breaking the banks into smaller pieces, so this isn't a major part of the reason why I think we should limit bank size. There are plenty of examples of crises involving smaller banks in the U.S. and elsewhere, so breaking banks up does not provide an impermeable defense against systemic issues.

The most frustrating part, though, is the implicit assumption in most of these discussions that big banks are inevitable. I have yet to see an analysis that convinces me that large banks provide a boost to efficiency that more than compensates for the problems their size brings about. I realize we are reluctant to impose per se rules against size for good reason, and that the fact that they may not increase efficiency is not sufficient justification to break them up, but the political power, the excessive risk taking, the economic power that come with size, etc. are. Maybe the problems aren't as large or worrisome as I believe, but it would be nice to have the sense that regulators are at least asking these questions. Instead they seem to be resigned to the fact that large banks are inevitable.

I hope to do more with this speech later -- we'll see if time permits that -- but here's Ben Bernanke talking about this issue earlier today: Notice the assumption in the background that large banks will exist:

"Too Big to Fail"
Many of the vulnerabilities that amplified the crisis are linked with the problem of so-called too-big-to-fail firms. A too-big-to-fail firm is one whose size, complexity, interconnectedness, and critical functions are such that, should the firm go unexpectedly into liquidation, the rest of the financial system and the economy would face severe adverse consequences. Governments provide support to too-big-to-fail firms in a crisis not out of favoritism or particular concern for the management, owners, or creditors of the firm, but because they recognize that the consequences for the broader economy of allowing a disorderly failure greatly outweigh the costs of avoiding the failure in some way. ...

In the midst of the crisis, providing support to a too-big-to-fail firm usually represents the best of bad alternatives; without such support there could be substantial damage to the economy. However, the existence of too-big-to-fail firms creates several problems in the long run.

First, too-big-to-fail generates a severe moral hazard. If creditors believe that an institution will not be allowed to fail, they will not demand as much compensation for risks as they otherwise would, thus weakening market discipline; nor will they invest as many resources in monitoring the firm's risk-taking. As a result, too-big-to-fail firms will tend to take more risk than desirable, in the expectation that they will receive assistance if their bets go bad. Where they have the necessary authority, regulators will try to limit that risk-taking, but without the help of market discipline they will find it difficult to do so... There is little doubt that excessive risk-taking by too-big-to-fail firms significantly contributed to the crisis...

A second cost of too-big-to-fail is that it creates an uneven playing field between big and small firms. This unfair competition, together with the incentive to grow that too-big-to-fail provides, increases risk and artificially raises the market share of too-big-to-fail firms, to the detriment of economic efficiency as well as financial stability.

Third, as we saw in 2008 and 2009, too-big-to-fail firms can themselves become major risks to overall financial stability, particularly in the absence of adequate resolution tools. ... The failures of smaller, less interconnected firms, though certainly of significant concern, have not had substantial effects on the stability of the financial system as a whole.

If the crisis has a single lesson, it is that the too-big-to-fail problem must be solved. Simple declarations that the government will not assist firms in the future, or restrictions that make providing assistance more difficult, will not be credible on their own. Few governments will accept devastating economic costs if a rescue can be conducted at a lesser cost; even if one Administration refrained from rescuing a large, complex firm, market participants would believe that others might not refrain in the future. Thus, a promise not to intervene in and of itself will not solve the problem.

The new financial reform law and current negotiations on new Basel capital and liquidity regulations have together set into motion a three-part strategy to address too-big-to-fail. First, the propensity for excessive risk-taking by large, complex, interconnected firms must be greatly reduced. Among the tools that will be used to achieve this goal are more-rigorous capital and liquidity requirements, including higher standards for systemically critical firms; tougher regulation and supervision of the largest firms, including restrictions on activities and on the structure of compensation packages; and measures to increase transparency and market discipline. Oversight of the largest firms must take into account not only their own safety and soundness, but also the systemic risks they pose.

Second, as I already discussed, a resolution regime is being implemented that allows the government to resolve a distressed, systemically important financial firm in a fashion that avoids disorderly liquidation while imposing losses on creditors and shareholders. Ensuring that that new regime is workable and credible will be a critical challenge for regulators.

Finally, the more resilient the financial system, the less the cost of a failure of a large firm, and thus the less incentive the government has to prevent that failure. Examples of policies to increase resiliency include the requirements in the recent bill to force more derivatives settlement into clearinghouses and to strengthen the prudential oversight of key financial market utilities such as clearinghouses and exchanges. ... In addition, prudential regulators should take actions to reduce systemic risks. Examples include requiring firms to have less-complex corporate structures that make effective resolution of a failing firm easier, and requiring clearing and settlement procedures that reduce vulnerable interconnections among firms.

I asked Bernanke if large banks are necessary. Here's what he said:

B. Mark Thoma, University of Oregon and blogger: ...The proposed regulatory structure seems to take as given that large, potentially systemically important firms will exist, hence, the call for ready, on the shelf plans for the dissolution of such firms and for the authority to dissolve them. Why are large firms necessary? Would breaking them up reduce risk?

...Although regulators can do a great deal on their own to improve financial regulation and oversight, the Congress also must act to address the extremely serious problem posed by firms perceived as “too big to fail.” Legislative action is needed to create new mechanisms for oversight of the financial system as a whole. Two important elements would be to subject all systemically important financial firms to effective consolidated supervision and to establish procedures for winding down a failing, systemically critical institution to avoid seriously damaging the financial system and the economy.

Some observers have suggested that existing large firms should be split up into smaller, not-too big- to-fail entities in order to reduce risk. While this idea may be worth considering, policymakers should also consider that size may, in some cases, confer genuine economic benefits. For example, large firms may be better able to meet the needs of global customers. Moreover, size alone is not a sufficient indicator of systemic risk and, as history shows, smaller firms can also be involved in systemic crises. Two other important indicators of systemic risk, aside from size, are the degree to which a firm is interconnected with other financial firms and markets, and the degree to which a firm provides critical financial services. An alternative to limiting size in order to reduce risk would be to implement a more effective system of macroprudential regulation. One hallmark of such a system would be comprehensive and vigorous consolidated supervision of all systemically important financial firms. Under such a system, supervisors could, for example, prohibit firms from engaging in certain activities when those firms lack the managerial capacity and risk controls to engage in such activities safely. Congress has an important role to play in the creation of a more robust system of financial regulation, by establishing a process that would allow a failing, systemically important non-bank financial institution to be wound down in an orderly fashion, without jeopardizing financial stability. Such a resolution process would be the logical complement to the process already available to the FDIC for the resolution of banks.

So the only benefit of size he lists is "large firms may be better able to meet the needs of global customers." I can't say I find this argument very convincing.

In addition, I am not at all convinced that the procedures to "resolve a distressed, systemically important financial firm in a fashion that avoids disorderly liquidation" can be made credible. The first time regulators start to use this in a big crisis and markets begin to tank over worries about whether it will work or not, will the administration in power be willing to risk creating a big meltdown? Or will they resort to procedures used in the past that were problematic for all the reasons cited above, but do seem to prevent the most catastrophic outcome? 

Until someone convinces me that there are significant advantages to having mega-banks that cannot be duplicated with banks that are not, by themselves, too big to fail, I will continue to call for them to be broken up. Again, I don't think it makes a big difference in terms of systemic risk, though if Bernanke's right it will reduce the magnitude of the crisis, and that reduction in risk is important to recognize. But I do think breaking them up could make a big difference in terms of addressing all the other problems that size (and connectedness) brings about.

A Dream House After All

Karl Case says the American dream is still alive:

A Dream House After All, by Karl Case, Commentary, NY Times: If you read the coverage of the latest figures on the sales of existing homes..., you may well have come to the conclusion that the American dream is dead. It is indeed worrisome that sales in July were down 25 percent from a year ago. But a little perspective is in order.

First, the bad news. What has happened in the housing markets since 2005 is a catastrophe that may take years for our economy to recover from. ...

Depressing, yes — but the end of a dream? Not exactly. I have never quite understood what the American dream really means when it comes to housing. For some people, it means having a solid and fairly safe long-term investment that is coupled with the satisfaction of owning the house they live in. That dream is still alive.

Others, however, think the American dream is owning property that appreciates by 30 percent a year, making a house into a vehicle for paying bills. But those kinds of dreams have become nightmares for the millions of foreclosed property owners who have found themselves sliding toward bankruptcy.

But for people with a more realistic version of the American dream, buying a house now can make a lot of sense. Think of it as an investment. The return or yield on that investment comes in two forms. First, it provides what is called “net imputed rent from owner-occupied housing.” You live in the house and so it provides you with a real flow of valuable services. ... Consider it this way: when Enron went belly up, shareholders ended up with nothing, but when the housing market drops, homeowners still have a house. And this benefit is tax-free.

The second part of the yield on investment in a house is the capital gain you receive if it appreciates and you sell the house. Gains are excluded from taxation if the property is a primary residence...

Consider a few other bonuses of buying a home today. You can deduct the interest you pay on the mortgage. Interest rates are about as low as they can get. And, don’t forget, home prices are down by 30 percent on average from the peak. ...

Do the math. Four years ago, the monthly payment on a $300,000 house with 20 percent down and a mortgage rate of about 6.6 percent was $1,533. Today that $300,000 house would sell for $213,000 and a 30-year fixed-rate mortgage with 20 percent down would carry a rate of about 4.2 percent and a monthly payment of $833. In addition, the down payment would be $42,600 instead of $60,000. ...

[H]ousing has perhaps never been a better bargain, and sooner or later buyers will regain faith, inventories will shrink to reasonable levels, prices will rise and we’ll even start building again. The American dream is not dead — it’s just taking a well-deserved rest.

There's been a lot of talk about the virtues of renting lately, but for me -- and from the sounds of it perhaps I'm one of the few -- renting and owning are nowhere near perfect substitutes. Not even close.

links for 2010-09-01

• What Kind of Model Is Brian Riedl Using? - Econbrowser
• Breaking down the ISM numbers - FT Alphaville
• Bond Market Instability in a Liquidity Trap - Andy Harless
• Why America Isn’t Working - Kenneth Rogoff
• The Economic Narrative - Paul Krugman
• Fiscal policy: Stimulus lost - The Economist
• The state of the macroeconomy today - The Berkeley Blog
• Romer's Farewell: We Averted Another Depression - NYTimes.com
• Economic theory suggests symbiosis driven by self-interest - EurekAlert
• Contagious FTAs: New evidence on the domino theory of regionalism - voxeu
• Development economics in historical context - UnderstandingSociety
• 16.6 million small business employees could benefit from ACA - EurekAlert
• The Right Kind of Helicopter Drop - David Beckworth
• Surprising Many, Manufacturing Is Bright Spot - Real Time Economics
• The Press Isn’t Talking Us Into a Recession - Real Time Economics
• The weekly papers - The Economist
• Too Big to Fail - FRB New York
• Austerians = Bubble Deniers? - Paul Krugman
• Data Show China Growth Merely Moderating - NYTimes.com
• New Deal 2.0 - links
• FT Alphaville - links
• Credit Writedowns - links
• Free Exchange - links
  
• Abnormal Returns - links
• naked capitalism - links
• Brad DeLong - links

Christina Romer’s Farewell Address

Here's a summary of:

Christina Romer’s Farewell Address

I also explain one reason I'm so furstrated with fiscal policymakers.

Thomas Sargent on Modern Macroeconomic Models

As a follow-up to the post below this one on the usefulness of modern macroeconomic modes, here's Tom Sargent. Given my remarks below, I was pleased to read this:

The criticism of real business cycle models and their close cousins, the so-called New Keynesian models, is misdirected and reflects a misunderstanding of the purpose for which those models were devised.⁶ These models were designed to describe aggregate economic fluctuations during normal times when markets can bring borrowers and lenders together in orderly ways, not during financial crises and market breakdowns.

Here's more (and there's even more in the original interview, I left out the interesting discussion on Europe). While I don't agree with everything, I am simply going to give Sargent the floor. He's earned the right to have his say:

Interview with Thomas Sargent, by Art Rolnick, Minneapolis Fed, June 15, 2010: ...MODERN MACROECONOMICS UNDER ATTACK

Rolnick: You have devoted your professional life to helping construct and teach modern macroeconomics. After the financial crisis that started in 2007, modern macro has been widely attacked as deficient and wrongheaded.

Sargent: Oh. By whom?

Rolnick: For example, by Paul Krugman in the New York Times and Lord Robert Skidelsky in the Economist and elsewhere. You were a visiting professor at Princeton in the spring of 2009. Along with Alan Blinder, Nobuhiro Kiyotaki and Chris Sims, you must have discussed these criticisms with Krugman at the Princeton macro seminar.

Sargent: Yes, I was at Princeton then and attended the macro seminar every week. Nobu, Chris, Alan and others also attended. There were interesting discussions of many aspects of the financial crisis. But the sense was surely not that modern macro needed to be reconstructed. On the contrary, seminar participants were in the business of using the tools of modern macro, especially rational expectations theorizing, to shed light on the financial crisis.

Rolnick: What was Paul Krugman’s opinion about those Princeton macro seminar presentations that advocated modern macro?

Sargent: He did not attend the macro seminar at Princeton when I was there.

Rolnick: Oh.

Sargent: I know that I’m the one who is supposed to be answering questions, but perhaps you can tell me what popular criticisms of modern macro you have in mind.

Rolnick: OK, here goes. Examples of such criticisms are that modern macroeconomics makes too much use of sophisticated mathematics to model people and markets; that it incorrectly relies on the assumption that asset markets are efficient in the sense that asset prices aggregate information of all individuals; that the faith in good outcomes always emerging from competitive markets is misplaced; that the assumption of “rational expectations” is wrongheaded because it attributes too much knowledge and forecasting ability to people; that the modern macro mainstay “real business cycle model” is deficient because it ignores so many frictions and imperfections and is useless as a guide to policy for dealing with financial crises; that modern macroeconomics has either assumed away or shortchanged the analysis of unemployment; that the recent financial crisis took modern macro by surprise; and that macroeconomics should be based less on formal decision theory and more on the findings of “behavioral economics.” Shouldn’t these be taken seriously?

Sargent: Sorry, Art, but aside from the foolish and intellectually lazy remark about mathematics, all of the criticisms that you have listed reflect either woeful ignorance or intentional disregard for what much of modern macroeconomics is about and what it has accomplished. That said, it is true that modern macroeconomics uses mathematics and statistics to understand behavior in situations where there is uncertainty about how the future will unfold from the past. But a rule of thumb is that the more dynamic, uncertain and ambiguous is the economic environment that you seek to model, the more you are going to have to roll up your sleeves, and learn and use some math. That’s life.

The Great Depression in Economic Memory

Jean Pisani-Ferry argues that "In extraordinary times, history is, in fact, a better guide than models estimated with data from ordinary times":

The Great Depression in Economic Memory, by Jean Pisani-Ferry, Commentary, Project Syndicate: The dispute that has emerged in the United States and Europe between proponents of further government stimulus and advocates of fiscal retrenchment feels very much like a debate about economic history. Both sides have revisited the Great Depression of the 1930’s – as well as the centuries-long history of sovereign-debt crises – in a controversy that bears little resemblance to conventional economic-policy controversies.

The pro-stimulus camp often refers to the damage wrought by fiscal retrenchment in the US in 1937... So, are we in 1936, and does the budgetary tightening contemplated in many countries risk provoking a similar double-dip recession?

Clearly there are limits to the comparison. ... Nevertheless, the 1937 episode does seem to illustrate the dangers of attempting to consolidate public finances at a time when the private sector is still too weak for economic recovery to be self-sustaining. (Another case with similar consequences was Japan’s value-added tax increase in 1997, which precipitated a collapse of consumption).

Fiscal hawks also rely on history-based arguments. The economists Carmen Reinhart and Kenneth Rogoff have studied centuries of sovereign-debt crises, and remind us that today’s developed world has a forgotten history of sovereign default. A particularly telling example is the aftermath of the Napoleonic wars of the early nineteenth century, when a string of exhausted states defaulted on their obligations. The 1930’s are relevant here as well, given another series of defaults among European states, not least Germany.

What history tells us here is that defaults are not the privilege of poor, under-governed countries. They are a threat to all... Again, there are limits to comparisons...

In normal times, history is left to historians and economic-policy debate relies on models and econometric estimates. But attitudes changed as soon as the crisis erupted in 2007-2008. Indeed, central bankers and ministers were obsessed at the time by the memory of the 1930’s, and they consciously did the opposite of what their predecessors did 80 years ago.

They were right to do so. In extraordinary times, history is, in fact, a better guide than models estimated with data from ordinary times, because it captures variance that standard time-series techniques ignore. If one wants to know how to deal with a banking crisis, the risk of a depression, or the threat of a default, it is natural to examine times when those dangers were around, rather than to rely on models that ignore such dangers or treat them as distant clouds. In times of crisis, the best guides are theory, which captures the essence of a problem, and the lessons of past experience. Everything in between is virtually useless.

The danger with relying on history, however, is that we have no methodology to decide which comparisons are relevant. Loose analogies can easily be regarded at proofs, and a vast array of experiences can be enrolled to support a particular view. Policymakers (whose knowledge of economic history is generally limited) are therefore at risk of being drowned in contradictory historical references.

History can be an essential compass when past experience provides unambiguous headings. But an undisciplined appeal to history risks becoming a confusing way to express opinions. Governance by analogy can easily lead to muddled governance.

My argument is a bit different. In "extraordianry times," the questions that are important change, and economists build models to answer those questions. When those same questions are asked again, it's natural to look to the models built to answer them:

Models are built to answer questions, and the models economists have been using do, in fact, help us find answers to some important questions. But the models were not very good (at all) at answering the questions that are important right now. They have been largely stripped of their usefulness for actual policy in a world where markets simply break down.

The reason is that in order to get to mathematical forms that can be solved, the models had to be simplified. And when they are simplified, something must be sacrificed. So what do you sacrifice? Hopefully, it is the ability to answer questions that are the least important, so the modeling choices that are made reveal what the modelers though was most and least important.

The models we built were very useful for asking whether the federal funds rate should go up or down a quarter point when the economy was hovering in the neighborhood of full employment, or when we found ourselves in mild, "normal" recessions. The models could tell us what type of monetary policy rule is best for stabilizing the economy. But the models had almost nothing to say about a world where markets melt down, or when prices depart from fundamentals. When this crisis hit, I looked into our tool bag of models and policy recommendations and came up empty (for the most part). It was disappointing. There was really no choice but to go back to older Keynesian style models for insight.

The reason the Keynesian model is finding new life is that it specifically built to answer the questions that are important at the moment. The theorists who built modern macro models, those largely in control of where the profession has spent its effort in recent decades,; did not even envision that this could happen, let alone build it into their models. Markets work, they don't break down, so why waste time thinking about those possibilities.

So it's not the math, the modeling choices that were made and the inevitable sacrifices to reality those choices entail reflected the importance the people making the choices gave to various questions. We weren't forced to this end by the mathematics, we asked the wrong questions and built the wrong models. ...

The fight - and main question in academics - has been about what drives macroeconomic variables in normal times, demand-side shocks (monetary policy, fiscal policy, investment, net exports) or supply-side shocks (productivity, labor supply). And it's been a fairly brutal fight at times - you've seen some of that come out during the current policy debate. That debate within the profession has dictated the research agenda.

What happens in non-normal times, i.e. when markets break down, or when markets are not complete, agents are not rational, etc., was far down the agenda of important questions, partly because those in control of the journals, those who largely dictated the direction of research, did not think those questions were very important (some don't even believe that policy can help the economy, so why put effort into studying it?).

I think that the current crisis has dealt a bigger blow to macroeconomic theory and modeling than many of us realize.

Paul Krugman:

Brother, Can You Paradigm?: A few months back one of my original mentors in economics — someone who got his graduate training in the pre-fresh-water era — asked me whether there was anything about the current crisis that required fundamentally new analysis. We agreed that there wasn’t.

This is one of the untold tales of the mess we’re in. Contrary to what you may have heard, there’s very little that’s baffling about our problems — at least not if you knew basic, old-fashioned macroeconomics. In fact, someone who learned economics from the original 1948 edition of Samuelson’s textbook would feel pretty much at home in today’s world. If economists seem totally at sea, it’s because they have carefully unlearned the old wisdom. If policy has failed, it’s because policy makers chose not to believe their own models.

On the analytical front: many economists these days reject out of hand the Keynesian model, preferring to believe that a fall in supply rather than a fall in demand is what causes recessions. But there are clear implications of these rival approaches. If the slump reflects some kind of supply shock, the monetary and fiscal policies followed since the beginning of 2008 would have the effects predicted in a supply-constrained world: large expansion of the monetary base should have led to high inflation, large budget deficits should have driven interest rates way up. And as you may recall, a lot of people did make exactly that prediction. A Keynesian approach, on the other hand, said that inflation would fall and interest rates stay low as long as the economy remained depressed. Guess what happened?

On the policy front: there’s certainly a real debate over whether Obama could have gotten a bigger stimulus. What we do know, however, is that his top advisers did not frame the argument for a small stimulus compared with the projected slump purely in political terms. Instead, they argued that too big a plan would alarm the bond markets, and that anyway fiscal stimulus was only needed as an insurance policy. Neither of these arguments came from macroeconomic theory; they were doctrines invented on the fly. Samuelson 1948 would have said to provide a stimulus big enough to restore full employment — full stop.

So what we have here isn’t really a lack of a workable analytical framework. The disaster we’re facing is the result of the refusal of economists, both in and out of the corridors of power, to go with the perfectly good framework we already had.

As the video from George Evans hopefully makes clear, we are starting to ask the right questions and building the models we need to answer them. Hopefully, decades from now when economists have moved on to other questions and another crisis hits, the theorists who are so defensive of the models being built today won't mind if economists of the future try to learn something from their work.

"Bring Back the Estate Tax Now"

Dear Deficit Hawks:

Bring Back the Estate Tax Now, by Robert Rubin and Julian Robertson, Commentary, WSJ: ...Congress is finally turning its attention to the expiring 2001 and 2003 tax cuts. But there is one tax issue that should have long since been addressed: the federal estate tax. That tax expired at the end of last year, and there have been no estate taxes levied this year. If a new estate tax is not enacted as soon as Congress returns from its August recess, this void will continue until the end of the year.

We would recommend continuing 2009's regime, with a top rate of 45% and a $3.5 million individual exemption. Small businesses and family farms can be protected both through the exemption (which is $7 million for a couple) and through special deferred payment rules.

We both believe that the estate tax should be a component of any federal tax system. ... A key criterion in choosing taxes is to have the least negative impact on economic activity. The estate tax, in our opinion, meets that test. An estate tax can provide revenue—with little, if any, adverse supply-side economic impact—to fund deficit reduction, additional public investment or added assistance to those affected by the economic crisis. ...

We also share the view that the estate tax is grounded in powerful philosophical underpinnings. Our nation views itself as a meritocracy and a land of opportunity and we have a proud legacy of upward mobility. An estate tax helps us promote this legacy, by avoiding the accumulation of inherited economic—and political—power that is antithetical to this historical vision of our society and to the vitality and dynamism that has contributed so much to our success. ...

Our country is losing revenue that, with its stressed fiscal conditions, it can ill afford to forego.

I don't have any disagreement with this. If anything, I'd favor even higher rates once the estate value passes certain thresholds, i.e. additional steps in the rates.

The Dynamic Properties of New Keynesian Models with Learning

[This one is, as they say, wonkisk.] As James Bullard noted in the previous post, we "have one of the world's experts on the question of the dynamics" of dynamic stochastic general equilibrium (DSGE) models here at the University of Oregon, particularly models that involve learning.

There has been considerable controversy recently about the dynamic properties of DSGE models near the zero bound, in particular whether raising the federal funds rate target can help to avoid falling into a deflationary trap. So I asked George to explain this on video, and he graciously agreed to do so. The bottom line is that in these models, the type of policy discussed by Minnesota Fed President Narayana Kocherlakota increases rather than decreases the chance of a deflationary spiral.Here's George Evans

Please note: As soon as we were done, George realized there was a typo on the whiteboard. The horizontal axis on both graphs should have the low inflation steady state inflation value labeled β instead of β^-1. The value of .99 on the right-hand graph is correct. Here are corrected versions of the graphs in the video: Figure 1 (on the left in the video), Figure 2 (on the right).

Papers mentioned in the video:

• P. Howitt, Interest rate control and nonconvergence, Journal of Political Economy (1992), vol. 100, pp. 776-800.
• G. Evans, E. Guse and S. Honkapohja, Liqudity traps, learning and stagnation, European Economic Review (2008), vol. 52, pp. 1438-1463.
• J. Benhabib, S. Schmitt-Grohe and M. Uribe, The Perils of Taylor rules, Journal of Economic Theory (2001), vol. 96, pp. 40-69.

links for 2010-08-31

• Bickering at the FOMC? - FT Alphaville
• For Many, a New Job Means Lower Wages - NYTimes
• America’s Saving Surprise - Martin Feldstein
• Ambiguity is another reason to mitigate climate change - voxeu
• The Jackson Hole papers (finally) - FT Alphaville
• Brother, Can You Paradigm? - Paul Krugman
• Yes, the Fed can do more...  - Greed, Green and Grains
• Climate Change and the Wealth of Nations - Ed Glaeser
• The Great Depression in Economic Memory - Project Syndicate
• Why Wall St. Donors Are Deserting Obama - Dealbook
• Why the ACA is a transfer program - The Incidental Economist
• The Tax Cuts That Matter in a Struggling Economy - NYTimes.com
• Policy tools that could lower interest rates further - Econbrowser
• Obama was too cautious in fearful times - Martin Wolf
• Bitter GOP Criticism Of The Fed May Be Ahead - Capital Gains and Games
• Things We Know About Inflation (Wonkish) - Paul Krugman
• Do countries “graduate” from crises? An historical perspective - voxeu
• FT Alphaville - links
• Marginal Revolution - links
• New Deal 2.0 - links
• Market Talk - links
• Credit Writedowns - links
• naked capitalism - links
• Free Exchange - links
• Brad DeLong - links
• Abnormal Returns - links

Jim Bullard Responds to Tim Duy

Via email, Jim Bullard, President of the St. Louis Fed, responds to Tim Duy:

Hi Tim,

I read your "Fed watch" column this morning in our news clips.  You do an excellent job of summarizing important issues facing the FOMC.  I have three comments, all of which I have made publicly recently, and I think they are critical ones for the direction policy will take:

--on the "raising interest rates" question:  I am not sure if you have looked at my paper, "Seven Faces of the Peril," but if not please take a look at Figure 1 there (web page below) and contemplate the left hand side of the picture.  This convinces me that staying with the near-zero interest rate policy alone--and promising to stay near-zero for a long time without doing anything else--risks a deflationary trap.  To avoid this, I am recommending additional QE as a supplement to the near-zero rate policy as our best option.  You actually have one of the world's experts on the question of the dynamics behind Figure 1 at the U. of Oregon: George Evans.  Rajiv Sethi's summary of this issue as linked in your blog is very good, but citing Howitt--a fine paper, to be sure--is missing the more sophisticated analysis of Evans and Honkapohja that I cite in my paper.  I am not saying I necessarily agree with the Evans and Honkapohja policy conclusions, but they have good analytics for framing these issues.

--on the effectiveness of QE:  I do not agree that asset purchases are somehow ineffective.  I talk about this in my CNBC interview at Jackson Hole (also posted on my web page).  The direct empirical evidence on the effectiveness of QE both in the U.S. and the U.K. is fairly strong.  For example, see the paper by Chris Neely of our staff cited in the "Perils" paper.

--on the "disciplined" QE program:  The quote from Vince Reinhart, who is a great guy, gives the "shock and awe" view of QE.  I do not think this is remotely correct.  We know how monetary policy works:  through the expected future path of policy, not through the actual move on a particular day.  When we make 25 basis point moves on the federal funds rate, those are small viewed in isolation, but they have important effects for macroeconomic stabilization because they imply an expected interest rate path over the coming years.  The same is true for QE.  A move on a particular day may seem small, but it implies a path for future policy, and a series of smaller moves may add up to a very large move if the incoming data are consistent with such an outcome.  The "shock and awe" view, if applied to interest rate targeting, would suggest very large interest rate movements in response to relatively small changes in incoming data, a policy that most would view as destabilizing for the macroeconomy.  The same is true for QE.  So the point is that QE moves should be commensurate with the incoming data (a.k.a. "state contingent").  Of course we can argue about the incoming data--and I know you have strong views on that--but I think my position on a "disciplined" QE program is correct and that the dangerous policy is to make destabilizing moves out of line with the incoming data.  Concerning the data itself, your colleague Jeremy Piger will update his recession probabilities shortly so I will be anxious to see how that comes out.

I hope these comments are not too confused, I enjoyed your blog and I think you do a fine job of tracking the issues in the Fed.

Best regards,

Jim

I am about to do a video with George Evans who will explain the issues involved with dynamics at the zero bound, how Howitt fits in, how learning changes things, etc., so please stay tuned...

Insulating Fiscal Policy from a Dysfunctional Congress

I have a new column up at the Fiscal Times:

Insulating Fiscal Policy from a Dysfunctional Congress: The economic crisis has made two things clear. First, monetary policy won’t always be capable of stabilizing the economy on its own. When the problems become large enough, fiscal policy must be part of the response.

Second, even when our economic problems are severe and righting the ship ought to be the primary concern, Congress is incapable of implementing fiscal policy with the timeliness and effectiveness that is needed. As Alan Blinder said recently, “I’m looking at the political system turning itself into a paralyzed beast.” ... [...continue reading...]

Is there a way around this problem?

Fed Watch: No Clothes

Tim Duy is "anything but" reassured by Ben Bernanke's recent speech outlining the Fed's possible policy actions, and what it will take to put them into action:

No Clothes, by Tim Duy:

Unless every able American pitches in, Congress and I cannot do the job. Winning our fight against inflation and waste involves total mobilization of America's greatest resources—the brains, the skills, and the willpower of the American people. --- President Gerald Rudolph Ford, "Whip Inflation Now" Speech (October 8, 1974)

Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. --- Federal Reserve Chairman Ben Bernanke, "The Economic Outlook and Monetary Policy" Speech (August 27, 2010)

Rereading Federal Reserve Chairman Ben Bernanke's recent speech and measuring it against the incoming data leaves me with a pit in my stomach. I sense Bernanke reveals in this speech he is the proverbial emperor without clothes, short on policy options but long on hope. A last ditch attempt to persuade us that as long as we don't believe deflation will be a problem, it will not be a problem. But he faces the same challenge as did then President Gerald Ford. All hat and no cattle. You need to be ready to back up your talk with credible policy options. While Bernanke outlined possible policy options, reading between the lines makes clear he lacks conviction in the viability of any of those options. Simply put, Bernanke is not ready to embrace the paradigm shift bold action requires.

First, it is worth considering the economic context of the policy environment via the lens of July Personal Income and Outlays report. Real gains fells short of what I believe to be already diminished expectations, with a clearly suboptimal trend in place:

When Bernanke expresses concern for the near term pace of economic growth, he is concerned with failing to track the current path of economic activity, as illustrated by the path of consumption since July of last year. This already is a substantial lowering of the bar, and appears to be a resignation that previous trends are unattainable. That is a problem in many respects, the most important of which is that previous trends were consistent with full employment. The failure to acknowledge the importance of re-achieving the previous path is, in my opinion, an admission of the willingness to accept a protracted period of high unemployment. This, of course, has been essentially admitted by Bernanke:

Although output growth should be stronger next year, resource slack and unemployment seem likely to decline only slowly. The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence.

As I have already commented, if unemployment is a concern, and there is no conflict between the Fed's dual mandate, then why is the Fed waiting for further evidence of disinflation before acting? Indeed, Scott Sumner saw a line in the sand in Bernanke's speech of a one percent inflation rate. The most recent PCE data suggests we are perilously close to testing that line already:

"I'm not talking about Medicare, I'm Talking about Socialized Medicine"

Maxine Udall is enlightened and discouraged by a conversation with an elderly relative:

...[T]he spectre of "socialized medicine" prevents us moving to single payer, where the incentives for prudent life cycle management of risk across all age and income groups would be better aligned. Why, when we already have what is in effect single payer for the elderly and the poor, do some believe that single payer is "socialized medicine" and why do they fear it so?

I gained some insight into this recently when an elderly relative started complaining about "Obamacare" and how it would lead to "socialized medicine." Knowing the person had heart surgery courtesy of Medicare and was receiving ongoing monitoring and care, I said, "I didn't realize you were so unhappy with Medicare." To which I received the reply: "I'm not talking about Medicare, I'm talking about socialized medicine."

"How is Medicare different from socialized medicine?" I asked.

"Medicare isn't socialized," came the reply. "I pay for it. I pay every month and when I've had surgery, I've had to pay some of it. Medicare is like any other insurance."

"Well," I said, "I know you're paying a premium for Part B and I know there are copayments and deductibles, but Medicare is a government run health insurance program."

To which the reply was: "But I'm talking about socialized medicine. You know that whenever the government gets involved in anything, it never does a good job."

"I had no idea you were having problems with Medicare." said I. "I always had the impression you were pretty satisfied with it. And with the VA, too. I know you've used the VA for some care recently. What problems have you had with Medicare or the VA?"

"Well, none with Medicare or the VA, but I'm not talking about Medicare. I'm talking about socialized medicine."

"So you're happy with Medicare?"

"Yes."

"Would you mind if your [adult] children could buy into it? Your son is unemployed. Would it be OK if he could buy into Medicare?"

"Well, sure. As long as he has to pay like I do."

You were all wondering how someone could say, "Keep your government hands off my Medicare?" Well, there you have it. Now that I've told you, I'm still not sure I understand it. It was one of the most frustrating and at the same time enlightening conversations I have had in a long time. The person with whom I was conversing is intelligent, educated, and not senile.

I'm just not sure how to use the above information. I was unable to persuade my elderly relative. I confess that since the conversation, I have despaired that the national conversation will ever be much better.

links for 2010-08-30

• Lomborg vs. Lomborg - Marginal Revolution
• A helicopter drop for the US Treasury - Ricardo Caballero
• What Can Sustain GDP Growth? Open Economy Version - Econbrowser
• JacksonHole - Reuters
• Poverty and terrorism - Chris Blattman
• The Trap We're In (Wonkish) - Paul Krugman
• 100 years of US obesity - voxeu
• The Fed should buy pro-cyclical assets, not bonds - Nick Rowe
• Government Regulation and the Financial Crisis - Rortybomb
• Beware those who think the worst is past - Reinhart and Reinhart
• Criteria for assessing economic models - UnderstandingSociety
• When paradigms collide - Kids Prefer Cheese
• The Real Lesson from the Great Depression: Fiscal Policy Works! - New Deal 2.0
• Economic policy: Making the impossible possible - The Economist
• Munchau On Germany - Paul Krugman
• When Is the Government Spending Multiplier Large? - FRB Atlanta
• Interest And Inflation Wonkery - Paul Krugman
• Economix - links
• New Deal 2.0 - links
• Felix Salmon - links
• FT Alphaville - links
• Credit Writedowns - links
• Free Exchange - links
• Market Talk - links
• Marginal Revolution - links
• Abnormal Returns - links
• naked capitalism - links
• Brad DeLong - links

Robert Barro's Questionable Claim

Robert Reich is unhappy with Robert Barro:

The Obscenity of the Right-Wing Professoriat, by Robert Reich: ...Harvard Professor Robert Barro ... opined in today’s Wall Street Journal that America’s high rate of long-term unemployment is the consequence rather than the cause of today’s extended unemployment insurance benefits. ...

In point of fact, most states provide unemployment benefits that are only a fraction of the wages and benefits people lost when their jobs disappeared. Indeed, fewer than 40 percent of the unemployed in most states are even eligible for benefits... So it’s hard to make the case that many of the unemployed have chosen to remain jobless and collect unemployment benefits rather than work. Anyone who bothered to step into the real world would see the absurdity of Barro’s position. ... Right now, there are roughly five applicants for every job opening in America. ...

Barro argues the rate of unemployment in this Great Jobs Recession is comparable to what it was in the 1981-82 recession, but the rate of long-term unemployed is nowhere as high. He concludes this is because unemployment benefits didn’t last nearly as long in 1981 and 82 as it they do now.

He fails to see – or disclose – that the 81-82 recession was far more benign than this one, and over far sooner. It was caused by Paul Volcker and the Fed yanking up interest rates to break the back of inflation – and overshooting. When they pulled interest rates down again, the economy shot back to life. ...

A record number of Americans is unemployed for a record length of time. This is a national tragedy. It is to the nation’s credit that many are receiving unemployment benefits. This is good not only for them and their families but also for the economy as a whole, because it allows them to spend and thereby keep others in jobs. That a noted professor would argue against this is obscene.

Alex Tabarrok is unimpressed with Barro's work:

Barro v. Barro, by Alex Tabarrok: Robert Barro today in the WSJ, The Folly of Subsidizing Unemployment, estimates that UI extensions have increased the unemployment rate by 2.7 percentage points.

To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then ... the unemployment rate would have been 6.8% rather than 9.5%.

It's not clear to me why we should assume that the share of long-term unemployment in this recession should equal that in 1983.

Barro also argues:

We have shifted toward a welfare program that resembles those in many Western European countries.

In contrast Josh Barro, son of Robert, in How much do UI Extensions Matter for Unemployment, concluded that 0.4% was probably on the high side:

...Two Fed studies suggest that [extensions of UI] may have contributed 0.4 to 1.7 percentage points to current unemployment. But a closer look at this research makes me skeptical that the effects have been so large.

...The incentive effects of UI extension must also be weighed against the stimulative effects of paying UI benefits. For some reason it’s become almost taboo to note this on the Right, but UI recipients tend to be highly inclined to spend funds they receive immediately, meaning that more UI payments are likely to increase aggregate demand. UI extension also helps to avoid events like foreclosure, eviction and bankruptcy, which in addition to being personal disasters are also destructive of economic value.

As a result, I am inclined to favor further extension of UI benefits while the job market remains so weak. I am not concerned that this leads us down a slippery slope to permanent, indefinite unemployment benefits (which historically have been one of the drivers of high structural employment in continental Europe) as the United States has gone through many cycles of extending unemployment benefits in recession and then paring them back when the economy improves, under both Republican and Democratic leadership.

I call this one on both counts for Josh.   

Arnold Kling says that if incentive problems exist for unemployment -- and he's right to be skeptical of the claim -- there's more than one way to fix them:

...Robert Barro ... claims that the unemployment rate would be much lower now if Congress had not passed any extensions of unemployment benefits. I have not gone through his analysis, but I suspect that I, like Alex Tabarrok, would not find it persuasive. Nonetheless, I think there is a case to be made for allowing people to continue to collect unemployment benefits after they find a new job, until their benefits are scheduled to expire. We can argue about how generous the unemployment benefits should be overall, but for any level of benefits it is possible to reduce the disincentive to find work. 

One more:

Shoe Staring: Robert Barro Edition, by Karl Smith: Based on Cable News and a notable NYT column one might think that economists are perpetually at one another’s throats. This is far from the truth. The hierarchical nature of the economics profession lends an ecclesiastical air to many of our interactions. Brilliant figures are treated with enormous reverence.

To wit, when an eminent figure like Robert Barro says something that strikes most of as inane the most common reaction is shoe staring. For example, Barro writes:

To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then, if the number of unemployed 26 weeks or less in June 2010 had still equaled the observed value of 7.9 million, the total number of unemployed would have been 10.4 million rather than 14.6 million. If the labor force still equaled the observed value (153.7 million), the unemployment rate would have been 6.8% rather than 9.5%.

Upon hearing this no one wants to make eye contact for fear of revealing that he sees that the emperor – or esteemed economist in this case – is without his clothes.

For better or worse the blogosphere has changed that. Economists of all stripes will descend upon Barro over the next 36 hours. If he replies, which I suspect he will not, this will be an interesting moment.

Calling Barro's claim questionable, as in the title, was probably too generous.

FRBSF Economic Letter: The Effect of Immigrants on U.S. Employment and Productivity

What effect does immigration have on U.S. job markets? "Data show that, on net, immigrants expand the U.S. economy’s productive capacity, stimulate investment, and promote specialization that in the long run boosts productivity. Consistent with previous research, there is no evidence that these effects take place at the expense of jobs for workers born in the United States":

The Effect of Immigrants on U.S. Employment and Productivity, by  Giovanni Peri, FRBSF Economic Letter: Immigration in recent decades has significantly increased the presence of foreign-born workers in the United States. The impact of these immigrants on the U.S. economy is hotly debated. Some stories in the popular press suggest that immigrants diminish the job opportunities of workers born in the United States. Others portray immigrants as filling essential jobs that are shunned by other workers. Economists who have analyzed local labor markets have mostly failed to find large effects of immigrants on employment and wages of U.S.-born workers (see Borjas 2006; Card 2001, 2007, 2009; and Card and Lewis 2007).

This Economic Letter summarizes recent research by Peri (2009) and Peri and Sparber (2009) examining the impact of immigrants on the broader U.S. economy. These studies systematically analyze how immigrants affect total output, income per worker, and employment in the short and long run. Consistent with previous research, the analysis finds no significant effect of immigration on net job growth for U.S.-born workers in these time horizons. This suggests that the economy absorbs immigrants by expanding job opportunities rather than by displacing workers born in the United States. Second, at the state level, the presence of immigrants is associated with increased output per worker. This effect emerges in the medium to long run as businesses adjust their physical capital, that is, equipment and structures, to take advantage of the labor supplied by new immigrants. However, in the short run, when businesses have not fully adjusted their productive capacity, immigrants reduce the capital intensity of the economy. Finally, immigration is associated with an increase in average hours per worker and a reduction in skills per worker as measured by the share of college-educated workers in a state. These two effects have opposite and roughly equal effect on labor productivity.

"This is Pretty Weak Evidence"

Karl Whelan identifies the questionable assumptions used by Jean Claude Trichet to support his calls for austerity:

Trichet on Ricardian Equivalence, by Karl Whelan: Jean Claude Trichet’s Jackson Hole speech is here. This bit caught my eye:

The economy, it is sometimes argued, is at present too fragile and thus consolidation efforts should be postponed or even new fiscal stimulus measures added. As I pointed out recently, I am sceptical about this line of argument. Indeed, the strict Ricardian view may provide a more reasonable central estimate of the likely effects of consolidation. For a given expenditure, a shift from borrowing to taxation should have no real demand effects as it simply replaces future tax burden with current one.

The written version of the speech cites two papers by Robert Barro as supporting evidence for this position.

I think it’s worth noting that the Ricardian equivalence idea put forward by Barro—that consumers see deficits and taxes as basically the same thing—has been tested many many times. And the general consensus on this, as I understand it, is that there is very little evidence to support the idea.

Moreover, though the idea works in one very simplified model set up, there are lots of reasons why the proposition does not hold in reality (liquidity constraints, people having finite lives, people not having rational expectations, uncertainty about the path of government spending—see this extract from David Romer’s textbook.)  Very few economists emerge from graduate schools believing in the Ricardian equivalence idea.

There are, of course, lots of arguments in favour of European governments setting out their long-term plans for the restoration of fiscal stability. However, it is a pity to see economic theories that are known to have little support regularly rolled out as arguments for fiscal austerity.

Trichet follows up on his Ricardian equivalence comments by arguing that expansionary fiscal contractions “are not just a theoretical curiosity” with the footnotes citing the old Giavazzi and Pagno paper with its two examples: Denmark in the mid-1980s and, of course, Ireland in the late 1980s. I’ve already said my bit about this, so I won’t repeat it. Suffice to say, this is pretty weak evidence that Trichet is serving up.

Trichet must know that the evidence for Ricardian equivalence is pretty shaky, and he must know that one or two papers with questionable results hardly offsets the build of the evidence pointing in the other direction. Yet the best case he can build revolves around those points. That tells you what you need to know about the strength of his argument.

Let me also add this from the "said my bit" link above:

The Enduring Influence of Ireland’s 1987 Adjustment, by Karl Whelan: When I was a junior economist in short trousers, the first research I ever did was inspired by Ireland’s successful 1987-89 fiscal adjustment.  Many international researchers looked at Ireland and decided that our successful adjustment stemmed from consumers stepping into the breach filled by the government spending cuts. The story was that increased consumer confidence, fueled by expectations of lower future taxes, was the key to the recovery.

From the research I did on this topic (both on my own and with John Bradley) I came away fairly convinced that this was not what had happened. Rather, the 1987 boom seemed to be fueled more by strong exports to the UK thanks to Nigel Lawson’s tax cutting exercise.

However, Ireland’s 1987 experience continues to pop up in discussions of fiscal austerity. I have to admit that I’ve not been too impressed by Alberto Alesina’s work (here and here) on how fiscal adjustment can be expansionary—work that has had a lot of influence this year. Well, sure enough, Paul Krugman now cites work from Arjun Jayadev and Mike Konczal showing that the only country that ever cut its way to growth in a slump was, you guessed it, Ireland in 1987. The power of this datapoint endures.

Paul Krugman: It’s Witch-Hunt Season

"This is going to be very, very ugly":

It’s Witch-Hunt Season, by Paul Krugman, Commentary, NY Times: The last time a Democrat sat in the White House, he faced a nonstop witch hunt by his political opponents. Prominent figures on the right accused Bill and Hillary Clinton of everything from drug smuggling to murder. And once Republicans took control of Congress, they subjected the Clinton administration to unrelenting harassment — at one point taking 140 hours of sworn testimony over accusations that the White House had misused its Christmas card list.

Now it’s happening again — except that this time it’s even worse. Let’s turn the floor over to Rush Limbaugh: “Imam Hussein Obama,” he recently declared, is “probably the best anti-American president we’ve ever had” ..., bear in mind that he’s an utterly mainstream figure within the Republican Party; bear in mind, too, that unless something changes the political dynamics, Republicans will soon control at least one house of Congress. This is going to be very, very ugly. ...

What we learned from the Clinton years is that a significant number of Americans just don’t consider government by liberals — even very moderate liberals — legitimate. Mr. Obama’s election would have enraged those people even if he were white. Of course, the fact that he isn’t, and has an alien-sounding name, adds to the rage.

By the way, I’m not talking about the rage of the excluded and the dispossessed: Tea Partiers are relatively affluent, and nobody is angrier these days than the very, very rich. Wall Street has turned on Mr. Obama with a vengeance:... And powerful forces are promoting ... this rage..., the superrich Koch brothers and their war against Mr. Obama has generated much-justified attention, but ... only the scale of their effort is new: billionaires like Richard Mellon Scaife waged a similar war against Bill Clinton.

Meanwhile, the right-wing media are replaying their greatest hits. ...Mr. Limbaugh used innuendo to feed anti-Clinton mythology, notably the insinuation that Hillary Clinton was complicit in the death of Vince Foster. Now ... he’s doing his best to insinuate that Mr. Obama is a Muslim. ... [And] Mr. Limbaugh is ... tame compared with Glenn Beck.

And where, in all of this, are the responsible Republicans, leaders who will stand up and say that some partisans are going too far? Nowhere to be found. To take a prime example: the hysteria over the proposed Islamic center in lower Manhattan... On this issue, as on many others, the G.O.P. establishment is offering a nearly uniform profile in cowardice.

So what will happen if, as expected, Republicans win control of the House? ...Politico reports that they’re gearing up for a repeat performance of the 1990s, with a “wave of committee investigations” — several ... over supposed scandals that we already know are completely phony. We can expect the G.O.P. to play chicken over the federal budget, too; I’d put even odds on a 1995-type government shutdown sometime over the next couple of years.

It will be an ugly scene, and it will be dangerous, too. The 1990s were a time of peace and prosperity; this ... time ... we’re still suffering the after-effects of the worst economic crisis since the 1930s, and we can’t afford to have a federal government paralyzed by an opposition with no interest in helping the president govern. But that’s what we’re likely to get.

If I were President Obama, I’d be doing all I could to head off this prospect, offering some major new initiatives on the economic front in particular, if only to shake up the political dynamic. But my guess is that the president will continue to play it safe, all the way into catastrophe.

Did I Hear that Right? You Want to Raise Interest Rates?

Let me explain, as simply as I can, the underlying reason for the strong reaction to Minnesota Fed president Narayana Kocherlakota's suggestion that raising interest rates would be helpful.

When a Federal Reserve president calls for an increase in interest rates while the economy is still struggling to recover, something that repeats the errors of 1937-38, all of his buddies in academia should expect a reaction. It comes with the job. The fact that he can point to a model that failed to provide much help with the situation we're in to justify the statement isn't of much comfort, and there are serious questions about the validity of the claim in any case.

This isn't just a theoretical exercise where finding novel, counter-intuitive results that may or may not have real world applicability draws the admiration of peers, people's livelihoods are at stake. Real people in the real world are depending on the Fed to get this right, and suggestions that the Fed raise interest rates to help with the recession go against every intuitive bone I have in my body. More importantly, for those who think those bones might be broken, it goes against the existing empirical evidence. This is not a game, actual policy is at stake that will affect people's lives, and we cannot be careless in how we approach it.

If I reacted strongly, it's because I don't want us to repeat the mistakes we made in the past, mistakes that would hurt people who have suffered enough already. Do the advocates of this policy really believe, way down deep, that raising interest rates is the right thing to do in this situation? Perhaps, but I sure don't, and I can't let it pass without comment.

links for 2010-08-29

• Taylor = Wicksell + Fisher + Friedman - Nick Rowe
• Did Californians break their contract? - Richard Green
• What I Hope Is the Last Word on Stephen Williamson... - Brad DeLong
• Bernanke Manages Expectations for Fed Role in Recovery - NYTimes.com
• Positional/Context/Prestige Externalities - Richard H. Serlin
• Why Cheaper Money Won't Mean More Jobs - Robert Reich
• Policy Options Dwindle as Economic Fears Grow - NYTimes.com
• Ethics and statistics in development research - Andrew Gelman
• Against Claims of “Structural Unemployment” - Brad DeLong
• Bring Your Genes to Your Life Insurance Sales Representative - Brad DeLong
• Two New Federal Programs for Struggling Home Owners - NYTimes.com
• Germany’s rebound is no cause for cheer - Wolfgang Münchau
• New Ideas about Monetary Policy from Jackson Hole - John Taylor
• New database on the maturity structure of publicly-held debt - Econbrowser
• I Am A Psychotic Ferret - Paul Krugman
• Free Exchange - links
• Paul Kedrosky - links
• Marginal Revolution - links
• Credit Writedowns - links
• Brad DeLong - links
• Abnormal Returns - links
• naked capitalism - links

"America’s Leaders are Letting the Country Down"

Clive Crook:

It falls to the Fed to fuel recovery, by Clive Crook, Commentary, Financial Times: The US recovery is stalling. As a matter of economics the balance of risks strongly favors further fiscal and monetary stimulus. Politics appears to rule out the first, and a divided Federal Reserve is hesitating over the second. America’s leaders are letting the country down. ...

Unlike most other advanced economies, the US could undertake further fiscal stimulus at acceptably low risk. Global appetite for its debt is undiminished. The risk, such as it is, could be all but eliminated if Congress could commit itself to stimulus now, restraint later – an easy thing, you might suppose, but evidently beyond its grasp. The administration could and should be pushing for just such a package, but it is not.

The political problem is that US voters ... have wrongly decided that the first stimulus was an expensive failure. The administration is partly to blame. It oversold the ... first package...

One cannot know how many jobs the stimulus saved, but it is absurd to see high unemployment as proof that it was ineffective. More likely this shows how powerful the recession’s downward pull has been, and still is. Most economists think the stimulus helped a lot. Yet, as in other areas, President Barack Obama’s defense of his policy has been strangely diffident. ...

Meanwhile, there is monetary policy. At the end of last week,... Ben Bernanke, Fed chief, acknowledged the faltering recovery, and reminded his audience that the central bank has untapped capacity for stimulus. ... Mr Bernanke and his colleagues are understandably nervous about extending the radical measures they have already taken. ... But the balance of risks has moved. They need to go further. ...

A Question for the Kansas City Fed

This has annoyed me for several years now. Why won't the Kansas City Fed make the papers for the Jackson Hole conference available until after the conference is over? What's the purpose of this? None that I can think of, other than making themselves special, but that's no way for a public agency to behave.

This is the opposite of transparency. I can understand waiting until the final versions are submitted, but at that point, why not post the papers so we can read them prior to the conference and give more informed commentary on the event? As it stands, I have to rely upon reporters to accurately tell me what's in the papers and, while I do trust some of them to mostly get things right (but not all), I'd like to be able to check the papers for myself. Sometimes participants will give a report after the event is over, but that's a bit late and even then I'd like to be able to come to my own conclusions, or at least verify the reports from reading the papers themselves. What's the point in locking them up? (As far as I can tell, the authors aren't even allowed to post the papers on their own sites.)

The pdfs will also be copy protected when they are posted, another step that places unnecessary hurdles in the way of commenting on the papers. Under the KC Fed's policy, which extends to speeches by the president of the KC Fed but isn't followed by other district banks, reproducing a graph or a few paragraphs then becomes tedious. The copy protection doesn't stop anyone who really wants to post a paragraph or two as you are permitted to do, it's simply harder and hence discouraging (and the speeches themselves are supposed to be in the public domain and hence fully reproducible). But why discourage conversation about these papers? Why make it so that we can't actually read the papers and comment on them until the conference is over and people have lost interest in the event. Why make it as hard as possible to even take small excerpts? How is that helpful?

Creating an exclusive event like this does give the people involved power, it makes them special, it gives them the power to include and exclude people, and so on. But their duty is to serve the public interests, not create a special little club that only some can participate in, and then dribble out the important information in a way that maintains their exclusivity and power.

I can live with the copy-protection, but the attempts to discourage access to the conference papers is puzzling when viewed through the Fed's mission to serve the public interest.

[Maybe I've missed something obvious, it certainly wouldn't be the first time that's happened, and there's a good reason for this policy. If someone at the KC Fed wants to explain why they can't do what most conferences do and make the papers available prior to or at the beginning of the conference, or at the very least at the time of or right after a session is over, I will post the explanation. It would be nice if the explanation also included the reasons for trying to lock up other documents such as Fed speeches, something no other Fed tries to do.]

Interest Rates and Inflation Once Again

The conversation with Stephen Williamson continues. See here and here (including comments).

Update: Brad DeLong responds to Williamson.

Update: Paul Krugman comments.

"Can Interest Rates Explain the US Housing Boom and Bust?"

Did low interest rates cause the financial crisis as John Taylor and others contend? (I've argued that the low interest rate policy contributed to the crisis, but by itself was not the major factor. That is roughly consistent with their conclusion, though their numbers on the degree to which interest rates mattered are lower than I would have predicted):

Can interest rates explain the US housing boom and bust?, by Edward Glaeser, Joshua Gottlieb, and Joseph Gyourko: Between 2001 and the end of 2005, the Standard and Poor’s/Case-Shiller 20 City Composite House Price Index rose by 46% in real terms. By the first quarter of 2009 the index had dropped by about one-third before stabilizing. The volatility of the Federal Housing Finance Agency (FHFA) repeat-sales price index was less extreme but still severe. That index rose by 53% in real terms between 1996 and 2006 and then fell by 10% between 2006 and 2008. As many financial institutions had invested in or financed housing-related assets, the price decline helped precipitate enormous financial turmoil.

Much academic and policy work has focused on the role of interest rates and other credit market conditions in this great boom-bust cycle.

• One common explanation for the boom is that easily available credit, perhaps caused by a “global savings glut,” led to low real interest rates that boosted housing demand (Himmelberg et al. 2005, Mayer and Sinai 2009, Taylor 2009).
• Others have suggested that easy credit market terms, including low down payments and high mortgage approval rates, allowed many people to act at once and helped generate large, coordinated swings in housing markets (Khandani et al. 2009).

Those easy credit terms may have been a reflection of agency problems associated with mortgage securitization (Keys et al., 2009, 2010, Mian and Sufi, 2009 and 2010, Mian et al. 2008).

If correct, these theories would provide economists with comfort that we understood one of the great asset market gyrations of our time; they would also have potentially important implications for monetary and regulatory policy. But economists are far from reaching a consensus about the causes of the great housing market fluctuation. For example, Shiller (2003, 2006) long has argued that mass psychology is more important than any of the mechanisms suggested by the research cited above.

Re-evaluating the missing link

Motivated by this question, we re-evaluate the link between housing markets and credit market conditions, to determine if there are compelling conceptual or empirical reasons to believe that changes in credit conditions can explain the past decade’s housing market experience.

Krugman vs. Holtz-Eakin: Has the Fed Done Enough?

The discussion starts around the 2:00 minute mark. Via C&L

Holtz-Eakin is encouraging us to balance the budget even though the economy is still relatively weak, and in doing so, to make the same mistake we made during the Great Depression. A quick look at recent data, and all the talk about the chance of a double dip we've been hearing, shows that we are anything but certain we we will be back at full employment anytime soon. Recovery from a financial crisis is often a long, drawn out process, and that may be true this time as well, but that means the economy needs more help over a longer period, not a premature return to austerity that risks sending the economy back into recession.

Why would we want to risk sending the economy back into a recession by beginning to balance the budget before the economy is growing robustly on its own? Republicans believe some sort of confidence effect from the decline in the deficit -- one that cannot actually be observed in the data but is, nevertheless, asserted to be there anyway -- will somehow more than offset the certain decline in demand from the reduction in the government deficit. But the problem is that the decline in demand will have it's own confidence effect on businesses, one that is negative, more certain, and likely much larger than any positive effects from deficit reduction.

And is anyone else getting tired of the "Obama is creating business uncertainty" argument from the Party that is creating most of the uncertainty and uneasiness about what crazy things might happen should they be elected? It worked out so well for the economy the last time they were in power and emphasized growth above all else. We're still trying to get out of that sinkhole -- talk about creating uncertainty. In any case, as noted by Paul Krugman on the video, there's nothing at all to indicate that businesses are, in fact, holding back due to uncertainties created by the administration's policies. Businesses face lots of uncertainties due to lack of demand for their products, and perhaps over what might change if Republicans take power, something that can hardly be blamed on the administration. But balancing the budget as Holtz-Eakin would have us do would reduce demand and cause fewer paying customers to walk through their doors. That makes the uncertainty problem worse, not better.

Putting it more succinctly, the Party in power when we got into this mess wants to be given another chance so it can try policies that failed during the Great Depression. And some people think that's a good idea.