"Desperate Times Require Desperate Measures"

Barry Eichengreen says we need to implement aggressive fiscal policy measures, and those measures need to be coordinated across countries:

Time to grasp the fiscal nettle, by Barry Eichengreen, CIF: ...[G]overnments now need to recognise that they have not just a financial crisis but an economic crisis on their hands. We are well past the point where it makes sense to speak of the possibility or even the unavoidability of recession. ...

What is no longer simply a financial crisis cannot be fixed by financial interventions alone. It cannot be fixed by more interest rate cuts... With consumption and investment both collapsing and only extra-terrestrials to sell additional exports to, there is only one element of global demand left. That's government spending. It is time, in other words, to think about aggressively using fiscal policy.

One can imagine the alarm with which this recommendation will be received. The US deficit is already rising steeply... European countries have uncomfortably high debts and the kind of gloomy demographics that make even existing debts painful to service. But these are problems for tomorrow. The imperative for today is to stabilise the economy. And fiscal policy is the only instrument left for doing this.

Fiscal initiatives will have to be large to succeed in stabilising an economy in freefall. In the US case, we are talking 5% of GDP, or $700bn (there's that number again). This means that the US deficit may be closer to $2tn than $1tn next year. But desperate times require desperate measures.

The problem with using fiscal policy in a financial crisis, as any emerging market official will tell you, is that it may do more to frighten than reassure investors. Worried that the government's big budget deficits will ultimately have to be financed by printing central bank money, investors may flee the country, causing its currency to crash and creating even more serious financial problems.

Of course, if all governments apply fiscal stimulus at the same time, there is then no reason for investors to flee in any particular direction. There is an urgent need, in other words, for coordinated fiscal (and not just monetary) action.

In the US, we need an income tax cut to put money in the pockets of consumers and an investment tax credit to get corporate spending going again. ... Other countries might prefer a different mix of emergency tax cuts. But they need to act together. ...

He says "there is only one element of global demand left. That's government spending." But then he calls for tax cuts (which stimulate consumption and investment - hopefully). However, to repeat the point one more time, while tax cuts may have the advantage of immediacy - an important consideration now that we've wasted so much time putting a fiscal policy package in place (it didn't have to be that way) - they do not produce as certain an impact on aggregate demand as government spending. In addition, it's harder to target specific areas of national need such as infrastructure, and tax cuts do not provide aid to state and local government who are being forced to cut back on development projects and other spending as the weakening economy lowers revenues. [See also: "Lawmakers Weigh Plan for Stimulus." A combination of tax cuts, the extension of unemployment benefits, the expansion of the food stamp program, and aid to states and citis is proposed. Putting a fiscal stimulus package in place as fast as we can is important - down the line somewhere each day of delay could cost people jobs - so let's hope legislators take the bail out of the innocent bystanders who could be hurt by this crisis as seriously and with as much urgency as they did the bail out of Wall Street.]

Comments

[ken melvin]

The tax cuts solution implies a consumption solution. Even if they spent it and didn't save it, a consumption solution ain't a gonna cut it, won't put people to work at well paying jobs.

[bakho]

A stimulus of this type would require the Congressional Dems to steamroll Bush, a political impossibility before Nov 4.

[anne]

There has been need for a fiscal stimulus for quite a while, expressly a spending stimulus, but this has been so completely overlooked that even the Democratic leadership just failed to vote on a mere $7 billion (not $700 billion) to extend health care insurance to 3.8 million needy children. A few days time can however change minds and there is some sentiment for a stimulus plan, though with little to no understanding of how successful Japan was in using spending during the years of deflation.

There needs to be a government commitment to supporting employment, precisely as the Japanese did though to the disapproval of almost every American and British analyst save for Paul Krugman.

[anne]

Democrats have majorities in Congress, and whether Congressional Republicans or the President agree to a stimulus plan or not makes no difference in showing clearly the economic difference between the Parties. Democrats just decided to break a promise so as not to embarrass Republicans by even voting to increase the number of needy children covered by health care insurance, and this was perfectly disgraceful.

The need is to set down proper policy ideas, and not to cater to Republican self-defeating absurdity.

[baileyman]

Tax rebates. Even if you file a return with no tax due. Something on the order of $50,000 for 130m taxpayers, $650 billion.

[Times]

"Of course, if all governments apply fiscal stimulus at the same time, there is then no reason for investors to flee in any particular direction."

It may accelerate the trend away from saving in a form that can be loaned out, and into inflation hedges instead. Witness how inflation and negative interest rates have eliminated savings in the US. A de facto gold price cap (via coordinated central bank selling) would not solve this problem, as too many other inflation hedges have become popular (homes, timber land, etc...) In the long run, the only way to establish a stable system is positive net real interest rates. Free money invites abuse and over leveraging. Positive real rates help funnel limited savings to the most productive activities. Productive activity enables repayment, keeping the system stable.

However, desperate times do require desperate measures. Just don't waste the rescue effort on non productive activity.

[Lafayette]

The Economist chimes in with its assessment of what's happened and some changes to come (excerpted from its October 9th edition): During the past month, little more than a year after the financial storm first struck in August 2007, America’s government made its most dramatic interventions in financial markets since the 1930s. At the time it was not even certain that the economy was in recession and unemployment stood at 6.1%. In two tumultuous weeks the Federal Reserve and the Treasury between them nationalised the country’s two mortgage giants, Fannie Mae and Freddie Mac; took over AIG, the world’s largest insurance company; in effect extended government deposit insurance to $3.4 trillion in money-market funds; temporarily banned short-selling in over 900 mostly financial stocks; and, most dramatic of all, pledged to take up to $700 billion of toxic mortgage-related assets on to its books. The Fed and the Treasury were determined to prevent the kind of banking catastrophe that precipitated the Depression. Shell-shocked lawmakers cavilled, but Congress and the administration eventually agreed.

The landscape of American finance has been radically changed. The independent investment bank — a quintessential Wall Street animal that relied on high leverage and wholesale funding—is now all but extinct. Lehman Brothers has gone bust; Bear Stearns and Merrill Lynch have been swallowed by commercial banks; and Goldman Sachs and Morgan Stanley have become commercial banks themselves. The “shadow banking system”—the money-market funds, securities dealers, hedge funds and the other non-bank financial institutions that defined deregulated American finance—is metamorphosing at lightning speed. And in little more than three weeks America’s government, all told, expanded its gross liabilities by more than $1 trillion—almost twice as much as the cost so far of the Iraq war.

What will be the long-term effect of this mess on the global economy? Predicting the consequences of an unfinished crisis is perilous. But it is already clear that, even in the absence of a calamity, the direction of globalisation will change. For the past two decades the growing integration of the world economy has coincided with the intellectual ascent of the Anglo-Saxon brand of free-market capitalism, with America as its cheerleader. The freeing of trade and capital flows and the deregulation of domestic industry and finance have both spurred globalisation and come to symbolise it. Global integration, in large part, has been about the triumph of markets over governments. That process is now being reversed in three important ways.

First, Western finance will be re-regulated. At a minimum, the most freewheeling areas of modern finance, such as the $55 trillion market for credit derivatives, will be brought into the regulatory orbit. Rules on capital will be overhauled to reduce leverage and enhance the system’s resilience. America’s labyrinth of overlapping regulators will be reordered. How much control will be imposed will depend less on ideology (both of America’s presidential candidates have promised reform) than on the severity of the economic downturn. The 1980s savings-and-loan crisis amounted to a sizeable banking bust, but because it did not result in an economic catastrophe, the regulatory consequences were modest. The Depression, in contrast, not only refashioned the structure of American finance but brought regulation to whole swathes of the economy.

[Fred]

Tax cuts are essential as a way for the middle-class to repair balance sheets that have been whacked by house price and stock market declines. Absent big tax cuts or some miracle that reflates house and stock prices, the only way for the middle-class to repair balance sheets is via savings. The impact of higher savings (non-consumption) by households could easily dwarf the most ambitious government spending plans, so it essential that we reassure households that cutting consumption drastically will not be necessary. Rather, the savings the households crave now or will crave in the future (a lot of households are still clueless about what is going on) can be supplied via tax cuts.

Let's put some numbers on this Keynesian balance sheet analysis. House prices have declined or will decline by about $4 trillion and households are also set to lose about $8 trillion via stock declines. Housing/stocks are risky equities, whereas tax cuts result in non-risky government bonds, so we don't need to replace the full $12 trillion of lost "wealth" with new government debt. But we do need to replace a good chunk of it, say $4 trillion. And that implies AT LEAST $1 trillion of middle-class tax cuts per year for several years to come. Added to the existing deficit of close to $1 trillion and we get those $2 trillion deficits which I have been calling for on this blog for some time now.

We also continue to need some form of tariff to prevent demand from being leaked out to foreign devils. The problem of demand leakage will grow more acute if the US cuts taxes and the Europeans don't.

[anne]

"We also continue to need some form of tariff to prevent demand from being leaked out to foreign devils."

Rottenness goes so well with idiocy.

[Oupoot]

Everone mentions the over indebtedness of banks and sometimes corporates which will require a govt capital injection with credit becoming so expensive/scarce. But what no one mentions is the over indebtedness of households. While they should never have gotten into debt over their heads, many will face salary cuts (just to keep their jobs) and/or loose their jobs in the coming months. Many thousands will not be able to keep up with their monthly mortgage payments and/or adjust their expenditure sufficiently. And if selling your house (or any other asset) does not eradicate the debt on it, then many more people will simply walk away. This will increase the spiraling effect of the financial and economic crisis. Some debt relief (or call it capital injection if you like) is necessary for many many households.

One can design any complicated mechanism to do this that have a short, medium or long term maturity to impact and target a selective group in the broader population. However, a simple tax rebate could act as a short term intervention by giving them cash in hand to do what they want to do with it. Most consumers smooth their incomes over time in order to meet past or future expenditure. Studies have indicated that up to 80% of the previous $100bn rebate has gone to savings or debt reduction by households. Why not give another $100bn or $200bn tax rebate and encourage the households that receive it to reduce their personal financial debts. If 80% is used to reduce debt, that is a $80bn/$160bn cash injection into banks. Not only is this vital liquidity to the banking sector, but it should also greatly reduce the risk of default for many mortgages, impacting positively on the MBS and ABS markets. And yes, the 20% will be a short term boost to consumption - but so what, it will keep the consumption part of the economy from turning down too steeply.

If it later proves necessary again, it could be repeated. This however, should not be stated up front, as it will affect the consumption behaviour of the rebate recipients.

The net effect is to nationalise some private debt by turning it into public debt. Higher taxes in the future will be used to repay the public debt, so there is no net benefit. Everyone wins now, and everyone is penalised in future (when the economy is in better shape and able to repay the cost of this bailout).

Other fiscal policy interventions that have a more medium and long term matury to impact that is required and should be implimented simultaneously to the above could focus on improving infrastructure and other social investments (healthcare, education, etc). And this include the federal govt providing the necessary funds to sustain current local and state govt spending. This should reduce the job losses and business foreclosures that would have been the case otherwise.

[Lafayette]

Fred: Housing/stocks are risky equities, whereas tax cuts result in non-risky government bonds

Tax cuts are blunt instruments; meaning the more you use them, the more they end up where you don't need them. For instance, the stock market or at the race track or wherever.

As a policy decision, it would be far better that we turn to targeted Keynesian government spending, focused upon projects that enhance our lives instead of our wallets.

Such expenditures in both health and education and ecology end up in the wallet anyway, but at least they've done some good getting there.

[Fred]

Tax cuts are blunt but they are also quick and easy to reverse. Infrastructure spending offers infinite possibilities for waste and political meddling. Bridges to nowhere in Japan, that sort of thing. Anyway, at 30% of GDP, government spending is plenty big enough. The problem is that the spending is often wasted. Military spending is mostly wasted, so is much of medicare, education is hopelessly inefficient. We certainly could use some new government-subsidized infrastructure and R&D spending, but I would prefer to see the money for that to come from cutting back on existing government waste. 30% of GDP to the combined fed/state/local governmetn is plenty. Let's not bloat the thing further.

Some households will blow there money at the race track. Others will sensibly insulate there houses to cope with higher heating costs. The invisible hand of capitalism does work.

"Spending" on the stock market just transfer money from one person to another and does not consistite real economic spending--it is neither consumption nor investment but rather a simple transfer of funds.

[anne]

"Bridges to nowhere in Japan, that sort of thing."

Are you describing the astonishing infrastructure base the characterizes Japan, or something of which I am unaware? And do please explain just where the so much waste in Medicare happens to be, and the hopeless inefficiency in education that call for less spending.

[Fred]

Japan does indeed have impressive infrastructe, just as we have an impressive military. Spend enough money on something and you eventually get impressive results. But the science of economics is about scarcity not infinite abundance of any of labor, land or existing capital. The Japanese wasted an incredible amount of all three of these inputs on their way to producing their infrastructure. And what of the future? Bridges to nowhere have to be maintained. Neither reinforced concrete nor raw steel lasts forever when exposed to the elements.

The waste in our medical system is notorious and Medicare is ground zero for waste since it is funded by a blank check. The massive spending does not relate to high quality of healthcare and that points to massive waste in my mind.

Education is another area where the normal rules of constant productivity improvements, which apply the the open competitive parts of our economy, simply don't apply. We take for granted that productivity improvements are possible in things like retailing, and then dismiss the possibility that education can also be made more productive. I can't prove that it can be made productive, mainly because no one has ever tried, mainly because there are also sorts of people who put up obstacles to any attempts at improvement.

I stand by what I said above. 30% of GDP is plenty for government. Government R&D is way too low, infrastrucure is also low, military spending is way too high, government run medical and education spending is also high.

I have on objection to the economy as a whole spending whatever it wants on non-essetial health care (plastic surgery) or education (learning to paint). But the government run parts of health care and education (the basics of both of these) should not be allowed to grow to consume the whole economy.

[Julio]

Fred,

"I stand by what I said above. 30% of GDP is plenty for government."

I totally disagree, I think it should be 26.7%.

[Bruce Wilder]

One of the arguments Galbraith lost, and Friedman won, back in the day, was over whether economists should abstract away from "choice".

Galbraith thought that he was performing an important service in pointing out that people, collectively, were making important choices about how resources were allocated and the culture built; Galbraith saw himself in the tradition of Veblen in identifying and criticizing those choices.

Friedman and various associates and colleagues argued vehemently that choice in a market-dominated and market-mediated society was individual, not collective and social. The point of minimizing government was to minimize collective/social choices. An efficient market was an ideal means of translating individual preferences into choice, and it was no business of the economist to comment on or criticize the shape of those collective choices. The economist, properly, should concentrate on making the market process work in an ideal fashion, mediating and translating individual preferences, which were no part of the economist's mandate.

I think it is often a tough job, to help us recognize how a society is collectively making choices, but that society does so, I have no doubt. Too many things, from the length of the workday to the possibility of obtaining health care at an affordable price, require collective choice.

The pretense that markets are spontaneous and self-regulating is just completely unsustainable, imho.

This is a long-winded way of saying that the argument for vigorous, massive fiscal policy in our present dire circumstances would be considerably re-inforced by a recognition that our present dire circumstances have something to do with some collective choices gone wrong.

The catalog of needs, that fiscal policy might usefully address, while supporting aggregate demand, can include such obvious needs as preparing the country to cope with a world of higher cost oil.

Friedman won't rise from his grave. He really won't.

"A combination of tax cuts, the extension of unemployment benefits, the expansion of the food stamp program, and aid to states and citis is proposed." This strikes me as a self-consciously generic proposal, that skirts Friedman's philosophic concerns about "choice". It may be that I'm reading too much into it -- that it is simply a catalog of the immediate in response to the urgent.

But, I don't think the need for fiscal stimulus will end, after a bit of vigorous "pump-priming", to bring back a popular metaphor, 1930-1965.

Though thinly disguised by the misallocative bubbles of the Bush Era, the U.S. economic paradigm is running on empty, if it insists on continuing to push the Suburbs, as a model. Maybe, that still works in Wasilla and in Utah, places that will vote for Sarah Palin.

But, mostly, the old paradigm of an American dream is exhausted. It had run its course in 1975. We kept it going by under-investing, letting the old house deteriorate, while we lived in it: giving up unions and corporate pensions, giving up one wage-earner household budgets for two, reducing the investment we made in education, we let college become expensive, we borrowed and borrowed.

We are going to need a strong fiscal policy, for several years, to lead the country in a new direction, to build a new paradigm. Consumers have to save, so consumer spending is going to diminish. But, more than that, the country needs to build a new framework, in which profitable private business opportunities can be conceived. Investments in electrical grid, rail net, internet, and renewed investment in education and research -- are necessary to the times and circumstances.

[Bruce Wilder]

To frighten Fred, let me be clear, I think Federal expenditures should rise from the current ~19% to about 30% of GDI, for the better part of the next decade.

[RealThink]

In view of one of the "Urgent and immediate necessary actions" advocated by Nouriel Roubini in his latest diagnostic and recommendations piece

"- a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government;"

And given that, having NR predicted this meltdown back in February, his thinking now weighs a ton with the establishment and therefore his advice will most probably be heeded, it is evident for anyone aware of physical limits to growth that the world is facing a most critical and urgent issue: how smart or dumb, from a Hubbert's Peak-aware perspective, the forthcoming massive public works, infrastructure spending, tax rebates, etc. will be? E.g., are governments going to:
- spend on airports or railways?
- build new roads or electrified urban rail networks?
- offer tax rebates for SUVs or efficient PHEVs?
- finance building in Las Vegas or wind farms?

In a word, using the Easter Island model, are governments going to start a massive moai construction program or a massive reforestation program?

So, this is "the" point, and this is "the" time for all good Limits to Growth-aware folks to come to the aid of their country (actually planet because this is global), by speaking out as loudly as possible to influence public thinking to ensure that the forthcoming stimulus packages will be conducive to helping society withstand the oncoming descent from Hubbert's Peak and not to accelerating its collapse, this time due to shortages of physical "liquidity" that no Central Bank can provide.

[ken melvin]

Fred, if increased consumption was the answer, we wouldn't have this problem.

[kthomas]

BW, sorry, "should" or "will"?

Forgive me, I was not clear on your response there.

"In a word, using the Easter Island model, are governments going to start a massive moai construction program or a massive reforestation program?" > Moai.....that's funny. Yes, we will build Moai in the likeness of our Precious Leaders, like Darth Cheney.

[anne]

"Japan does indeed have impressive infrastructure, just as we have an impressive military."

What is the point of just making stuff up?

[Bruce Wilder]

kthomas: ""should" or "will"?

On our current course, between the shrinkage of GDP and the cost of serial bailouts, maybe, "will"?

But, I meant "should". I am advocating truly massive expansion of Federal spending.

[Lafayette]

Palliative Economic Policy

Fred: Anyway, at 30% of GDP, government spending is plenty big enough.

Yes, big and misspent; rather than big and well-spent.

Which is why it should be orientated towards objectives that renew our economic wherewithal. We are a modern nation with one of the highest neonatal death rates -- because nobody is looking after a mother's pregnancy. Secondary and tertiary level students dropping out because they "can't make it" (which means they've no guidance) -- meaning they end up in some non-durable job, floating through life. A nation with an enormous energy bill because of huge waste.

I could go on ... but it would obviously bore you. Have a tax break. You'll feel better ... until its all spent. Then you can look forward to yet another one. And another one. It's like a drug.

Tax breaks look good announced on the nightly news, but get us know where. Their use is called Palliative Economics.

[Julio]

Bruce Wilder,

"The pretense that markets are spontaneous and self-regulating is just completely unsustainable, imho. "

I don't think that's quite right; markets ARE spontaneous and self-regulating -- it's almost a tautology. And that's why you'll still have people defending them.

The pretense that their self-regulation leads to socially useful or beneficial ends is what's unsustainable.

Which circles back to your main point about collective decisions.

[Fred]

>To frighten Fred, let me be clear, I think Federal expenditures should rise from the current ~19% to about 30% of GDI, for the better part of the next decade.

It doesn't frighten me, but I'm not too enthusiastic about it either. We are currently spending about 5% of GDI on the military, including the sums for the Iraq/Afghanistan wars which aren't included in the budget for some reason. I would think 2% was plenty. So that frees up 3% of GDI right there for better use. We are also spending something like 12% of GDI on health care and maybe getting 6% of GDI worth of results. That is, 6% of GDI spent properly would deliver the same results as the 12% of GDI we are spending improperly. Part of that 12% of GDI is direct government expenditures, part is private but heavily subsidized by tax breaks. The final result is 6% of GDI could be reallocated to better use if we got our health care system in order. Add this 6% to the 3% of GDI from reduced military spending and we have 9% of GDI, which is not far from the 11% of GDI Bruce Wilder is talking about. I don't think I'm part of the lunatic right-wing fringe when I say our current government is bloated and inefficient and needs reform. I am not mindlessly advocating reduction in size, but merely reallocation of waste to better purposes.

As for those voters who insist on the suburban development scheme, those voters are dominant in our society. If government grows to 40% of GDI, then all that means is that government will be able to spend an additonal 11% of GDI on subsidizing suburban development. The voters are not going to be putting Bruce Wilder and Lafayette in charge of social and economic policy anytime soon.

[Bruce Wilder]

Julio: " don't think that's quite right; markets ARE spontaneous and self-regulating -- it's almost a tautology."

I really don't know what you are asserting here. "Tautology"?!?

I do think think there's a lot of value in the conception that markets, as institutions, are an emergent phenomenon, an epiphenomenon of a self-organizing chaos, so that there's usefulness in thinking of market systems as being similar to natural ecologies. The idealization of the traditional perfect competition model has some definite limitations, which might be better addressed by a model of evolution, driven by processes, if not exactly random, that are nevertheless not entirely intentional or well-informed.

In that context, from observation and study of actual markets and enterprises, I am inclined to believe that markets and firms only sometimes and in some respects find some kind of stable equilibrium.

"Is there an equilibrium?" "What kind of equilibrium?" are two questions, which ought to be primary for economists, and asked every day.

Markets, in my view, are emergent phenomena, and they go right on emerging. Sometimes, they find a kind of equilibrium -- but they don't all find the same kind of equilibrium, and none find an equilibrium in every respect. The equilibrium, that is found, is likely temporary and may contain elements of sustained disequilibrium that give the institution forward momentum.

Minsky's credit cycle is based on insights about the importance of sustained disequilibria and about the pressures that keep emergent institutions, emerging.

Among the pressures in any market are the constants of entropy: there will be opportunities to cheat, and incentives to cheat, as well as limits on the incentives and resources of whatever enforcement mechanisms and control systems emerge.

Imagining that markets could exist, or have ever existed, or should exist, without institutional containment and enforcement and control mechanisms is one of the more irritating and ignorant pretensions of some economists.

That said, just as I don't think idealization of markets is intellectually responsible, I don't think idealization of control mechanisms is intellectually tenable, either. It is a co-evolution, with important elements of chaotic experimentation imposed by the limits of human rationality. Ultimately, we make somewhat arbitrary political decisions on how to balance things we don't fully understand, and we muddle onward.

[Bruce Wilder]

Fred, just don't forget to vote the first Wednesday in November

[Bruce Wilder]

Fred: "I don't think I'm part of the lunatic right-wing fringe when I say our current government is bloated and inefficient and needs reform."

I actually like Fred's percentage notes on misallocation of GDI.

Fred's mistake, though, is in thinking that it is "government" that is bloated and inefficient and needs reform.

It is the so-called "private sector" that is bloated and inefficient and needs reform.

Hello? We're talking about nationalizing the banks. Banks. Private sector. Banks failed.

It is private contractors sucking on the Cheney-Rumsfeld tit that are responsible for the inflated Defense expenditure -- not the gov't employees of the uniformed military.

Enron. WorldCom. General Motors.

Even sectors that are doing well, are doing well, badly. Time-Warner. Microsoft. Boeing. Wal-Mart.

The need to pay CEOs $10+ million a year is driving American business into a hole.

[don]

I'm still amazed that the only solutions are to keep up U.S. borrowing. We don't have deficient aggregate demand - we are spending more than our income.

[Fred]

Even if I waited until Wednesday to vote, most people won't and even if most people vote for a Democratic landslide, the result administation/congress is quite unlikely to repudiate the suburban development paradigm in favor of something else.

Also, we currently have an economy on the verge of implosion. Bruce Wilder's solution is more federal spending, which means a delay into late 2009 before the spending starts and perhaps 2010 before the spending really has results on aggregate demand. This is much too long a delay. Thats leaves two possibilities for immediate stimulus:

a) middle-class tax cuts and rebates. Helicopters dumping money on main street.
b) massive purchases of junk financial paper at inflated prices. Helicopters dumping money on wall street.

Those who are opposed to option A leave option B as the only alternative, a point I have long been making on this blog.

I would also repeat that doing something about the trade deficit, such as imposing tariffs, is another way to stimulate demand. Now that the dollar is rising against the euro again, this becomes even more imperative, since we can't rely on a cheap dollar to do the tariffing for us.

[hari]

Berlosconi, the billionaire PM of Italy, is apparently suggesting to Bush (right now!) to close down G-7 financial markets until a new financial super-structure is put in place. What kind of new financial structure, he's in mind, is not dispelled to the press yet.

[Bruce Wilder]

I basically agree with you, Fred that there's a real danger that Obama will prove way too conservative (in the sense of protecting the vested interests and fears of the Suburbs).

As don says, the basic problem is not insufficient aggregate demand.

I don't have any problem, though, with immediate and urgent action to ameliorate. My original point, though, is that we have to make some huge, structural re-allocations, and government spending will have to be the engine to bring that about.

If I can borrow don's clarity, the base problem is one of insufficient aggregate production.

And, we cannot solve that base problem by just trying futilely to restore the status quo ante. Which is what I think Fred is trying to say: that there will be tremendous political pressure, regardless of political party, to try to get back to the status quo ante, whether that's conceived to be "cheap gas" or "rising house prices" or "a strong dollar" financing imports of junk from China. And, that pressure for a restoration of what no longer works, cannot work, is self-destructive.

[strange attractor]

Emergent phenomena. Entropy. Chaos. Natural ecology. Evolution. Entropy. Stable equilibrium. Dude, you are deep inside your own head.

I love Prignone and Mandelbrot as much as the next guy, but the only thing you said thats relevant or makes any sense whatsoever is

"Ultimately, we make somewhat arbitrary political decisions on how to balance things we don't fully understand, and we muddle onward."

Too true Feigenbaum! Well demonstrated! Clearly.

[Fred]

>the basic problem is not insufficient aggregate demand

Ha! Wait until a few month's from now when retailers start going belly up en masse. Demand can turn on a dime, supply changes speed and direction about as fast as a supertanker. The cause of the coming demand crash will be American households trying to rebuild their balance sheets. That was my original point in my first posting above.

[don]

Fred: "We also continue to need some form of tariff to prevent demand from being leaked out to foreign devils. The problem of demand leakage will grow more acute if the US cuts taxes and the Europeans don't."
I agree the leakage must stop, but a cessation of foreign currency intervention would be much better than tariffs.
As for BE's calls for coordinated fiscal measures, Asian countries should spend the massive reserves they have accumulated. I don't think Europe will go for such measures in anything like the necessary magnitude.
All these calls for massive U.S. federal spending. PK's webiste has an intriguing entry today - he cites someone with his hand on the pulse of the market who experienced a moment of panic over whether there will be a collapse of foreign faith in U.S. Treasury debt. That is much, much scarier than the recession we stand to face now. And it will move from a momentary qualm to an eminent certainty if we don't stop our profligate ways and halt the buildup of U.S. debt abroad.

[Holly W.]

Fred:Tax cuts are essential as a way for the middle-class to repair balance sheets that have been whacked by house price and stock market declines. Absent big tax cuts or some miracle that reflates house and stock prices, the only way for the middle-class to repair balance sheets is via savings.

Many of us in the middle class probably don't pay enough in income taxes to make much of a difference in making up our balance sheets, even if our non-payroll taxes were cut to zero.

I know I sound like a broken record to regular readers here, but IMO we need to start pushing harder for the idea that average workers are actually worth something, and should be paid decently and given raises that keep up with the actual cost of living. I realize that's not going to happen right away with unemployment rising, but the attitude needs to start changing to a belief that the people who make a company run, and not just the board of directors and top management, are actually valuable. Too many publicly-owned corporations seem to have bottomless pockets when it comes to their top brass but empty pockets when it comes to the rest of their staffs, and that sets the tone and allows smaller companies to be cheap, too.

In addition, I wonder if there is a connection between tax cuts and stagnating wages -- "well, our workers got tax cuts; they don't need raises," sounds like plausible thinking to me.

If you seriously want Americans to be able to repair their balance sheets, better pay (and better control of healthcare premiums) is going to have to be part of the plan.

[ken melvin]

Greed was a big factor. Hear of the free lunch in re welfare but wasn't them doing the dirty. Folks making a few didn't want to pay much for dining, mowing, etc.; figured they could keep it to themselves and to hell with the rest. Who needs overpaid unions when you can get it from China?

[Fred]

>non-payroll taxes were cut to zero

Hello? where I did say anything about "non-payroll"? On the contrary, payroll taxes for those making less than $30K is the first thing I would advise cutting or rebating. Those taxes represent about 15% of wages now, so that is a big deal to the working class. The next thing I would advise is replacing the sales taxes and state income taxes by federal to state grants. The working poor are currently paying like 20% of their income on taxes starting with the first dollar of income. This screams for reform and instead we get these calls for blowing a bunch of money building passenger rail lines that no one will ever use.

BTW why are payroll taxes so high? Because Greenspan raised them high back when he was working for Reagan. That was before he became Sir Alan the Maestro, the man who argued that it was impossible to know a bubble existed until after it had popped, and that there was nothing to worry about with derivatives. An even earlier Greenspan was some sort of economics forecaster, with perhaps the worst record of anyone who has ever practiced that pseudo-profession. Talk about the Peter Principle...

[Fred]

Oops. I should have written "the working class are paying something like 25-30% of their income on taxes". Because in addition to payroll taxes, sales and income taxes, we have to add property taxes and other taxes that are paid by businesses but passed on to consumers.

[Larry]

"Of course, if all governments apply fiscal stimulus at the same time, there is then no reason for investors to flee in any particular direction."

They can flee in the direction of their mattresses, or towards Vegas...

@anne - "There has been need for a fiscal stimulus for quite a while"

We have a large fiscal stimulus already. It's known as "the deficit" and it isn't small. We may have places we want to put additional money, but that's different.

"with little to no understanding of how successful Japan was in using spending during the years of deflation."

Isn't Japan the example of what not to do? They had 10 years of stagnation, while they paved over the entire country. No thanks.

"Democrats just decided to break a promise so as not to embarrass Republicans by even voting to increase the number of needy children covered by health care insurance, and this was perfectly disgraceful."

Dems never miss a chance to embarrass Reps. (Nor does the reverse ever happen.)

@Times - 'The “shadow banking system”—the money-market funds, securities dealers, hedge funds and the other non-bank financial institutions that defined deregulated American finance—is metamorphosing at lightning speed. And in little more than three weeks America’s government, all told, expanded its gross liabilities by more than $1 trillion'

You have to give them credit. This ain't laissez faire...

"First, Western finance will be re-regulated. At a minimum, the most freewheeling areas of modern finance, such as the $55 trillion market for credit derivatives, will be brought into the regulatory orbit."

It has always been regulated. The regs weren't that great, but there were libraries full of them. They failed to evolve as quickly as markets, but is the new goal really just to slow things down? What's missing are principles that say how to regulate in a baby-and-bathwater-separating sort of way. The world has vastly more mobile capital than ever before. How can regulation keep it from creating another bubble?

"Rules on capital will be overhauled to reduce leverage and enhance the system’s resilience. America’s labyrinth of overlapping regulators will be reordered."

This isn't a greater/lesser regulation trade-off. It's a smarter/dumber regulation trade-off.

@Fred - "Tax cuts are essential as a way for the middle-class to repair balance sheets"

Good point, but if all we're doing is shifting debt from individuals to taxpayers (via the deficit) I'm not sure what we're accomplishing.

"the only way for the middle-class to repair balance sheets is via savings."

Yup.

@Oupoot - "Some debt relief (or call it capital injection if you like) is necessary for many many households."

It would be nice, but households can repair their balance sheets on their own, albeit with sacrifices ranging from unpleasant to devestating.

"Why not give another $100bn or $200bn tax rebate and encourage the households that receive it to reduce their personal financial debts."

How does it benefit the country to transfer those debts from individuals to the taxpayer?

@Lafayette - "Tax cuts are blunt instruments; meaning the more you use them, the more they end up where you don't need them."

The same applies to governent spending. Whether individuals or governments spend money more wisely is partly philosophical and partly empirical. The real difference is that individuals are more likely to be prudent - to save windfalls - than governments which never save.

@Fred - "Infrastructure spending offers infinite possibilities for waste and political meddling."

Totally agree, except that if we use spending to replace existing programs and projects that empty state/local coffers are forcing to be cut. Program protection is the momentary sweet spot for stimulating (or preventing shrinkage in) today's economy.

@Bruce Wilder - "One of the arguments Galbraith lost, and Friedman won"

Reminds me of the economics joke:

Theorem: All great economists are tall, with two exceptions - Galbraith at 6' 9" and Friedman at 5' 2".

"I think it is often a tough job, to help us recognize how a society is collectively making choices, but that society does so, I have no doubt."

Even more so today, given our monumentally disfunctional government. Perhaps all will be changed if Dems run both the executive and the legislative, but somehow I doubt it.

[Fred]

>Good point, but if all we're doing is shifting debt from individuals to taxpayers (via the deficit) I'm not sure what we're accomplishing.

True, giving everyone $100K in government bonds doesn't make us richer, because backing those bonds is $100K of debt per person. Financial credits are always matched by equal financial debt and the net result is zero. But the average person doesn't think this way. A quote from Keynes is applicable, with my comments in italics: "The people want the moon (financial savings independent of financial liabilities somewhere else in the system) but we can't give them that. Instead, we give them green cheese (financial credits, in the form of bonds, which are linked to financial liabilities, in the form of government debt) and to do that we open a green cheese factory (Fed plus Treasury)."

A sudden drop in aggregate demand, such as we are now facing, is ultiamtely a psychological phenomena (fear) and thus the solution must be psychological in nature. We have to calm people down so they don't reduce consumption too fast, and dumping money on them is the best way to accomplish this. Later, once the crisis passes, we can mop the excess money up via higher taxes, so that it doesn't cause people to overconsume and thereby generate inflation.

[Too Much Fed]

What about a "wage bubble" with MANDATORY debt repayment or MANDATORY savings?

[Larry]

@Fred - Can't we find a better way to pierce the fear than a "pay Peter from Paul's pocket" swindle?

[Gegner]

Um, you'd think the solution would be obvious, you don't need to 'own' the stack of lumber or even rent it, you just need to 'use' it.

Make the 'stack of lumber' free and look at how much income you'd free up!

Then, you declare the entire shadow banking system a 'Ponzi scheme' thereby eliminating any legal recourse.

Stoke of a pen, problem solved.

[Lafayette]

The M-I-C

Larry: The same applies to governent spending. Whether individuals or governments spend money more wisely is partly philosophical and partly empirical. The real difference is that individuals are more likely to be prudent - to save windfalls - than governments which never save.

The difference between government spending and consumer prompted spending (by tax breaks) is VERY different. The former is focused and the latter dispersed.

Also, I can site a good number of European countries of which the governments were excellent savers, even whilst being profligate. Because taxation was so high. And, for all their profligacy they have lower Income Inequity than the US.

The US government spending is misspent, because it has emphasized far too much Corporate Welfare, namely the Military-Industrial-Complex.

What America refuses to understand, condemning it as “Creeping Socialism”, is Europe’s success in employing high taxation and redistribution as Social Investments – that pays for its benchmark Health Care systems and free Education up to the tertiary level. It also is very generous to local communities in a long tradition incited by the need to completely rebuild infrastructure, both capital and social, after WW2.

This last factor is key. America’s Federal Government has little historical foundation in infrastructural investment, particularly Social Investments. Yes, it did build a huge road network, but let the rail network languish. Why? To please Detroit. Housing however has never been a real priority, which has led to the present Sub-prime Mess. Far too many schools are dilapidated, whilst funding was shunted allowing lead-head to play games over in the Iraqi sandbox.

It always makes the same mistakes, administrations often wrapping themselves in Ole Betsy to justify the expenditures.

It is also an erroneous assumption that philanthropies are sufficient to the task of meeting the requirements of Social Investments, when they are not. So, the Federal government spends lavishly on DoD and NASA, for reasons that seem well-founded but actually do very little for Main Street Americans.

Mens sana in corpore sano

European governments take the matter of Social Investments very seriously, by focusing them on continued government expenditures in key areas fundamental to the well-being of a country – namely Health and Education, according to the Latin dictum cited above.

[Larry]

@Bruce Wilder - "The pretense that markets are spontaneous and self-regulating is just completely unsustainable, imho."

Straw man. The very first requirement of markets is private property, which can only be ensured by government. The problem is that regulating ever-more dynamic markets without losing their benefits is very difficult.

"collective choices gone wrong."

Yup. But also individual choices gone wrong, by literally everyone involved in the housing market from home buyers to brokers to bankers to rating agencies to regulators to politicians, with the media cheering all along the way.

:But, I don't think the need for fiscal stimulus will end, after a bit of vigorous "pump-priming", to bring back a popular metaphor, 1930-1965."

We saw again this year that pump-priming just doesn't work. It's crack.

"Suburbs"

Suburbs are way over half of the population. Stick to attacking exurbs if you want to get anywhere.

"But, mostly, the old paradigm of an American dream is exhausted."

You may be exhausted but the dream is very alive. For a quick tour of 1975, check out Life On Mars. Itr ain't pretty.

"giving up one wage-earner household budgets for two"

That's called women's liberation isn't it? Etc.

"the country needs to build a new framework, in which profitable private business opportunities can be conceived. Investments in electrical grid, rail net, internet, and renewed investment in education and research -- are necessary to the times and circumstances."

Those investments will come from private money if we arrange things so that investors can make a profit. Government money is pretty well spoken for, until the baby boom dies off.

"Federal expenditures should rise from the current ~19% to about 30% of GDI, for the better part of the next decade."

Where does that money come from? Higher income tax rates?

@RealThink - "- a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government;"

If they can't stabilize the system, I'm not sure this will even be possible. We already have large deficits. There is a limit...

"- spend on airports or railways?
- build new roads or electrified urban rail networks?
- offer tax rebates for SUVs or efficient PHEVs?
- finance building in Las Vegas or wind farms?"

Knowing Congress, it could easily "be all of the above". Can you say "earmark"?

@Bruce Wilder "I am advocating truly massive expansion of Federal spending."

And you think Iraq was a fiasco...

@Lafayette - "one of the highest neonatal death rates -- because nobody is looking after a mother's pregnancy. Secondary and tertiary level students dropping out"

Aren't these as much a problem of ignorance and lifestyle as it is the healthcare system? Our culture, especially youth culture has some badly broken bits in it. Government can't fix that.

"tax break."

There are many kinds of tax breaks. We should focus on those that encourage the behavior that we want, namely saving and investing, and those that make the system simpler. Those would help our economy.

@Fred - "We are currently spending about 5% of GDI on the military, including the sums for the Iraq/Afghanistan wars which aren't included in the budget for some reason. I would think 2% was plenty. So that frees up 3% of GDI right there for better use. We are also spending something like 12% of GDI on health care and maybe getting 6% of GDI worth of results. That is, 6% of GDI spent properly would deliver the same results as the 12% of GDI we are spending improperly. Part of that 12% of GDI is direct government expenditures, part is private but heavily subsidized by tax breaks. The final result is 6% of GDI could be reallocated to better use if we got our health care system in order."

The odds of achieving such savings are about those of reaching a new high in the S&P this year. I do think we're entering a new era, when government will be bigger. I have no clue how we'll pay for it, though. If they increase income tax rates, the income will hide and growth will slow. Maybe we'll get a VAT.

@Bruce Wilder - "It is the so-called "private sector" that is bloated and inefficient and needs reform."

We need reform, but not because of bloat and inefficiency. Most of the private sector is doing fantastically. We have problems at the interface between public and private, which the financial crisis and federal contracting highlights, and with globalization. Outside keptocracies like Russia, the movement worldwide is towards markets, not towards government.

@Fred - "delay into late 2009 before the spending starts and perhaps 2010 before the spending really has results on aggregate demand. This is much too long a delay. Thats leaves two possibilities for immediate stimulus:

a) middle-class tax cuts and rebates. Helicopters dumping money on main street.
b) massive purchases of junk financial paper at inflated prices. Helicopters dumping money on wall street."

The third idea is to replenish the empty coffers of state and local government, protecting existing programs and projects. That money doesn't suffer from the time lags that plague truly "new" spending. If anything, 2010 is ambitious, especially if you're talking about moving dirt. The environmental reviews alone will add years.

@Bruce Wilder - "Obama will prove way too conservative (in the sense of protecting the vested interests and fears of the Suburbs)."

Obama won't be making those decisions. Congress will, and it is not particularly disposed to follow the Executive. Obama will give speeches explaining how great it's going to be. His big individual influence will be to exit Iraq and apparently, to attack Pakistan.

"insufficient aggregate production."

Is that the same as GDP? If so, increasing GDP means getting business to invest. Who is going to build the mass transit systems? FedCo or a contractor? If it's the former, you've just delayed the process by years, because there is no FedCo. If it's the latter, don't you get back to the contractor problems you were discussing before?

@Fred - "Demand can turn on a dime, supply changes speed and direction about as fast as a supertanker."

Government can turn the demand knob.

@don - "tariff to prevent demand from being leaked out to foreign devils. The problem of demand leakage will grow more acute if the US cuts taxes and the Europeans don't."

Have you ever heard of Hoot Smalley? That tariff substantially worsened and lengthened the depression. For years now, US exports have been booming, and the associated jobs pay a lot better than the rest. "Nice little software/aircraft/farm equipment/services industry you've got there. Too bad if something were to happen to it...." Free trade makes both sides wealthier. Even Krugman (and certainly Thoma) has that figured out.

"Asian countries should spend the massive reserves they have accumulated."

Not likely...

@Holly W. - "Tax cuts are essential as a way for the middle-class to repair balance sheets that have been whacked by house price and stock market declines."

If we pay for those tax cuts with federal debt, all we're doing is moving debt from one balance sheet to another. And the federal balance sheet is already looking pretty squiffy.

"average workers are actually worth something, and should be paid decently and given raises that keep up with the actual cost of living."

In the end, wages are set by ever-more global supply and demand. We can only pay workers above-market if we subsidize them from some other pocket, as we do today with the EITC. Otherwise the jobs will go. Health care is where the money has gone instead of into worker's pockets. If we fixed health care, every worker could get a 5% raise tomorrow, and we'd have a lot more money left in federal and state budgets to do other stuff.

@Fred - "BTW why are payroll taxes so high?"

Because SS has a big deficit. We're going to have to dedicate a big chunk of regular tax revenues to paying back the trust fund over the next few decades. Not fun.

@Laff - "The difference between government spending and consumer prompted spending (by tax breaks) is VERY different. The former is focused and the latter dispersed."

I don't know if I would say "focused". I'd choose "concentrated". Look at federal spending today. Most of it goes for entitlements and defense. The rest is a complete hodge podge,of which earmarks are just the most visibly embarrassing. Those are the people who will "focus" future spending. Scary.

"Also, I can site a good number of European countries of which the governments were excellent savers, even whilst being profligate."

I guess you're saying that they waste their government spending even though indivduals are smart enough to save. The big European states run significant deficits...

"Europe’s success"

But Europe is moving towards our model. Their corporate tax rates are already below ours and moving down. Etc.

"Housing however has never been a real priority"

We have more and better housing than any country on earth, to our great discomfort. We massively over-invested in that sector, in significant degree at government behest.

"Far too many schools are dilapidated, whilst funding was shunted allowing lead-head to play games over in the Iraqi sandbox."

For all his faults, Bush massively increased federal spending on education - to no visible effect.

[Lafayette]

Larry: The big European states run significant deficits...

Presently yes, but historically not so.

If they do so now, it is out of solidarity with social objectives -- meaning keeping social services sufficiently available to those who need them most.

Europe has been going through a bad patch since the mid-1990s. Most Europeans are grateful that social services did not suffer more from cutbacks than they did.

Larry: But Europe is moving towards our model. Their corporate tax rates are already below ours and moving down.

I am not sure what this means. So what?

Tax rates are a function of their importance in providing state (read government) funding for policy options. Where the money comes from is not nearly as important as to where it goes.

The US Treasury depends more on corporate taxes than the EU, whilst the latter depends for almost 60% of its tax revenue upon a consumption tax.

A discussion regarding tax sources, therefore, is secondary to that of the economic policy alternatives regarding their expenditure. The US, in general, does not care to fund the social prerogatives that are most valued by the Europeans.

So, how the taxes are derived is almost irrelevant. American companies whine incessantly about heavy taxation "costing us jobs". This is deep dung blather. Corporate chieftans are more concerned that taxation reduces corporate net income ... and therefore their stock-option income.

Less taxation means more in-the-pocket income, which does not necessarily translate directly into a better outcome in general well-being. In terms of priorities, let's not confuse personal income (that benefits individual consumption of goods/services) with taxation (that assures collective consumption of social services), since the benefits are clearly different.

How about a bit less freaking-out on Chinese gadgets in exchange for a universal Health Care system that works?

Dontcha think that a good exchange? I do.

[Larry]

Agree that paying for services is separate than providing them. Both can have dramatic effects on things like investment, productivity, and so on.

We have universal health care for seniors. It's expensive, its costs are exploding, and as we've all lamented, its outcomes could be a lot better.

[Lafayette]

Creeping Socialism

Larry: We have universal health care for seniors. It's expensive, its costs are exploding, and as we've all lamented, its outcomes could be a lot better.

Yes, Health Care in America is expensive. We spend twice as much per capita on it than the Europeans. And, what do we get? The World Health Organization classifies most European systems in the top 15 and the US is around 36th in the ranking.

Why the poor showing? Because we think Health Care insurance and provision is Private Enterprise, but not a Public Service. If it were a Public Service, the practitioners (GPs, specialists and surgeons) would not be earning an average $150,000 per year. And, for possessing some of the best medical technology in the world, fully 16% of the American workforce is without any medical insurance whatsoever. With another 20/25% having insurance that is insufficient.

We should not be surprised that the provision of American Health Care needs Life Support. For it to be more fairly accessible by the population, it needs major revision. Which is the prime reason the WHO ranking was so bad.

Moreover, we have little focus on Preventive Health Care, having placed the onus on Remedial Care. An ounce of prevention is worth a tone of cure. But, to have that, as in Europe, you need easy access to medical care – meaning low cost preventive care that seeks out health problems long before they end up at ER when it is too late.

Furthermore, we have an obesity time-bomb hovering on the far horizon. Already a pandemic touching most Americans, when that bomb explodes, it will most certainly have not only an impact upon total costs but economic productivity.

Health Care and Education, perhaps two of the most important factors in terms of the long-term economic viability are not Public Services that we should overlook. And, yet we've left them to the Market Solution, which has made of them prohibitively expensive for far too great a number of our population.

In any country of the EU, either public services is either mostly paid or entirely paid for by the state. Instead of sneering at Creeping Socialism, wouldn't it be better if our people had a bit of it?

Try it ... you'll like it.