The Financial Crisis and Short-Run Stabilization Policy

Short-run stabilization policy for the economy during a downturn involves either cutting taxes to stimulate consumption and investment (and sometimes net exports), or increasing government spending. Which of these is used and the specific policy adopted has important implications for the effectiveness of policy, but no matter how it is done it will raise the deficit, and the increase in the deficit is often used to oppose the policy.

Theoretically, however, there is no reason at all why short-run stabilization policy ought to impact the long-run budget picture. Ideally, the deficits that accumulate during bad times are paid for by raising taxes or cutting spending during the good times so that there is no net change in the budget in the long-run.

Historically, we have been pretty good at spending money in bad times, but not so good at paying for the spending when times are better. But if we are serious about stabilization, that's what we need to do. When output is below the long-run sustainable rate we increase economic activity by deficit spending, and when output exceeds the long-run sustainable rate, we decrease activity by running a surplus. Doing this fills the troughs with the shaved peaks from the booms and keeps the economy closer to the long-run trend value.

I've been wondering if the current crisis will change our attitude about paying for stabilization policy, i.e. if it will make us more willing to raise taxes and cut spending when times are good. One of the problems with the last two boom-bust cycles was unchecked exuberance. Any calls to raise taxes or interest rates were met with howls about how it would cut off the boom, and who would want to do that? But tempering the boom might have helped to reduce the size of the meltdown we are experiencing now and left us much better off.

When the next boom develops, will we be more willing to raise taxes, cut spending, and tighten Fed policy? Will we remember what happened when the previous two booms ended and be more willing to step in and slow down the booming economy, will we be less susceptible to the argument that doing so will eliminate creative and productive innovation (as opposed to misdirecting resources during the mania phase)? This doesn't mean creating a recession or slamming on the brakes so hard we hit our heads, it doesn't mean ending innovative activity, it simply means what it says, bringing the growth rate down to its sustainable rate, and attenuating the exuberance that leads to housing and dot.com bubbles. Will we be more willing to take the necessary steps the next time the economy begins to boom?

I doubt it.

And the problem is that if we aren't willing to pay our bills during the good times, then it will be much harder to spend the money we need to spend when times are bad -- our hands will be tied when it comes to stabilization policy.

So perhaps a business cycle version of Paygo is needed. Legislation could be clearly identified as a countercyclical measure, and it would contain both the deficit spending to address the downturn along with an explicit plan to pay for the policy when times get better. That is, the legislation would contain a specific trigger saying that when the recession is over and GDP growth, employment growth, etc. exceed some predefined amount (e.g. two quarters of strong growth), taxes would go up or spending would be cut by enough to pay for the stabilization package.

My concern is that worries over the deficit will prevent us from taking the countercyclical policy steps we need to take to protect people who are vulnerable to job loss, etc. in a downturn. Thus, the goal here is to find a way to ease the long-run budget worries so that we don't hesitate to do what's needed to stabilize the economy. I'm not sure if a business cycle version of Paygo is the answer, it may be just as hard to promise to raise taxes in the future as it is at any other time (though perhaps this would be easier if it returned rates to old levels), and the triggers would be hard to define, but somehow we need to learn to pay for the policies we put in place so that they will still be there the next time we need them.

A better answer would be a legislature that does this on its own without the need for mechanisms such as Paygo to force them to do what is best for the economy over the long-run, but that hasn't worked. Maybe we''l get a better class of legislators in the future, but I'm not counting on that.

Finally, this is separate from spending on infrastructure, health care, etc., and whether we can afford it. I think we can afford it, and that we should invest in infrastructure to enhance future productivity, that we should take on health care (our biggest long-run budget worry), and that we should make other investments in our future, but that is a different discussion. They can be connected - short-run stabilization can be directed a longer-run problems when it's feasible to do so - but the case for short-run stabilization can be made independent of whether or not it contributes to solving longer run issues. If it does, so much the better.

Comments

[ken melvin]

We need a reset of Jarvis-Gann/Prop 13 mentality in re taxes. California raises to hell in a hand basket but no politician dares mention raising taxes; not even good time of the nineties. Yet today, McCain/Palin raise it as an anathema.

In re spending; let's invest. Consumption just goes to China, creating no good jobs here. And, let's make damned sure the wages for the investments go to US citizens, not to the Halliburtons hiring illegals ala Katrina.

[Bruce Wilder]

The classic example of using massive fiscal policy to end a severe recession is the Federal spending on WWII. An element of that "program" was, of course, massive deficit spending, but deficit spending matched by forced savings through bond drives, and limits on the availability of consumer goods.

In our present circumstances, we have neither the prospect of anything as dire as the Great Depression, nor nothing, so far, as motivating, as Total War against authoritarian regimes bent on world domination. One could argue, plausibly, that the economic collapse may well become a close second or third, and that the prospects of global warming, peak oil, etc., though less acute in their immediacy, are also an existential threat. But, leave that aside.

Isn't there a case to be made that policy should address savings rates and domestic investment in instruments of financial capital?

Expanded Federal support for consumer spending on gasoline and junk from China, while ignoring the depletion of household wealth -- the attempt to restore something like the status quo ante -- doesn't seem sensible or prudent.

And, having just seen the effect of hitting the global commodity ceiling . . . shouldn't economic policy going forward take this new reality, this new hard constraint on global economic growth into account?

[hari]

I've feeling MTs wish will be more or less fulfilled by G-20 decision-making on current US currrent account deficit and its impact on foreign exchange, in particular EU/Asian markets. Currency policy will become central to global regulatory regime - US will have no choice in the matter(!) -
after having created this once-in-life-time financial crunch.

So, in one way or another, the issues raised by MT will be officially regulated under IMF/Bretton Woods II.

Let's hope they get there first and set the goal posts for G-20. Otherwise protectionism will be the alternative to current globalization.

[robertdfeinman]

Between the plutocrats who (secretly) fund the libertarian think tanks and the general feeling that one isn't getting one's money's worth from taxes, there is little appetite for increasing taxes at any time.

Whenever there is a surplus there is sure to be a pol who will run for office on a platform of cutting taxes because, obviously, the government is collecting more than it needs. I think this mindset is much more prevalent at the state and local level, where deficits aren't permitted.

To get people to accept paying for things would require a new mindset. One more like that in the advanced EU countries - solidarity instead of every man for himself.

Furthermore people aren't getting good value for their taxes, with 54% of the federal discretionary budget going towards militarism. This is a cost that the other advanced countries don't bear at anywhere near the same level. It is not relevant to compare military spending to the GDP. The amount available to the government is much more important relatively than is a similar amount in the private sector. If this wasn't so we wouldn't be hearing so much about restoring infrastructure and the like - private firms would be doing it.

So taxes are too high relative the benefits that the average person sees directly and the needed social services and public projects are starved of funds by the cancer of militarism. Notice that Obama has come out just as strongly as McCain on expanding military spending. They only differ on how the money is to be allocated.

Governments have a 2000 year history of solving their debt issues by means of inflation, there is little reason to think that this temptation will be resisted this time either.

says...

Nice essay.

Mark Thoma:

"Finally, this is separate from spending on infrastructure, health care, etc., and whether we can afford it."

I am beginning to think the Obama health care insurance plan will be unworkable for quite a while simply because of the cost increases the plan will entail for business which will be required to participate. To my surprise a form of single-payer plan strikes me as more politically viable in this economic climate, worrisome or not since single-payer will not come easy.

[IM]

Professor Thoma,

In Spain, during the credit boom, the central bank obligued finantial institutions to make extraordinary reserves and this has reduced losses so far. Nevertheless, this measure did not prevent by itself the credit boom. Also, the government accumulated some surplus during the good booming days. No, we are ready to waste the surplus lending money to bankers that need it to pay back MBSs adquired by foreign investors that currently don't want to buy new MBSs.

Well this is not fiscal policiy.

[anne]

http://www.nytimes.com/2008/10/27/us/politics/27healthcare.html?hp&pagewanted=print

October 27, 2008

Businesses Wary of Details in Obama Health Plan
By KEVIN SACK

AGAWAM, Mass. — Dave Ratner, owner of Dave's Soda and Pet City, is pretty sure he is about to get "whacked" by the new state law that requires employers to contribute to health care benefits for their workers or pay a $295-per-employee penalty. In order to avoid thousands of dollars in fines, Mr. Ratner is considering not adding part-time workers at his four pet supply stores in Western Massachusetts.

But the penalty in Massachusetts is picayune compared with what some health experts believe Senator Barack Obama, the Democratic presidential nominee, might impose as part of his plan to provide affordable coverage for the uninsured. Though Mr. Obama has not released details, economists believe he might require large and medium companies to contribute as much as 6 percent of their payrolls....

[That was me being careless, above.]

[IM]

My conclussion is: beware credit booms, specially if they are financed abroad, because then, fiscal policies won't be used to stabilize the economy, but ro repay debt.

[anne]

IM:

"In Spain, during the credit boom, the central bank obligued financial institutions to make extraordinary reserves and this has reduced losses so far...."

Was this the explanation for the current asset depth of Banco Santander?

[Rational expectations]

Governments also distribute, not just provide public goods. Unless people are immortal (which they are not -- this is a safe assumption, no?). Cyclical taxes are in effect a transfer of wealth from the young to the old. Any surprises here why those who made the laws and the economy are now asking for a handout?

[Scott]

There is a principle called Ockham's razor which is attributed to the 14th-century English logician and Franciscan friar, William of Ockham. It basically states that – "All other things being equal, the simplest solution is the best."

The following are two simple ideas that effectively create the ideal social construct.

Simple Idea #1

1. Socialize ALL Land

2. Charge leases on ALL Land based on demand.

3. Return 100% of the resulting revenue to every man, woman and child in the form of a yearly dividend check.

4. Make the Universal Birthright of Land an Everlasting Standard in the education of every Child.

This effectively makes the average piece of Land Free for every Living Soul and restores our Natural Birthright as well as coupling our social construct to the Principles of Life.

Simple Idea #2

1. Remove ALL FORMS of taxation

2. Implement a Tax on ALL new goods based on the resources they contain and the resources they use in production and delivery (this can easily be implemented with the current barcode system used at the checkout)

3. Use this system to encourage/discourage various resource usages (High tax on non-renewable/ecosystem damaging products and low/no tax on renewable/ecosystem enhancing products) and to encourage purchasing of local products.

4. Use the resulting revenue to fund infrastructure expenses and the restoration of ecosystems.

This effectively encourages the creation/use of longer lasting, high quality products as well as encouraging recycling and reuse of existing products.

Idea #2 effectively constrains the ravaging appetite of the capitalistic consumer society within the Boundaries of Sustainability while Idea #1 effectively encloses both Sustainability and capitalism within the Principles of Life.

That's it!!! Simple and Effective

Scott
There is a principle called Ockham's razor which is attributed to the 14th-century English logician and Franciscan friar, William of Ockham. It basically states that – "All other things being equal, the simplest solution is the best."

The following are two simple ideas that effectively create the ideal social construct.

Simple Idea #1

1. Socialize ALL Land

2. Charge leases on ALL Land based on demand.

3. Return 100% of the resulting revenue to every man, woman and child in the form of a yearly dividend check.

4. Make the Universal Birthright of Land an Everlasting Standard in the education of every Child.

This effectively makes the average piece of Land Free for every Living Soul and restores our Natural Birthright as well as coupling our social construct to the Principles of Life.

Simple Idea #2

1. Remove ALL FORMS of taxation

2. Implement a Tax on ALL new goods based on the resources they contain and the resources they use in production and delivery (this can easily be implemented with the current barcode system used at the checkout)

3. Use this system to encourage/discourage various resource usages (High tax on non-renewable/ecosystem damaging products and low/no tax on renewable/ecosystem enhancing products) and to encourage purchasing of local products.

4. Use the resulting revenue to fund infrastructure expenses and the restoration of ecosystems.

This effectively encourages the creation/use of longer lasting, high quality products as well as encouraging recycling and reuse of existing products.

Idea #2 effectively constrains the ravaging appetite of the capitalistic consumer society within the Boundaries of Sustainability while Idea #1 effectively encloses both Sustainability and capitalism within the Principles of Life.

That's it!!! Simple and Effective

Scott

[ndk]

5 year real interest rates tonight are 3.74%, 115bps above nominal yields. These real yields were down to .5% at times during the housing boom.

http://www.treas.gov/offices/domestic-finance/debt-management/interest-rate/real_yield.shtml

I like these ideas a lot, but until our monetary policy is reasonably countercyclical, it seems premature to talk about such broad-reaching plans.

[Lafayette]

The EU answer

MT: Legislation could be clearly identified as a countercyclical measure, and it would contain both the deficit spending to address the downturn along with an explicit plan to pay for the policy when times get better.

Why not do it the way the EU does? A law is passed that limits long-term (that is a three- or five-year running average) of deficit that exceeds 3% of GDP.

Regardless of the party in power, the PotUS would be obliged by law to maintain spending such that the deficit remains within guidelines.

Were that the case, lead-head might not have gone to war in Iraq.

[bakho]

Year Revenue Outlays (%GDP)

1997 19.3 19.6
1998 20.0 19.2
1999 20.0 18.6

2000 20.9 18.4

This looks to me like stabilization.
Bush is an idiot.

[Winslow R.]

mark wrote: "When output is below the long-run sustainable rate we increase economic activity by deficit spending, and when output exceeds the long-run sustainable rate, we decrease activity by running a surplus. "

In regard to surpluses.....

"THE ONLY 6 US DEPRESSIONS WERE CAUSED BY THE FIRST 6 BUDGET SURPLUSES. THE 7TH SURPLUS IS CRUSHING US NOW, BUT, UNLIKE BEFORE, WE ARE NOT ON THE GOLD STANDARD AND CAN RUN DEFICITS AS LARGE AS NEEDED. THAT’S WHY THERE HAVEN’T BEEN ANY DEPRESSIONS SINCE THE 30’S AND THE RECESSIONS HAVE BEEN RELATIVELY MILD." Mosler #84

http://crookedtimber.org/2008/10/17/those-stupid-bankers-and-their-stupid-stupidity/#more-8164

[Winslow R.]

hari wrote: "Currency policy will become central to global regulatory regime - US will have no choice in the matter(!) -"

I don't see it happening and for good reason. Though you do seem stuck on the idea.

[Winslow R.]

Mark wrote: "Ideally, the deficits that accumulate during bad times are paid for by raising taxes or cutting spending during the good times so that there is no net change in the budget in the long-run."

Ideally there is no increase in net private sector savings? Why?

[Jim]

Carrying some debt makes sense if the borrowing is invested rather than consumed. Medicare and Social Security are consumption. The war might have been an investment, but does not appear to be. Mr. Obama will have the exceedingly unpleasant duty of cleaning up after the (Republican) party, the alleged party of responsible financial policies. Few would call them that now.

Only growth or inflation can support an increased deficit. Option B seems more likely.

[ndk]

Winslow, the entire goal of counter-cyclical economic policy is to accelerate consumption into the present period during downturns and decrease the time value of money. Increasing private sector savings are, perversely or not, a sign you're doing it wrong.

[Fred]

The simplest way to bring spending and taxing into long-run balance is to set the base tax rate higher than spending (like 35% of GDP compared with government spending at around 30% of GDP) and then hand out tax rebates whenever there is a sign of a slowdown. This is politically feasible because it allows the politicans to pose as Santa Claus, giving back to the taxpayers what the mean IRS has taken away from them.

The best time to set up such a system (or to increase the base tax rate) would be during a deep recession, because any increase in the base tax rate then would be immediately rebated and so no one would be immediately affected. Ideally, the Fed or a similar quasi-independent agency would set both the base tax rate (based on projections of future spending) and the level of rebates, with Congress merely rubberstamping these changes.

[Fred]

>Mr. Obama will have the exceedingly unpleasant duty of cleaning up after the (Republican) party

Au contraire, the next president will be in the exceedingly pleasant position of being able to deficit spend like a drunken sailor without any risk of inflation. It will be the president elected in 2012 (assuming the crisis ends before then) who will then have the unpleasant duty of bringing inflation under control.

[Patricia Shannon]

Winslow R. says...

mark wrote: "When output is below the long-run sustainable rate we increase economic activity by deficit spending, and when output exceeds the long-run sustainable rate, we decrease activity by running a surplus. "

In regard to surpluses.....

"THE ONLY 6 US DEPRESSIONS WERE CAUSED BY THE FIRST 6 BUDGET SURPLUSES. THE 7TH SURPLUS IS CRUSHING US NOW,

Is this supposed to show how silly is the person being quoted? Or was the original a deliberate farce, also?

[Winslow R.]

"Increasing private sector savings are, perversely or not, a sign you're doing it wrong."

I'd say 'not perverse' as a lack of savings adds to instability. Now if you have an idea of how we can somehow create a perfectly stable system without savings, I'd like you to explain.

[Winslow R.]

"Is this supposed to show how silly is the person being quoted? Or was the original a deliberate farce, also?"

I find the source to be highly credible. Take my word for it or if you'd like to challenge the post with some counter-factual evidence, I'm listening.

[Winslow R.]

Jim wrote : "Only growth or inflation can support an increased deficit. Option B seems more likely. "

Wrong. Increased savings can also support an increased deficit.

[JAN]

Check my math, but to pay off the $10T debt in 30 years, at 2% interest, would take $27B a month.
Won't happen, until we get to the $1000 Big Mac.

[Jim]

Winslow, good point. Let us wait for higher savings before incurring higher deficits.

[ndk]

You guys are completely missing the point of counter-cyclical economic policy. It's even in the name: "deficit" spending. We need to increase present spending and decrease the time value of money. If your government expenditures are netted by a reduction in private expenditures, you've accomplished nothing and probably taken a few steps backwards, unless you think the government is better at money allocation than the market.

I'm much more sympathetic to arguments about Ricardian equivalence.

I'm also very sympathetic to Austrian views that we shouldn't have used Keynesian stimulus so many times in succession, resulting in present debt burdens, FSR's, and savings rates. It's a little too late for that now though.

Your arguments, by contrast, are just plain dangerous.

[Jim]

Winslow,
Given the loss of wealth that this market event has caused, it is unlikely that anyone, poor or wealthy, will increase their savings any time soon. The U.S. can afford to carry a certain percentage of debt against its GNP. My regret is that the Feds will certainly continue to borrow to consume rather than to invest, following in the footsteps of the borrowing-to-spend fools (the U.S. public and their representatives) who got us here.

[Jim]

And on the 'Ricardian equivalence' issue, net present value is not accurately calculated by the recipients of the largess. Just write the check, please.

[Winslow R.]

Jim wrote "Winslow, good point. Let us wait for higher savings before incurring higher deficits."

Public deficits are the flip side of net private savings.
You don't have one without the other.

Jim wrote "The U.S. can afford to carry a certain percentage of debt against its GNP."

Right, and doing so will increase net private savings.

[Fred]

Question for the Austrian types: if the government runs a balanced budget and we disregard foreign surpluses for the time being (which is more than reasonable, given that the US is not likely to be running foreign account surpluses anytime soon), then how do the households save? I'm talking about financial savings, not savings in the sense of learning a new skill (human capital), expanding their network of friends (social capital), renovating their house (physical capital), planting a tree in their front yard (improving natural capital). I and every competent economics or finance major knows the answer to my question, but do you? And if you did know the answer, then isn't it obvious that the answer won't work right now?

[Winslow R.]

ndk wrote:"If your government expenditures are netted by a reduction in private expenditures, you've accomplished nothing and probably taken a few steps backwards, unless you think the government is better at money allocation than the market."

" unless you think the government is better at money allocation than the market."

Yes, sometimes it is.

Especially when it comes to public infrastructure, education, healthcare, defense......things that are required for the public good.

[Karl Bonner (aka Eric)]

Countercyclical fiscal policy, while the obvious ideal way to go, is of course politically difficult to pass. Only the outbreak of war in 1941 convinced the government to pump up spending to the levels that would end the depression. (We started to recover in 1937 but then the govt. slammed on the fiscal brakes.) Sweden, on the other hand, returned to full employment in the mid-1930s thanks to the prevailing party's social-democratic ideology.

A lot of Americans just don't get countercyclical fiscal theory. They don't understand that deficits are good during recessions, but we need to pay for them by running surpluses in boom times. It's far too easy to run scared of deficits during a hard recession and not provide enough stimulus (this is a time when revenues go way down and spending has to be dramatically increased, so the short-run deficits end up being quite massive if done properly), and it's equally tempting to raid the cookie jar during a boom time by refunding the surplus in tax cuts - overheating the boom and leaving us in a worse fiscal situation for the next recession/slump.

Besides the various liberal-progressive systemic reforms I support to build up infrastructure, provide health care and education, and combat inequality and plutocracy, I think there need to be a set of cyclical macro reforms written into the budget process: if the average voter doesn't understand the need to spend against the wind, the general budgetary guidelines need to acknowledge this. And it will also require the unseating of politicians whose ideological dogma procludes them from practicing cyclical macro policy.

BTW: recessions should be seen as an opportunity as much as a hardship. It is an excellent time to shore up infrastructure and provide funding for critical research projects.

[Winslow R.]

Fred wrote: "if the government runs a balanced budget and we disregard foreign surpluses for the time being (which is more than reasonable, given that the US is not likely to be running foreign account surpluses anytime soon), then how do the households save?"

I'm not an Austrian but given your scenario households would not be able to increase 'net' savings of financial assets. Not now, not ever.

A portion of households could 'save' but they would net against those that 'dissave' adding nothing to overall household saving.

[Winslow R.]

Eric wrote: "And it will also require the unseating of politicians whose ideological dogma procludes them from practicing cyclical macro policy."

The problem is both democratic and republican politicians are afflicted with the disease as well as many economists.

[a]

"Legislation could be clearly identified as a countercyclical measure, and it would contain both the deficit spending to address the downturn along with an explicit plan to pay for the policy when times get better. "

When good times return, what's stopping the legislature from overturning the countercyclical measure, under the guise that times really aren't all that good?

[Just Thinking]

One problem might be how do you know when you are in a boom? Suppose sustainable GDP has increased due to increased productivity of inputs. Having a contractionary policy kick in would be needlessly costly. You don't know what you don't know, do you?

[Oupoot]

How long is the average business cycle? How does it correspond to a presidential term? I support Lafayette that it should be written into law that the average deficit over a 3/4/5 year period be no more than long term sustainable rate (2%?). And ideally it should be prosecutable / impeachable if it is higher than this (with some exceptions - world war/long term depression/etc). Could GWB & Congress have been impeached on this in the case of the Iraq war?

The democracy in the US is strong enough to ensure that a lower deficit or even surplus for a sustained period of time will not be tolerated by the opposition and voters in general. I.e. should be realised in lower tax rates or higher govt spending visible to the voters.

Inflating away debt is not an option anymore. IMHO, Roubini argues successfully that this could only happen if it is an inflation shock (i.e. unexpected). If its policy, a rational lender to the govt will expect to be compensated for this and/or protected against this (e.g. higher interest rates and/or inflation linked treasuries).

PS: Mark specifically refer to fiscal savings/deficits. Private savings certainly requires other approaches which may include both fiscal and monetary policy.

[hari]

If you follow the currency meltdown across EU + emerging Asia, deleveraging is going on with a vengence to protect portfolios. USD, Yen (Euro to some extent) was central to carry trade - all unwinded now! Consequence - run for safety!
(Similar to Asean financial crisis, I recall.)

Dollar is appreciating at a phenomenal rate against major trading currencies...treasuries are still not affected. Euro is down to 1.24 dollars today. Yen was seldom so strong....

This financial crisis is one of its kind and we're going to learn a lot of lessons from American consumption binge based on all sorts of leveraging including house mortgages and credit cards. Hedge Funds will also become central to G-20 talks to control their global tentacles (investment banks are now gone!).

The SWFs have been financing this US overconsumption. The policy impact of the crisis will tell how Chinese, Gulf States and other's reflect on their current financial policies.

[Lafayette]

WR : Ideally there is no increase in net private sector savings? Why?

Corporate profits are not "private sector savings" ? They are not taxed to become Federal sector savings? They do not increase with economic expansion?

They are not redistributed by means of government expenditures? One of those expenditures is not debt maintenance?

[Lafayette]

To have your cake AND it

Fred: The best time to set up such a system (or to increase the base tax rate) would be during a deep recession, because any increase in the base tax rate then would be immediately rebated and so no one would be immediately affected.

During a deep recession, increasing the base tax rate simply diminishes net disposable income – which the worst possible economic policy. An economy spends itself out of a recession.

I suggest that, for America to tame its deficit problem, focuses on preventing them, rather than the remedy. I.e., that it binds the hands of state and Federal spendthrifts, that is, introduces a law that requires the government to maintain the deficit at less than 3% of GDP (on a 3 or 5 year running average).

Which should allow for deficit spending out of minor recessions. The magic necessary is to keep economic recessions less deep but perhaps a bit longer in tenure.

Even a restrained deficit, however necessary, remains insufficient. Current Account Imbalances also produce debt and therefore debt maintenance. The debt being maintained is that of Treasury T-notes being sold to maintain chronic Current Trade balance (deficit). What do we do about that?

Meaning, how do we get Americans to buy less from abroad and stop binging on low-cost Chinese produce? (Ask the super-rich Waltons of Wal-Mart fame … they typically have an answer for everything.)

In fact, the only effective policy to tame a chronic CA-imbalance is to convince Americans that they should “Buy American”. But, Americans, for all the wailing and gnashing of teeth prompted by job dislocations to the Far East, are not inclined to buy higher cost American produced products. Their preference for low-cost is ingrained, despite the fact that this preference has been at the root of a chronic trade deficit for decades.

Americans want their cake AND eat it. I.e., low-cost gadgets from abroad but good jobs with which to purchase the imported low-cost gadgets. Uh, uh ... that has become a no-no.

Successive American governments have played to the tune that they can do provide the cake AND Americans could eat it. It helps get them reelected. Our VP once claimed that “Nixon had proven that deficits don’t matter”. (Which makes for TWO Twits in the White House.)

Americans will be forced to go through a period of lean where they must readjust their consumption patterns. This is a sine-qua-non for the US to emerge from the recession to a position of strength, meaning no longer burdened by a debt held by foreigners.

Will that make for an America less attuned to the American Dream? If that American Dream was of the kind, “I want it ALL and I want it NOW!”, then, obviously yes. Will we survive despite this dream having become lately a nightmare?

Of course we will. Might we, even, be better off? Quite possibly. The answer depends upon how modest we can remain with our ambitions into the future.

[paine]

"So perhaps a business cycle version of Paygo is needed"

corporate keynes
worthy of herb stein

enlightened domar calcs
don't require this
burden is a relative notion

what if
the lender class
pays the carrying cost thru a wealth tax....???

okay
a secular increase in
the national public external debt ratio
might need addressing ...someday
but only if ...
some one ....any one
had a way to optimize that ratio
short of heroic assumptions
dressed in low confidence

[paine]

talk of private savings is a fudge

let's start where we oughta
with
corporate sector domestic expenditures less
then domestic cash flow

[paine]

laff

your economics is not science
its passages from a 18th century
rule book for moral living

[david]

I follow you Mark. I think it was a terrible mistake that the dems did not reinstate paygo when they had the chance(*). I also think it will be unrealistic for the federal govt to build up a rainy day fund like many states have.
So, it would be nice for the legislative system to put in
force paygo with the exception that anything not following this rule (i.e., deemed countercyclical) needs a 2/3 majority. I honestly think this is SO important to the future of our democracy that such a "paygo+" system should be inserted in the constitution.

(* I also wonder whether this is simply an irony of the current situation or whether the dems foresaw eventual disaster was coming if they reinstated it and then had to withdraw it during crisis.)

[Fred]

>I'm not an Austrian but given your scenario households would not be able to increase 'net' savings of financial assets. Not now, not ever.

Wrong! You forgot the role of corporations, the other element of the private sector besides households. In times of economic growth, households pile up financial credits in the form of bonds as corporations pile up debts, which in turn is offset by rising stock prices. But this won't work now, because corporations that have clean balance sheets and could issue bonds (Microsoft, Exxon) are instead hoarding their cash.

[Fred]

>>The best time to set up such a system (or to increase the base tax rate) would be during a deep recession, because any increase in the base tax rate then would be immediately rebated and so no one would be immediately affected.

>During a deep recession, increasing the base tax rate simply diminishes net disposable income – which the worst possible economic policy. An economy spends itself out of a recession.

Can't you read English?! Increasing the tax rate while rebating the increase results in no effect on taxes. Is this not clear?

As for your proposal of binding the government's hand with a 3% max deficit, that would be disastrous right now and it will prove the undoing of the Euro pact countries in the near future (assuming they don't just disregard such a limit). Japan ran 8% of GDP deficits and got nowhere and I suspect we'll need something along those lines as well. (I keep throwing out the idea of $2 trillion deficits, which is 10% of GDP.)

[Fred]

Let me restate, since I confused things above. In times of economic growth, households lend to corporations and thereby pile up financial savings, by buying newly issued stocks and bonds. (Buying existing stocks and bonds does not consistute lending to corporations, but merely exchanges cash and paper assets between different households.) In times of crisis, corporation stop issuing new stocks and bonds, so the government must step in as the debtor of last resort. That is, the government must run sufficiently large deficits that households can save as much as they want, in the form of government bonds.

If households go on a savings spree to the tune of 10% of GDP, which is not unlikely, and we assume that corporations run a zero balance and the foreign trade deficit shrinks to 3% of GDP (from 6% of GDP a year ago), then the government deficit must be 13% of GDP or about $2 trillion. This is simple bookkeeping logic and is irrefutable.

If the government deficit is only 7% of GDP or about $1 trillion and we continue to assume trade deficit of 3% and housing savings of 10%, then the only way to balance the books is for corporations to be FORCED to run up 7% of GDP in UNWILLING debt/dissaving, aka losses. This will result in a deflationary depression, because when corporations are FORCED to dissave, as opposed to running up debt willingly during times of economic growth, they start laying people off, which causes households to save even more, causing more losses, etc. I am hesitant to mention Keynes here, because I know how the Austrian see that name and immediately put on their stupid hat. But much of the logic above is simple bookkeeping. There is no refuting the bookkeeping, regardless of whether you are Austrian or Keynesian. What you can argue about is the train of cause and effect. For example, corporations that run up unwanted losses need not necessarily lay off workers and households need not necessarily attempt to save in the face of massive layoffs and bad economic news. Perhaps corporations which run up losses will instead go on an investment spending spree and households staring at bankruptcy will go on a consumption spending spree. Though I fail to see why the Keynesian train of cause-and-effect is so offensive to the Austrians.

[Fred]

Change that last 7% for the corporations to 6%. Too bad we can't edit these posts.

[reason]

I like the moving average idea, BUT the problem is that the next government would be handicapped by the last one.

And I'm on record as suggesting that in time of debt deflation cum liquidity trap you REALLY do need helicoptor money (MOST important NOT offset by government borrowing as they did disastrously in Japan.) Why hasn't Helicoptor Ben done it instead of just keeping stealing banks solvent? Spread that money evenly around Ben!

http://economistsview.typepad.com/economistsview/2006/05/babysitting_the.html

[Lisa]

“When the next boom develops…………”
When the time is good, we are very much into making quick gains. We do not indulge in the thinking that paying higher taxes, saving higher. etc stuff will help get over the unforeseen predicament. When growth is at home, we can not deviate from that creative/excitement/innovation associated with it. And, making a balance between the growth and the foresight to resolve the future dark days – not sure if it is possible ever.

Lisa

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