Economist's View

Paul Krugman: Looking for Mister Goodpain

The advocates of fiscal austerity can't admit that contractionary policy is contractionary despite the evidence that has stacked up against their policy prescriptions:

Looking for Mister Goodpain, by Paul Krugman, Commentary, NY Times: ... In recent columns, I’ve argued that worries about the deficit are, in fact, greatly exaggerated — and have documented the increasingly desperate efforts of the deficit scolds to keep fear alive. Today,... I’d like to talk about a different but related kind of desperation: the frantic effort to find some example, somewhere, of austerity policies that succeeded. For the advocates of fiscal austerity — the austerians — made promises as well as threats: austerity, they claimed, would both avert crisis and lead to prosperity.

And let nobody accuse the austerians of lacking a sense of romance; in fact, they’ve spent years looking for Mr. Goodpain.

The search began with a passionate fling between the austerians and the Republic of Ireland, which turned to harsh spending cuts soon after its real estate bubble burst, and which for a while was held up as the ultimate exemplar of economic virtue. ... Since then, every uptick in the Irish economy has been hailed as proof that the nation is recovering — but as of last month the unemployment rate was 14.6 percent...

After Ireland came Britain... Unlike Ireland, Britain had no particular need to adopt austerity... Nonetheless, the government of Prime Minister David Cameron insisted ... that it would actually boost the economy by inspiring confidence. What actually happened was an economic stall. ...

At this point, you might have expected austerity advocates to consider the possibility that there was something wrong with their analysis... But no. They went looking for new heroes and found them in the small Baltic nations, Latvia in particular... Latvians,... however,... have only regained part of the lost ground..., and the unemployment rate is still 14 percent. If this is the austerians’ idea of an economic miracle, they truly are the children of a lesser god.

Oh, and if we’re going to invoke the experience of small nations as evidence about what economic policies work, let’s not forget the true economic miracle that is Iceland — a nation that was at ground zero of the financial crisis, but which, thanks to its embrace of unorthodox policies, has almost fully recovered.

So what do we learn from the rather pathetic search for austerity success stories? We learn that the doctrine that has dominated elite economic discourse for the past three years is wrong on all fronts. ... It’s time to put the deficit obsession aside and get back to dealing with the real problem — namely, unacceptably high unemployment.

 

Kudlow Celebrates Negative Growth

Larry Kudlow tries to use the fact that the fall government spending in the fourth quarter of last year was associated with a big drop in GDP growth to argue that lower government spending is good for the economy. Antonio Fatas correct his misguided thinking:

Celebrating negative growth, by Antonio Fatas: GDP growth during the last quarter of 2012 turned negative in the US (-0.1%)... Looking at the different components of GDP, the biggest decline happened in government spending and in net exports (due to the weakness in other economies). This is just one quarter and the data is likely to be revised later in the year, but what is to be learned from the data? The answer is whatever justifies your priors. Here is the interpretation that Larry Kudlow does in CNBC...

He makes the claim that this is indeed a good quarter because private spending (consumption and investment) grew at about 3.4% - after removing inventories that fell significantly. From here he concludes:

"Even with the fourth-quarter contraction, the latest GDP report shows that falling government spending can coexist with rising private economic activity. This is an important point in terms of the upcoming spending sequester. Lower federal spending, limited government, and a smaller spending-to-GDP ratio will be good for growth. The military spending plunge will not likely be repeated. But by keeping resources in private hands, rather than transferring them to the inefficient government sector, the spending sequester is actually pro-growth."

So this is an interesting test that he is using to prove that decreasing government spending is good for growth. As long as we see any growth in private spending it means that the decrease in government spending is helping the private sector grow. Of course, the real test is to compare the -0.1% to what would have happened to GDP growth if government spending had not decreased. Reading Larry Kudlow's article it sounds as if GDP growth would have been even lower (although his statement is not as precise as this). Yes, consumption grew and investment (once we exclude inventories) grew as well, but how much? Not enough to compensate the decrease in government spending so the final outcome is a negative (literally negative) performance for GDP growth. ...

We see that government spending fell and this is a component of GDP. A natural reaction might be to argue that the fall in government spending had a negative effect on GDP. Given that the GDP growth number is so low (and lower than expected), this is a reason to believe that the multiplier is positive and possibly large. But, as Larry Kudlow shows, there are always other interpretations.

According to Kudlow's theory (which is contrary to the empirical evidence, but why should actual data matter when there's ideology to promote...note how he tosses inventories aside when they don't agree with his priors, doubt he does that if it is helpful to his case), a decline in government spending should cause the private sector to boom by more than enough to offset the decline in government spending (otherwise growth would fall on net). Yet he is pleased that the decline in government spending didn't cause a decline in the private sector ("shows that falling government spending can coexist with rising private economic activity"), as though that somehow supports his case. It doesn't. Government spending fell, the private sector didn't boom by anywhere near enough to offset it, and the net result was a decline in GDP growth.

[Note: As Antonio points out, "we should not be doing this, to understand fiscal multipliers we need more than one quarter of data, but I am just trying to follow his logic." For example, to qualify this is a way that could be helpful to Kudlow, there may be lags between changes in government spending and changes in private sector activity that cannot be captured in a single quarter of data. But as noted above, this actually doesn't help -- when the empirical analysis is done correctly, government spending multipliers in a depressed economy appear to be relatively large.

Let me add one more thing. I'm all for maximizing growth (with externalities internalized), but I'm also for full employment and sometimes a temporary increase in government spending in the short-run to put people back to work is the best course for long-run economic growth. This is one of those times, especially spending focused on infrastructure. Addressing our short-run problems in this way is, if anything, and contra the Kudlows, helpful for growth.

I don't have any problem asking question such as "what is the best way to raise a given amount of revenue," i.e. trying to minimize inefficiencies and inequities in the tax code with an eye toward growth. I also think it's worthwhile to think about what size of government we want to have, and figure out the best way to support it. I do have a problem with high unemployment, especially when there are steps we could take to put people to work, and even more so when theories about long-run growth that have been rejected by the data are used to institute policies that work against helping people find employment in a depressed economy (e.g. austerity). In any case, with all of our employment problems, why would anyone cheer -.1 percent growth unless "those people" don't matter?]

Spending on Infrastructure Can Reduce Our Expected Debt

I couldn't resist one more plea for infrastructure construction:

How Spending on Infrastructure Can Reduce Our Long-Run Debt Burden

Spending more on infrastructure will improve our growth prospects, lower long-term unemployment, and some types of spending can actually save us money in the long-run.

The Unemployment Problem is Cyclical

John Taylor argues, indirectly, that the unemployment problem is mostly cyclical, not structural:

... I like to tell the story about what Senator Hubert Humphrey said when President Ford’s Council of Economic Advisers, where I worked with Alan Greenspan, reported to the Joint Economic Committee (JEC) that it was raising the definition of the normal unemployment rate from 4.0% to 4.9%.  Humphrey, who chaired the JEC, was outraged and told us in the JEC hearing that “if the country was suffering a plague and you economists were doctors your solution would be to raise the definition of normal body temperature above 98.6 degrees”   

So I am worried when people stop talking about today’s very high unemployment rates as if they were normal. ...

He goes on to try to blame Obama for the slow recovery of labor markets ("It is not a good sign that the inaugural address was silent on the subject..."), as though the Republicans -- his party -- and its obstructionist ways has nothing to do with the fact that Obama couldn't get his jobs program passed, or any further stimulus measures put in place. But it's nice to see Taylor acknowledge that the problem is cyclical not structural, and that fiscal policy can make a difference (Obama can hardly be blamed for the Fed's actions, so when he complains that Obama isn't talking about this problem, he must have fiscal policy in mind -- probably tax cuts for the wealthy rather than, say, spending on infrastructure, but it's a start.)

How Big Should Government Be?

Travel day, so a quick one:

How Big Should Government Be?, by Justin Fox: There are a couple of fundamental questions at the bottom of Washington's ongoing battles over deficits and debt: (1) How big should the U.S. government to be? and (2) How should we pay for it? The answers to both will ultimately have to be political ones — messy calculations based on who pays, who benefits, who votes, and who makes the campaign contributions. But it would be nice to know what the economics are, wouldn't it?

It turns out economists have lots of theories of optimal government spending and optimal taxation. This isn't the same as saying they have reliable or consistent answers. As one critic wrote of Robert Lucas's American Economic Association presidential address on economic growth in 2003, in which the Nobel laureate cited several studies showing dramatic welfare gains from hypothetical tax cuts in France and the U.S.:

Such findings have two distinctive features. First, they show big numbers. Second, they are not really findings. Contrary to the words offered so traditionally and casually by economists, none of these authors actually 'found' or 'showed' their results. Rather, they chose to imagine the results they announced. In every study Lucas cited here the crucial ingredient was a theoretical model laden with assumptions.

The author of these words is University of California, Davis economic historian Peter Lindert... People on the left love Lindert's conclusion, contained in this shorter working paper, that the rise in spending (and accompanying taxation) has not carried with it the costs predicted by neoclassical economic theories such as the ones wielded by Lucas. But those on the right love his explanation that this is mostly because countries with high social spending have tax systems that appear to have been designed by a neoclassical economist: with low progressivity, low taxes on capital, and big value-added taxes on consumption. ...

European Labor Markets: Six Key Lessons

Jonathan Portes (he also provides discussion of each of these points):

European labor markets: six key lessons from the Commission report, by Jonathan Portes: I haven't always been complimentary about the European Commission - either its economic analysis or its policy advice. So it's nice to be able to be wholeheartedly positive about the excellent report "Employment and Social Developments in Europe 2012"...

The report is really worth reading. But it's close to 500 pages, and the main messages deserve as wide an audience as possible, so I thought I'd try to highlight them with some commentary. To my mind, the key ones are the following:

1. Economic weakness in Europe, and the consequent rise in unemployment, are mostly to do with a lack of aggregate demand, which in turn is the result of mistaken macroeconomic policies - especially aggressive fiscal consolidation...

2. Although financial markets may have stabilized - who knows for how long - things are getting worse, not better, in the real economy of the crisis countries...

3. Countries with more generous welfare states, but also more flexible labor markets, have fared best...

4. Following on from this, structural reforms in labor markets are required in many countries - but they need to be based on evidence! Segmented labor markets are a problem and raise youth unemployment...

..and even in recession, minimum wages at a sensible level do more good than harm. ...

5. Where they were allowed to operate, the "automatic stabilizers" worked...(in both macroeconomic and social terms)...

...while where they were overridden, in the pursuit of "self-defeating austerity", things have got worse...

6. Latvia, Ireland (and even Estonia) may look like "success stories" to some in the Commission, and perhaps to the financial markets (at present) but the reality in terms of jobs and incomes is rather different. ...

Too bad fiscal policymakers didn't do their homework and learn these lessons about austerity, social insurance, automatic stabilizers, and so on before putting harmful or ineffective policy in place (or failing to implement policy when action is called for, e.g. to reduce unemployment). Wish I thought they were doing their homework now.

Paul Krugman: Japan Steps Out

Will we learn from Japan?:

Japan Steps Out, by Paul Krugman, Commentary, NY Times: For three years economic policy throughout the advanced world has been paralyzed ... by a dismal orthodoxy. Every suggestion of action to create jobs has been shot down with warnings of dire consequences. If we spend more, the Very Serious People say, the bond markets will punish us. If we print more money, inflation will soar. Nothing ... can be done, except ever harsher austerity, which will someday, somehow, be rewarded.

But now it seems that one major nation is breaking ranks — and that nation is, of all places, Japan. ... Shinzo Abe, the new prime minister, has ... already taken steps orthodoxy says we mustn’t take. And the early indications are that it’s going pretty well.

Some background: Long before the 2008 financial crisis plunged America and Europe into a deep and prolonged economic slump, Japan held a dress rehearsal in the economics of stagnation. When a burst stock and real estate bubble pushed Japan into recession, the policy response was too little, too late and too inconsistent. ... because it’s hard getting policy makers to accept the need for bold action. That is, the problem is mainly political and intellectual, rather than strictly economic. For the risks of action are much smaller than the Very Serious People want you to believe...

Enter Mr. Abe, who has been pressuring the Bank of Japan into seeking higher inflation — in effect, helping to inflate away part of the government’s debt — and has also just announced a large new program of fiscal stimulus. How have the market gods responded?

The answer is, it’s all good. Market measures of expected inflation, which were negative not long ago — the market was expecting deflation to continue — have now moved well into positive territory. But government borrowing costs have hardly changed at all; given the prospect of moderate inflation, this means that Japan’s fiscal outlook has actually improved sharply. True, the foreign-exchange value of the yen has fallen considerably — but that’s actually very good news, and Japanese exporters are cheering.

In short, Mr. Abe has thumbed his nose at orthodoxy, with excellent results.

Now, people who know something about Japanese politics warn me not to think of Mr. Abe as a good guy. ... Whatever his motives, Mr. Abe is breaking with a bad orthodoxy. And if he succeeds, something remarkable may be about to happen: Japan, which pioneered the economics of stagnation, may also end up showing the rest of us the way out.

'The Debt Reduction That's Already Happened'

Something to remember:

The debt reduction that's already happened, by Steve Benen: When it comes to most of the major political disputes in Washington, congressional Republicans insist Democrats focus on reducing the debt Republicans built up during the Bush/Cheney era. It underpins everything from the budget fight to the debt ceiling to efforts to expand public investments.

What the debate tends to ignore is the debt reduction that's already happened. Michael Linden and Michael Ettlinger reported yesterday that since the start of 2011 fiscal year, President Barack Obama "has signed into law approximately $2.4 trillion of deficit reduction" over the next decade. ...

Roughly three-quarters of the deficit reduction has come is in the form of spending cuts, which should further make Republicans happy. ... To be sure, it would be my strong preference that policymakers not make this a priority at all. What the nation needs is jobs and economic growth, and the most sensible course of action would be to delay fiscal concerns for a later day. ...

But... The conventional wisdom suggests nothing is being done to address a perceived debt "crisis," and that somehow Republicans have the high ground in demanding more and more cuts. It seems spectacularly insane to me to think the GOP has credibility on the subject given that it was Republicans who created the budget shortfall in the first place, but establishment assumptions are hard to shake.

But that's what makes the Linden/Ettlinger report so worthwhile: something is being done, whether this deserves to be a priority or not. ... What's more, let's also not forget cost-saving measures Obama proposed -- cap and trade, Dream Act -- and the GOP killed. ...

Postscript: Just as an aside, let's also take a moment to compare administrations. Obama, in just the last two years, has accepted $2.4 trillion in debt reduction through multiple proposals. How many debt-reduction proposals did Republicans approve during the Bush/Cheney era? None. Even when there was a Republican-led House, Republican-led Senate, and Republican-led White House? Yep, even then.

What can Washington do to Boost the Recovery?

The editors at MoneyWatch asked me to answer the question:

What can Washington do to Boost the Recovery?: As we enter the new year, the nation's most pressing economic problem remains the slow recovery, particularly the job market. Unemployment is still far too high and the rate at which we are creating new jobs is far too low. At the present rate of job growth, we are still several years away from full employment.

Monetary and fiscal policymakers could accelerate the return to full employment through tax cuts, increases in government spending -- particularly in areas that tend to create lots of jobs -- and further monetary easing. However, the ability of monetary and fiscal policymakers to combat the slow recovery is constrained by three things: fear that aggressive monetary policy will drive up inflation to an unacceptable level; fear that tax cuts or increases in spending will worsen our long-run debt problem; and political disputes over taxes and the size and role of government. ...[continue reading]...

Policymakers are unlikely to do more to help the economy recover, the question is whether fear of deficits and fear of inflation will cause them to adopt policies that make it worse.

'Stimulus or Stymied?: The Macroeconomics of Recessions'

Brad DeLong's opening remarks at the "Stimulus or Stymied?: The Macroeconomics of Recessions" session at the ASSA meetings. The panel inlcuded Carlo Cottarelli (International Monetary Fund), Paul Krugman (Princeton University) Valerie Ramey (University of California-San Diego), and Harold Uhlig (University of Chicago):

Stimulus or Stymied?: The Macroeconomics of Recessions: Between 1985 and 2007--the period of the "Great Moderation"--the Federal Reserve and the rest of the U.S. government on the west edge and the central banks and institutions of the European Union on the east edge of the Atlantic Ocean provided a broadly stable macroeconomic environment within which private-sector businesses, workers and investors could make their economic plans. In the U.S., on an annual basis: the rate of nominal GDP growth dropped below 4% for only 3 of those years and rose above 7% for only 2 of those 22 years; the rate of consumer price inflation rose above 5% for only 3 and fell below 2% percent for only 2 of those 22 years; and the civilian adult employment-to-population ratio remained between 60% and 64% for that entire period. And Western Europe experienced a similar "Great Moderation" with low inflation, relatively smooth growth, and diminishing unemployment.

As Robert Lucas put it in those halcyon days: “the problem of depression prevention has been solved”.

Then in 2008-9 the rate of nominal GDP growth in the U.S. crashed to -3%--a major, major downward surprise to anybody expecting and relying on a continuation of "Great Moderation" rates of nominal spending growth--the rate of consumer price inflation on an annual basis bottomed out at -2%, and the employment-to-population ratio dropped from 63% to between 58% and 59%, since when it has flatlined. In Western Europe the initial recession was smaller, but the subsequent labor market performance was even more disappointing, so that now the net fall relative to trend in Western European productio and employment exceeds that in the United States.

The problem of depression prevention—and of depression cure—has not been solved.

In this context, we are here to explore four questions:

1. Are there policies the Federal Reserve, the ECB, and the rest of the government could adopt that would quickly move the civilian adult employment-to-population ratio back toward what from 1985-2007 we thought of as "normal"--that could produce in the next couple of years rates of employment growth within shouting distance of those the U.S. economy experienced over the Reagan boom of 1982-1989?

2. If so, what are those policies?

3. If so, are those policies desirable ones that the Federal Reserve, the ECB, etc. and the rest of the government should adopt?

4. How is your view on questions (1) through (3) different today than it was six years ago?

Carlo Cottarelli from the International Monetary Fund? ...[continue reading rough transcript of remarks from participants]...

Paul Krugman: The Big Fail

Who should be blamed for the slow recovery?:

The Big Fail by Paul Krugman, Commentary, NY Times: It’s that time again: the annual meeting of the American Economic Association and affiliates... And this year, as in past meetings, there is one theme dominating discussion: the ongoing economic crisis.

This isn’t how things were supposed to be. If you had polled the economists attending this meeting three years ago, most of them would surely have predicted that by now we’d be talking about how the great slump ended, not why it still continues.

So what went wrong? The answer, mainly, is the triumph of bad ideas.

It’s tempting to argue that the economic failures of recent years prove that economists don’t have the answers. But the truth is ... standard economics offered good answers, but political leaders — and all too many economists — chose to forget or ignore what they should have known. ...

A smaller financial shock, like the dot-com bust at the end of the 1990s, can be met by cutting interest rates. But the crisis of 2008 was far bigger, and even cutting rates all the way to zero wasn’t nearly enough.

At that point governments needed to step in, spending to support their economies while the private sector regained its balance. And to some extent that did happen... Budget deficits rose, but this was actually a good thing, probably the most important reason we didn’t have a full replay of the Great Depression.

But it all went wrong in 2010. The crisis in Greece was taken, wrongly, as a sign that all governments had better slash spending and deficits right away. Austerity became the order of the day...

Of the papers presented at this meeting, probably the biggest flash came from one by Olivier Blanchard and Daniel Leigh of the International Monetary Fund. ... For what the paper concludes is not just that austerity has a depressing effect on weak economies, but that the adverse effect is much stronger than previously believed. The premature turn to austerity, it turns out, was a terrible mistake. ...

The really bad news is ... European leaders ... still insist that the answer is even more pain. ... And here in America, Republicans insist that they’ll use a confrontation over the debt ceiling ... to demand spending cuts that would drive us back into recession.

The truth is that we’ve just experienced a colossal failure of economic policy — and far too many of those responsible for that failure both retain power and refuse to learn from experience.

Fed Watch: The Japan Story Continues to Evolve

Tim Duy:

The Japan Story Continues to Evolve, by Tim Duy: Evolving economic policy in Japan is an excellent distraction from the fiscal cliff story. From my perspective, the most interesting idea Abe floated was forcing the Bank of Japan to buy government debt to support additional fiscal stimulus. Noah Smith countered that Abe is unlikely to experiment with monetary policy and will simply fall back on a mercantilist policy. While I think it is too early to ignore the fiscal policy aspect, it is increasingly clear that Abe thinks the future of Japan is in its past. From Ambrose Evans-Pritchard:

Premier Shenzo Abe is to spend up to one trillion yen (£7.1bn) buying plant in the electronics, equipment, and carbon fibre industries to force the pace of investment, according to Nikkei news.

This on the back of:

The disclosure came just a day after Mr Abe vowed to revive Japan's nuclear industry with a fresh generation of reactors, insisting that they would be "completely different" from the Fukishima Daiichi technology.

I imagine that should advanced civilizations ever travel to the Earth, they would be amazed that we allow fission reactors on the surface of the planet. I am amazed after by this after the lessons of Chernobal and Fukishima.

I have trouble with this characterization:

The industrial shake–up shows the ferment of fresh thinking in the third–largest economy after years of paralysis.

I am not sure this is fresh thinking at all. It sounds as if Japan is trying to go backwards in time to the 1980's. Especially when combined with an obvious intent to devalue the Yen for mercantilist reasons:

He has set an implicit exchange range target of 90 yen to the dollar, instructing the Bank of Japan to drive down the yen with mass purchases of foreign bonds along lines pioneered by the Swiss.

Finance minister Taro Aso brushed aside warnings that naked intervention would anger trade partners and damage Japan's strategic alliance with the US. "Foreign countries have no right to lecture us," he said, accusing the West of failing to abide by a G20 pledge in 2009 to forgo competitive devaluations.

As I have said in the past, I think that a yen/dollar target of 90 will yield only minor economic benefits at the price undermining Japan's international relationships. The US and Europe will reply that their quantitative easing programs are primarily aimed at boosting domestic demand, whereas if Japan appears to be pursuing an obvious beggar-thy-neighbor strategy. Of course, Abe isn't too worried about offending the international community. From Reuters:

Japanese Prime Minister Shinzo Abe wants to replace a landmark 1995 apology for suffering caused in Asia during World War Two with an unspecified "forward-looking statement", a newspaper reported on Monday...

..Any hint that Japan is back-tracking from the 1995 apology, issued by then Prime Minister Tomic Murayama, is likely to outrage neighbours, particularly China and North and South Korea, which endured years of brutal Japanese rule.

This is shaping up as a year in which Japan moves to center-stage in the international arena.

Bottom Line: Explicit cooperation between fiscal and monetary authorities to dramatically support domestic demand in Japan would be a step forward, but everything else that seems to be coming from Abe is a step backwards.

'A Pitfall with DSGE-Based, Estimated, Government Spending Multipliers'

This paper, which I obviously think is worth noting, is forthcoming in AEJ Macroeconomics:

A Pitfall with DSGE-Based, Estimated, Government Spending Multipliers, by Patrick Fève,  Julien Matheron, Jean-Guillaume Sahuc, December 5, 2012: 1 Introduction Standard practice in estimation of dynamic stochastic general equilibrium (DSGE) models, e.g. the well-known work by Smets and Wouters (2007), is to assume that government consumption expenditures are described by an exogenous stochastic process and are separable in the households’ period utility function. This standard practice has been adopted in the most recent analyses of fiscal policy (e.g. Christiano, Eichenbaum and Rebelo, 2011, Coenen et al., 2012, Cogan et al., 2010, Drautzburg and Uhlig, 2011, Eggertsson, 2011, Erceg and Lindé, 2010, Fernández-Villaverde, 2010, Uhlig, 2010).

In this paper, we argue that both short-run and long-run government spending multipliers (GSM) obtained in this literature may be downward biased. This is so because the standard approach does not typically allow for the possibility that private consumption and government spending are Edgeworth complements in the utility function[1] and that government spending has an endogenous countercyclical component (automatic stabilizer)... Since, as we show, the GSM increases with the degree of Edgeworth complementarity,... the standard empirical approach may ... result in a downward-biased estimate of the GSM.

In our benchmark empirical specification with Edgeworth complementarity and a countercyclical component of policy, the estimated long-run multiplier amounts to 1.31. Using the same model..., when both Edgeworth complementarity and the countercyclical component of policy are omitted,... the estimated multiplier is approximately equal to 0.5. Such a difference is clearly not neutral if the model is used to assess recovery plans of the same size as those recently enacted in the US. To illustrate this more concretely, we feed the American Recovery and Reinvestment Act (ARRA) fiscal stimulus package into our model. We obtain that omitting the endogenous policy rule at the estimation stage would lead an analyst to underestimate the short-run GSM by slightly more than 0.25 points. Clearly, these are not negligible figures. ...
_____

1 We say that private consumption and government spending are Edgeworth complements/substitutes when an increase in government spending raises/diminishes the marginal utility of private consumption. Such a specification has now become standard, following the seminal work by Aschauer (1985), Bailey (1971), Barro (1981), Braun (1994), Christiano and Eichenbaum (1992), Finn (1998), McGrattan (1994).

Let me also add these qualifications from the conclusion:

In our framework, we have deliberately abstracted from relevant details... However, the recent literature insists on other modeling issues that might potentially affect our results. We mention two of them. First, as put forth by Leeper, Plante and Traum (2010), a more general specification of government spending rule, lump-sum transfers, and distortionary taxation is needed to properly fit US data. This richer specification includes in addition to the automatic stabilizer component, a response to government debt and co-movement between tax rates. An important quantitative issue may be to assess which type of stabilization (automatic stabilization and/or debt stabilization) interacts with the estimated degree of Edgeworth complementarity. Second, Fiorito and Kollintzas (2004) have suggested that the degree of complementarity/substitutability between government and private consumptions is not homogeneous over types of public expenditures. This suggests to disaggregate government spending and inspect how feedback rules affect the estimated degree of Edgeworth complementarity in this more general setup. These issues will constitute the object of future researches.

What have Monetary and Fiscal Policymakers Learned from the Great Recession?

New column:

What have monetary and fiscal policymakers learned from the Great Recession?

Not enough, particularly fiscal policymakers, but maybe there's a way to do better.

Paul Krugman: That Terrible Trillion

Deficit scolds long for "frickin' sharks with frickin' laser beams attached to their frickin' heads" to use against "programs that shield both poor and middle-class Americans from harm":

That Terrible Trillion, by Paul Krugman, Commentary, NYTimes: ...I find myself in a lot of discussions about U.S. fiscal policy, and the budget deficit in particular. And there’s one thing I can count on..: At some point someone will announce, in dire tones, that we have a ONE TRILLION DOLLAR deficit.

No, I don’t think the people making this pronouncement realize that they sound just like Dr. Evil in the Austin Powers movies.

Anyway, we do indeed have a ONE TRILLION DOLLAR deficit,... actually $1.089 trillion. ... What the Dr. Evil types think, and want you to think, is that the big current deficit is a sign that ... a debt crisis is just around the corner, although they’ve been predicting that for years and it keeps not happening. ... But more often they use the deficit to argue that we can’t afford ... programs like Social Security, Medicare and Medicaid. So it’s important to understand that this is completely wrong. ...

So, let’s talk about the numbers. The first thing we need to ask is what a sustainable budget would look like. The answer is that in a growing economy, budgets don’t have to be balanced to be sustainable. ... Right now, given reasonable estimates of likely future growth and inflation, we would have a stable or declining ratio of debt to G.D.P. even if we had a $400 billion deficit. You ... should take $400 billion off the table right away.

That still leaves $600 billion or so. What’s that about? It’s the depressed economy — full stop.

First of all, the weakness of the economy has led directly to lower revenues ... by at least $450 billion. Meanwhile, the depressed economy has ... temporarily raised spending ... by at least $150 billion.

Putting all this together, it turns out that the trillion-dollar deficit isn’t a sign of unsustainable finances at all. ... We do indeed have a big budget deficit, and other things equal it would be better if the deficit were a lot smaller. But other things aren’t equal; the deficit is a side-effect of an economic depression, and the first order of business should be to end that depression — which means, among other things, leaving the deficit alone for now.

And you should recognize all the hyped-up talk about the deficit for what it is: yet another disingenuous attempt to scare and bully the body politic into abandoning programs that shield both poor and middle-class Americans from harm.

'The Height of Fiscal Folly'

Laura Tyson echoes the message at the end of the post below this one (here too):

The Trade-Off Between Economic Growth and Deficit Reduction, by Laura D’Andrea Tyson, Commentary, NY Times: ...After three years of recovery, the economy is still operating far below its potential and long-term interest rates are hovering near historic lows. Under these circumstances, the case for expansionary fiscal measures, even if they increase the deficit temporarily, is compelling.

A recent study by the International Monetary Fund finds large positive multiplier effects of expansionary fiscal policy on output and employment under such circumstances. ... The rationale for expansionary fiscal policy is particularly compelling for federal investment spending in areas like education and infrastructure...

The economy does not need an outsize dose of fiscal austerity now; it does need a credible deficit-reduction plan to stabilize the debt-to-G.D.P. ratio gradually as the economy recovers. As I contended in an earlier Economix post, the plan should have an unemployment-rate target or trigger that would postpone deficit-reduction measures until the target is achieved. ...

The goal of deficit reduction is to ensure the economy’s long-term growth and stability. It would be the height of fiscal folly to kill the economy’s painful recovery from the Great Recession in pursuit of this goal.

Why the GOP Won't Admit That Supply-Side Economics Has Failed

The Bush tax cuts have not delivered the economic growth and widely shared prosperity that were promised, and if the Republican Party was really the party of business it would end our bad investment in supply-side economics:

    Why the GOP Won't Admit That Supply-Side Economics Has Failed - Mark Thoma

But maybe the tax cuts were about something else?

Let's Get Serious about Getting Serious

Jonathan Weiler:

The Republican Party Should Have Zero Credibility on Deficits, by Jonathan Weiler: Speaker Boehner's angry response to the White House's opening gambit in the budget negotiations related to the so-called fiscal cliff provides a useful opportunity to remind folks that the GOP should have zero credibility on deficit reduction. Boehner claims that the Democrats proposal is not serious and is a bad-faith offer. Coming from him, that's rich. We have a three-decades long record to prove definitively that Republicans are themselves unserious about deficits. That has been evident during periods in which they've controlled the presidency, as both Reagan and W. presided over explosions in our national debt. And we have the account of GOP insider after GOP insider revealing the true motives behind GOP fiscal policy. As far back as 1981, Reagan budget director David Stockman admitted that Republicans' professed concern with the impact of deficits and debts on our children and grandchildren was just a ruse to allow Republicans to avoid responsibility for the adverse consequences of lowering taxes on the rich. Bruce Bartlett, a former Reagan treasury official has explained in detail that the right-wing's rhetorical push against deficits over the past thirty years was not the product of a sincere commitment to fiscal prudence. Rather, Bartlett has shown, the goal was to reduce taxes on the rich, which would starve the government of funds, which would require government to cut spending for the less well off. In other words, the concern was never deficits. The desire was to reduce social spending for those deemed undeserving by the Republicans, including poor children, the struggling elderly and other disfavored groups. Deficits were merely the excuse for doing so. And Vice President Dick Cheney stated as emphatically as he could that, when Republicans hold power, "deficits don't matter." ...

He says "Boehner claims that the Democrats proposal is not serious." Paul Krugman explains:

What Defines A Serious Deficit Proposal?, by Paul Krugman: Just a thought: if you follow the pundit discussion of matters fiscal, you get the definite impression that some kinds of deficit reduction are considered “serious”, while others are not. In particular, the Obama administration’s call for higher revenue through increased taxes on high incomes — which actually goes considerably beyond just letting the Bush tax cuts for the top end expire — gets treated with an unmistakable sneer in much political discussion, as if it were a trivial thing, more about staking out a populist position than it is about getting real on red ink.

On the other hand, the idea of raising the age of Medicare eligibility gets very respectful treatment — now that’s serious. So I thought I’d look at the dollars and cents — and even I am somewhat shocked. Those tax hikes would raise $1.6 trillion over the next decade; according to the CBO, raising the Medicare age would save $113 billion in federal funds over the next decade.

So, the non-serious proposal would reduce the deficit 14 times as much as the serious proposal.

I guess we have to understand the definition of serious: a proposal is only serious if it punishes the poor and the middle class.

Here's an example:

On Sunday, during an appearance on Meet the Press, Sen. Bob Corker (R-TN) reiterated his call for restructuring entitlement programs like Medicare, highlighting the “very painful cuts” he has proposed as part of a package to avert the fiscal cliff. ...

Host David Gregory seemed to agree with Corker’s characterization and pressed fellow panelist Sen. Claire McCaskill (D-MO) to accept reforms that will shift health care costs to seniors in order to show that Democrats are “serious” about entitlements:

CORKER: Look, I laid out in great detail very painful cuts to Medicare. ...

GREGORY: Name some specific programs that ought to be cut that would cause pain in terms of the role of our government that Democrats are prepared to support.

McCASKILL: Well,... a lot of us voted for more cuts in the farm program…and defense. I spent a lot of times in the wings of the Pentagon. if you don’t think there’s more money to be cut in contracting at the pentagon, you don’t understand what has happened at the Pentagon. [...]

CORKER: David, as much as I love Claire, those are not the painful cuts that have to happen. We really have to look at much deeper reforms to the entitlements …

Note the "those are not the painful cuts that have to happen." It's not enough that the cuts be "painful." To actually count and be endorsed, the cuts have to be targeted at particular people and programs.

Should We Extend the Payroll Tax Cut?

Jared Bernstein says we should renew the payroll tax cut:

When You’re Trying to Decide if We Need to Renew the Payroll Tax Break, Picture This. by Jared Bernstein: It’s just a slide…in both senses of the word…of the real earnings—pretax, which is important—of middle-wage workers: blue collar workers in manufacturing and non-managers in services, adjusted for inflation. And it’s not inflation holding back these wage rates—it’s the weak economy. This series starts in 1964, and in nominal terms, it’s never grown more slowly than it has this year.

Source: BLS

So it is to his great credit that the President proposed another round of the payroll tax break, or something like it, as part of his opening bid for the cliff negotiations... With unemployment still way too high, we need to continue to support workers’ paychecks and temporarily offset some of the fiscal contraction from the tax increases and spending cuts that are likely to come out of the cliff negotiations.

I know that adding a spending program to a deficit reduction package may sound counterintuitive, but it’s really countercyclical. And by dint of being temporary—we could even write in the legislation that it expires when unemployment goes (and stays) below 7%–it won’t affect the medium-term deficit. ...

I think the payroll tax should be extended, but as I noted when this first came up, I'd prefer the "optics" to be different:

I see the payroll tax reduction as potentially troublesome... Though the revenue the Social Security system loses due to the tax cut will be backfilled from general revenues, the worry is that the tax cut will not expire as scheduled -- temporary tax cuts have a way of turning permanent. That's especially true in this case since labor markets are very unlikely to recover within the next year and it will be easy to argue against the scheduled "tax increase" for workers. In fact, it will never be a good time to increase taxes on workers and if the tax cut is extended once, as it's likely to be, it will be hard to ever increase it back to where it was. That endangers Social Security funding -- relying on general revenue transfers sets the system up for cuts down the road -- and for that reason I would have preferred that this be enacted in a way that produces the same outcome, but has different political optics. That is, leave the payroll tax at 6% on the books and keep sending the money to Social Security, and fund a 2% tax "rebate" out of general revenues. The rebate would come, technically, as a payment from general revenues rather than through a cut in the payroll tax, but in the end the effect would be identical. But the technicality is important since it preserves the existing funding mechanism for Social Security even if the taxes are permanently extended.

[On the connection between the payroll tax and support for Social Security, see here. As Bruce Bartlett notes while expressing similar worries, "Arch Social Security hater Peter Ferrara once told me that funding it with general revenues was part of his plan to destroy it by converting Social Security into a welfare program, rather than an earned benefit. He was right."]

'The Outlook Has Already Improved'

Laura D’Andrea Tyson:

... The single most important factor behind the projected growth in federal spending is the growth in health care spending, driven primarily by the growth in Medicare spending per beneficiary.

The outlook has already improved as a result of significant changes in the delivery and payment of health care services in the Affordable Care Act. As a result of these changes, growth in Medicare spending per enrollee is projected to slow to 3.1 percent a year during the next decade, about the same as the annual growth of nominal G.D.P. per capita and about two percentage points slower than the annual growth of private insurance premiums per beneficiary.

Speeding up the pace of the Affordable Care Act changes along with others, such as reducing subsidies for high-income beneficiaries and drug benefits and introducing small co-pays on home health-care services, would mean even larger Medicare savings.

A “structural reform” popular among Republican deficit hawks like Representative Paul Ryan of Wisconsin to convert Medicare to a premium-support or voucher system would be counterproductive and would drive up both spending per beneficiary and overall costs in the health care system.

The goal of a “go big” plan for deficit reduction should be to ensure the economy’s long-term growth and competitiveness. Yet the debate over spending in Washington is fixated on cutting entitlement spending. Very little is heard about the need to increase federal spending in education and training, research and development and infrastructure, three areas with proven track records in rate of return, job creation, opportunity and growth. ...

'The Multiplier is at Least Two'

For infrastructure spending, in particular spending on roads and highways, Sylvain Leduc and Daniel Wilson "find that the multiplier is at least two":

Highway Grants: Roads to Prosperity?, by Sylvain Leduc and Daniel Wilson, FRBSF Economic Letter: Increasing government spending during periods of economic weakness to offset slower private-sector spending has long been an important policy tool. In particular, during the recent recession and slow recovery, federal officials put in place fiscal measures, including increased government spending, to boost economic growth and lower unemployment. One form of government spending that has received a lot of attention is public investment in infrastructure projects. The 2009 American Recovery and Reinvestment Act (ARRA) allocated $40 billion to the Department of Transportation for spending on the nation’s roads and other public infrastructure. Such public infrastructure investment harks back to the Great Depression, when programs such as the Works Progress Administration and the Tennessee Valley Authority were inaugurated.

One criticism of public infrastructure programs is that they take a long time to put in place and therefore are unlikely to be effective quickly enough to alleviate economic downturns. The fact is, though, that surprisingly little empirical information is available about the effect of public infrastructure investment on economic activity over the short and medium term.

This Economic Letter examines new research (Leduc and Wilson, forthcoming) on the dynamic effects of public investment in roads and highways on gross state product (GSP), the total economic output of a state. This research focuses on investment in roads and highways in part because it is the largest component of public infrastructure in the United States. Moreover, the procedures by which federal highway grants are distributed to states help us identify more precisely how transportation spending affects economic activity.

We find that unanticipated increases in highway spending have positive but temporary effects on GSP, both in the short and medium run. The short-run effect is consistent with a traditional Keynesian channel in which output increases because of a rise in aggregate demand, combined with slow-to-adjust prices. In contrast, the positive response of GSP over the medium run is in line with a supply-side effect due to an increase in the economy’s productive capacity.

We also assess how much bang each additional buck of highway spending creates by calculating the multiplier, that is, the magnitude of the effect of each dollar of infrastructure spending on economic activity. We find that the multiplier is at least two. In other words, for each dollar of federal highway grants received by a state, that state’s GSP rises by at least two dollars.

The Federal-Aid Highway Program

The federal government’s involvement in financing road construction goes back to the early part of the past century. Although initially small, this involvement became much more significant in 1956 with the enactment of the Federal-Aid Highway Act, which authorized almost $34 billion in 1956 dollars over 13 years for the construction of the Interstate Highway System. At the time, The New York Times noted that “the highway program will constitute a growing and ever-more-important share of the gross national product … (affecting) every phase of economic life in this country.”

The Interstate Highway System was completed in 1992. Since then, the federal government has continued to provide funding to states mostly through a series of grant programs collectively known as the Federal-Aid Highway Program (FAHP). The FAHP helps fund construction, maintenance, and other improvements on a wide range of public roads beyond the interstate highways. Local roads are often considered federal-aid highways and are eligible for federal funding, depending on how important the federal government judges them to be.

Because road projects typically take a long time to complete, advance knowledge of future funding sources can help smooth planning. Congress designs transportation legislation to minimize uncertainty. First, it enacts legislation that typically extends five to six years. Second, it apportions funds to states according to set formulas. Thus, a typical highway bill will specify an annual national amount for each highway program over the life of the legislation and spell out the formula by which that program’s national amount will be apportioned to states. Importantly, these formulas are based on road-related metrics measured several years earlier. That means that changes to current and future highway funding are not driven by current economic conditions.

Highway bills generally include information that helps states forecast relatively accurately the amount of grants they are likely to receive while the legislation is in effect. For the past two highway bills, the Federal Highway Administration (FHWA) published forecasts of each state’s annual future grants under each program.

Estimating the effects of road spending

We conduct a statistical analysis to estimate the effects of federal highway spending on state economic activity. Specifically, we construct a variable that captures revisions to forecasts of current and future highway grants to the states, based on information from highway bills since 1991. We closely follow, but also expand on, the FHWA’s methodology for forecasting each state’s future grants.

These forecast revisions serve as proxies for changes in expectations about current and future highway spending in a given state. In economic terms, these changes can be regarded as shocks, that is, unanticipated events that affect economic activity.

We study forecast revisions rather than changes in actual highway spending for two reasons. First, actual spending may both affect and be affected by current economic conditions, making it difficult to sort out the true causal effects of the spending.

Second, changes in actual spending are most likely to be anticipated years in advance. For that reason, some of their economic effects may be felt before the spending changes actually take place. For instance, a state government and other important players, such as construction and engineering firms, may decide to spend more today if they expect the state to receive more highway grants in the future. In this way, changes in expectations regarding future grants to the states may be important for current economic activity. Failing to account for changes in expectations may lead to incorrect conclusions about how government spending affects economic activity (see Ramey 2011a).

Figure 1
Average response of state GDPs to unexpected grants

In our analysis of how changes in forecasts of highway grants to the states affect state GSP, we control for lags in state GSP, lags in receipt of highway grants, average state GSP levels, and national movements of gross domestic product (GDP) over the sample period from 1990 to 2010.

In Figure 1, the solid line shows the average percentage change in a state’s GSP following a 1% increase in forecasted future highway grants to the states. The shaded area around the line represents a 90% probability range. The horizontal axis indicates the number of years after the unanticipated change in forecasted highway grants to the states. The figure shows that changes in the forecasts have a significant short-term effect on state output in the first one to two years. This effect fades, but then increases sharply six to eight years after the forecast revisions, before declining again. This pattern holds up well with alternative estimation techniques, the inclusion of different control variables, and with different data samples.

This pattern is consistent with New Keynesian theoretical models in which public infrastructure, such as roads, are used by the private sector in the production of goods and services and take time to be built (see Leduc and Wilson, forthcoming). In this framework, the initial impact is due to a traditional Keynesian effect of an increase in aggregate demand. The medium-term effect on output arises once the public infrastructure is built, thus increasing the economy’s productive capacity.

The highway grant multiplier

One concept often used to assess the effectiveness of government spending is the multiplier. The fiscal multiplier represents the dollar change in economic output for each additional dollar of government spending. Thus, a multiplier of two implies that, when government spending increases by one dollar, output rises by two dollars.

Based on the results shown in Figure 1, we find that multipliers for federal highway spending are large. On initial impact, the multipliers range from 1.5 to 3, depending on the method for calculating the multiplier. In the medium run, the multipliers can be as high as eight. Over a 10-year horizon, our results imply an average highway grants multiplier of about two.

Our estimated multipliers are noticeably larger than those typically found in the literature on the effects of government spending. For instance, in a recent survey, Valerie Ramey reports multipliers between 0.5 and 1.5 (see Ramey 2011b). One possible reason for the wide differences is that we consider a very different form of government spending. Most of the literature concentrates on the multiplier effect of military spending. But such spending is arguably nonproductive in an economic sense. By contrast, government investment in infrastructure, such as roads, can raise the economy’s productive capacity. In that respect, it can have a higher fiscal multiplier. Another difference is that we concentrate on the multiplier effect on GSP, while the literature typically studies the effect on U.S. GDP as a whole.

The American Recovery and Reinvestment Act

The deep recession of 2007–09 led to the enactment of ARRA, which included a large one-time increase of $27.5 billion in federal highway grants to states. ARRA was designed to have strong short-term effects. In general, infrastructure projects are not viewed as effective forms of short-term stimulus because of the long lags between authorization, planning, and implementation. By the time the projects get under way, a recession may be over. The extra spending could ultimately end up feeding an already booming economy. To address this problem, ARRA stipulated that state governments had to fully use their share of federal highway grants by March 2010.

It is conceivable that highway spending during a major downturn, when productive capacity is underutilized, may affect output in a substantially different way than spending during more normal times. To test this, we examined whether unanticipated changes in highway spending in 2009 and 2010 had a different effect on GSP than in other years in our sample. We found that spending in 2009 and 2010 was roughly four times as large as the peak response shown in Figure 1. This suggests that highway spending can be effective during periods of very high economic slack, particularly when spending is structured to reduce the usual implementation lags.

Conclusion

Surprise increases in federal investment in roads and highways appear to have had positive effects on gross state product in both the short and medium run. The short-run impact is akin to the traditional Keynesian effect that stems from an increase in aggregate demand. By contrast, the positive impact on GSP in the medium run is probably due to supply-side effects that boost the economy’s productive capacity. Infrastructure investment gets a good bang for the buck in the sense that fiscal multipliers—the dollar of increased output for each dollar of spending—are large.

References

Leduc, Sylvain, and Daniel J. Wilson. Forthcoming. “Roads to Prosperity or Bridges to Nowhere? Theory and Evidence on the Impact of Public Infrastructure Investment.” NBER Macroeconomics Annual 2012.

Ramey, Valerie A. 2011a. “Identifying Government Spending Shocks: It’s all in the Timing.” Quarterly Journal of Economics 126(1), pp. 1–50.

Ramey, Valerie A. 2011b. “Can Government Purchases Stimulate the Economy?” Journal of Economic Literature 49(3), pp. 673–685.

Underinvesting in Resilience: The Role of Automatic Stabilizers

A Romney win would have provided fertile ground for econ blogging -- there were so many polices that I passionately disagree with. But even though it makes the job here a little tougher, and not quite as fun, I'll take the outcome we got. There will still be plenty to complain about in a second Obama administration, and the top priority for me is protecting social insurance programs from the cuts that the Republicans and misguided, centrist, grand bargain types on the left would like to make.

The other thing I would like to push even though it is pretty much hopeless to expect much change is our approach to fiscal policy. In deep recessions, we need it to buttress our monetary policy efforts with fiscal policy, but as it stands discretionary fiscal policy is largely dysfunctional due to the inability of Congress to agree on how to proceed (that would be easier to understand if it was simply an honest disagreement over the underlying economics, but politics -- winning the next election -- gets in the way and obstructs the ability of fiscal policymakers to respond to economic downturns).

But while discretionary policy is generally difficult to implement, and usually suboptimal when it is, another type of policy, what are known as automatic stabilizers, did much better (much of the increase in spending during the recessions was due to social programs expanding as conditions worsened). To the extent that we can shift policy from discretionary to automatic -- spending and tax cuts that kick in automatically when economic conditions deteriorate, and reverse themselves when things improve -- we would be better off.

We will worry a lot about improving the equivalent of automatic stabilizers for natural disasters in light of events like Sandy and Katrina. For example, Michael Spence could be writing about automatic versus discretionary fiscal policy instead of preparedness for national disasters:

Underinvesting in Resilience, by Michael Spence, Commentary, Project Syndicate:  ... There are two distinct and crucial components of disaster recession preparedness. The one that understandably gets the most attention is the capacity to mount a rapid and effective response. Such a capacity will always be necessary, and few doubt its importance. When it is absent or deficient, the loss of ... livelihoods can be horrific...

The second component comprises investments [in automatic stabilizers] that minimize the expected damage to the economy. This aspect of preparedness typically receives far less attention. ...

Recessions like we have just been through are costly in both personal and economic terms, and we need to worry just as much about fixing fiscal policy -- both our preparedness to ease damage with automatic stabilizers and our ability to respond rapidly with additional fiscal policy measures -- as we do about preparing for hurricanes. We will likely think hard about ways to improve hurricane preparedness, but, unfortunately, there are few signs that politicians even understand what a disaster fiscal policy has been -- how much blame they should shoulder for the continuing unemployment problem for example. Since the first step in fixing a problem is recognizing you have one, I have little hope that any effort will be devoted to improving our ability to use fiscal policy to respond in deep recessions (there are ideological barriers as well, and while the mounting evidence that fiscal policy works ought to break those barriers down, that hasn't happened).

[See also: Putting Fiscal Policy on Autopilot, a column I wrote on this in late 2010.]

'The Challenge Now is to Maintain Fiscal Stimuli'

Richard Koo:

Explain the disease to help US citizens, by Richard Koo, Commentary, Financial Times: .... Today, the US private sector is saving a staggering 8 per cent of gross domestic product – at zero interest rates, when households and businesses would ordinarily be borrowing and spending money. ... This is the result of the bursting of debt-financed housing bubbles, which left the private sector with huge debt overhangs ... giving it no choice but to pay down debt or increase savings, even at zero interest rates.

However, if someone is saving money or paying down debt, someone else must be borrowing and spending that money to keep the economy going. ... With monetary policy largely ineffective and the private sector forced to repair its balance sheet, the only way to avoid a deflationary spiral is for the government to borrow and spend the unborrowed savings in the private sector. ... The challenge now is to maintain fiscal stimuli until private sector deleveraging is completed. ...

...Average citizens find it hard to understand why the government should not balance its budget when households and businesses must all do so. It is risky for politicians to explain but, until they make it clear that the economy will implode if everybody is saving and nobody is borrowing, public support for the necessary fiscal stimulus is likely to weaken, as seen during the past four years of the Obama administration.

The US economy is already losing forward momentum as the 2009 fiscal stimulus is allowed to expire. There is no time to waste: the government must take up the private sector’s unborrowed savings... Fiscal consolidation should come only once the private sector has repaired its finances and returned to profit-maximizing mode. ...

I'm a bit more confident in monetary policy than he is, but to repeat what's been said here many, many times, monetary policy alone is far from enough, and more fiscal policy (e.g. spending on infrastructure) is needed to help the economy recover. It will still take time no matter what we do, there are no quick cures, but policy can still make a difference. (I know this message is repetitive, and that there's little chance of fiscal stimulus actually happening -- I'll be satisfied if Congress keeps its harmful austerity instincts under control and avoids big cuts that would further slow the recovery -- but I believe this is the right policy, and it's worth repeating now and then.)

'Being Rude about Austerity'

Simon Wren-Lewis tries to get his anger over austerity under control:

How rude should I be about policymakers?...I have to say that the 2010 switch from fiscal expansion to austerity does make me very angry. I’d like to think that this is just because of the immense harm it is doing, but there is something else as well. It represents the abrogation of knowledge: knowledge which, largely through accident, I was particularly aware of. I think this is something that even economists who are not macroeconomists, and not just non-economists, do not fully appreciate. In the mid-2000s my main research was on monetary and fiscal policy interactions, and this was a field that appeared to be characterised by considerable common ground, and certainly not by alternative ‘schools of thought’. Some of this knowledge began to be applied in 2008/9, and even an institution like the IMF which was famed for its fiscal conservatism was quite happy applying that knowledge.

It is as if you are a doctor, treating a patient with proven but also state of the art medication. The patient is not well but the treatment you are applying is working. Then suddenly the hospital administrator tells you to stop, because the drugs are expensive and they would like to try some spiritual healing instead. And, in case you ask, the financial crisis did not suddenly render the sum of macroeconomic knowledge accumulated over the previous decades obsolete (whether embodied in textbooks or DSGE models).

But in a sense all this makes trying to be dispassionate about the reasons for the switch to austerity all the more important. So here is a list. I’ve talked about all of these before, but not in one place. These reasons for advocating austerity are not in order of their relevance (see Farrell and Quiggin (pdf) for the basis of such an assessment), but I am going to give them marks out of ten, where the lower the mark the more rudeness is justified. ...

I think it's also important to ask, beyond what justifies rudeness -- it is certainly justified when it comes to advocates of harmful austerity -- how effective rudeness will be in changing minds. To me, that's the real goal (though the goal may not be to change the mind of the person making a particular claim, rudeness toward the source of an outlandish claim may be an effective way to change the mind of other people, but even then rudeness has its limits).

'Why Should Government Respond Differently to Natural vs. Economic Disasters?'

Speaking of (the lack of) fiscal policy to address problems like long-term unemployment:

Why Should Government Respond Differently to Natural vs. Economic Disasters?, by David Callahan, American Prospect: ...Natural disasters are often highpoint moments for the public sector, reminding us of the power of common institutions that allow citizens to help each other in times of need. The residents, say, of sunny Los Angeles needn't do anything special at this moment, because they have already been doing something—helping fund FEMA with their tax dollars so that it has the capacity to respond...

But here's a question: If most of us take for granted that we should be there for our fellow citizens during natural disasters, using the tool of government, why is it so controversial that we should also lend a helping hand during man-made economic disasters? Why are unemployment benefits under attack in numerous states, even as millions remain jobless through no fault of their own? Why is an idea as obvious as a direct government jobs program off the table in Washington?

The answer is no great mystery: Critics of a government safety net tend to think that individuals will solve their own economic problems...

Even if you believe that individual willpower matters a lot, as I do, it's naive to imagine that individuals can do much in the face of large-scale economic downturns driven by structural factors that are national  and even global in scope. ... Meanwhile, charity will simply never have enough resources to provide a decent safety net...

In the wake of Hurricane Sandy, you won't hear public officials ... saying that devastated towns should pull themselves up by their bootstraps. No one thinks that government should walk away with the recovery job only half done.

Likewise, we should never walk away from the victims of man-made economic disasters when they are still suffering acutely. Yet that is what existing public policy is doing right now. ...

'Little Federal Help for the Long-Term Unemployed'

Fiscal policymakers have dropped the ball on job creation, and it could turn out to be a costly error:

Little Federal Help for the Long-Term Unemployed, by Annie Lowrey and Catherine Rampell, NY Times: In the economy-focused presidential campaign, the two candidates and their teams have scarcely mentioned what economists describe as not just one of the labor market’s most pressing problems, but the entire country’s: long-term unemployment.

Nearly five million Americans out of work for more than six months are left to wonder what kind of help might be coming, as the Federal Reserve, the International Monetary Fund and a bipartisan swath of policy experts implore Washington to act — both to alleviate human misery and to ensure the strength of the economy. ...

On the agenda for the next Congress and the next president is ensuring that the unusually long spells of unemployment now afflicting jobless workers remain a temporary setback of the recession.

Economists warned that long-term unemployment could be transformed in the next few years into structural unemployment, meaning that the problem is not just too few jobs and too many job seekers, but a large group of workers who no longer match employers’ needs or are no longer considered employable. ...

In Washington, many politicians support measures for the long-term unemployed; few demand them...

'White House Quells Talk of New Tax Cuts'

Given how slow the recovery has been, we should at least try to maintain the fiscal stimulus we have. And if we can help middle class households a bit at the same time, so much the better. Unfortunately:

White House quells talk of new tax cuts, by James Politi, FT: The White House has sought to damp speculation it is considering new tax cuts for the middle class, as it comes under pressure from fellow Democrats to limit the economic damage from the expiration of the payroll tax cut at the end of the year.

The expected increase in payroll tax would be one element of the “fiscal cliff” ... that would shrink the disposable income of middle-class American workers. One option for Barack Obama would be to propose new temporary tax breaks for the middle class, which would go a long way towards easing those concerns.

However, such a move would probably face resistance from Republicans...

I guess that settles it. There's no way to use the fact that Republicans are proposing tax cuts for the wealthy while resisting a tax cut that helps the middle class to any political advantage. Republicans would resist, so why bother?

Romer: The Fiscal Stimulus, Flawed but Valuable

Christina Romer:

The Fiscal Stimulus, Flawed but Valuable, by Christina Romer, Commentary, NY Times: As a former member of President Obama's economic team, I have a soft spot for the fiscal stimulus legislation... But I'm also an empirical economist who's spent a career trying to estimate the effects of monetary and fiscal policy. So let me put on my empiricist's hat and evaluate what we know about the legislation's effects. ...

After going through the considerable historical and empirical evidence that the fiscal stimulus worked, she concludes:

Though the Recovery Act appears to have had many benefits, it could have been more effective. Most obviously, it was too small. When we were designing it, most forecasters estimated that the United States would lose around six million jobs... Compared with this baseline, creating three million jobs would have filled roughly half of the employment hole. As it turned out,... the correct no-stimulus baseline was a total employment fall of nearly 12 million. With a loss that big, creating three million jobs was helpful, but not nearly enough.

A different mix of spending increases and tax cuts might also have been desirable. ... And I desperately wish we'd been able to design a public employment program that could have directly hired many unemployed workers, especially young people.

Finally, there's little question that policy makers — myself included — should have worked harder to earn the public's support... One frustrating anomaly is that many of its individual components routinely received favorable reactions in polls, while the overall act was viewed negatively. ...

Recovery measures work better when they raise confidence — as Franklin D. Roosevelt understood. ... Recent research suggests that New Deal programs may actually have had their primary impact on the economy by influencing consumer and business expectations of future growth and inflation.

Partly because of fierce political opposition, and partly because of ineffective communication and imperfect design, the Recovery Act generated little such rebound in confidence. As a result, it didn't have that extra, Rooseveltian kick. ...

I believe that as more research occurs and the political rancor fades, the fiscal stimulus will be viewed as an important step at a bleak moment in our history. Not the knockout punch the administration had hoped for, but a valuable effort that improved the lives of many.

That seems to come dangerously close to saying that a "Mr. Awesome" as president might have made the recovery much better. But not quite, at least not if one has Romney's claims about himself in mind. As Paul Krugman noted in his last column, Mr. Romney "doesn’t have a plan. ... Mr. Romney himself asserted that he would give a big boost to the economy simply by being elected, 'without actually doing anything'..., the true Romney plan is to create an economic boom through the sheer power of Mr. Romney’s personal awesomeness."

To put it another way, Romney would cure the economy by relying upon a placebo effect, an effect that somehow works through the powers of his personality. The Obama cure provided too little medicine, and there was not enough communication with the patient -- both could have been improved -- but the medicine it did provide was real, not a placebo, and it did have positive effects.

Helicopter Money

Simon Wren-Lewis:

... In this sense, helicopter money is just another name for a fiscal stimulus combined with QE. We have the QE, so why not call for fiscal stimulus rather than helicopter money?

Much more here.

Paul Krugman: Triumph of the Wrong?

Republicans believe that austerity promotes recovery, but when other countries have tried this the results have been disastrous:

Triumph of the Wrong?, by Paul Krugman, Commentary, NY Times: In these closing weeks of the campaign, each side wants you to believe that it has the right ideas to fix a still-ailing economy. So here’s what you need to know: If you look at the track record, the Obama administration has been wrong about some things, mainly because it was too optimistic about the prospects for a quick recovery. But Republicans have been wrong about everything.

About that misplaced optimism: In a now-notorious January 2009 forecast, economists working for the incoming administration predicted that by now most of the effects of the 2008 financial crisis would be behind us... It wasn’t exaggerated faith in the ... stimulus plan; the report predicted a fairly rapid recovery even without stimulus. Instead, President Obama’s people failed to appreciate something that is now common wisdom among economic analysts: severe financial crises inflict sustained economic damage, and it takes a long time to recover.

This same observation, of course, offers a partial excuse for the economy’s lingering weakness. And the question we should ask given this unpleasant reality is what policies would offer the best prospects for healing the damage. Mr. Obama’s camp argues for ... the American Jobs Act. Republicans, on the other hand, insist that the path to prosperity involves sharp cuts in government spending.

And Republicans are dead wrong.

The latest devastating demonstration of that wrongness comes from the International Monetary Fund... What the monetary fund shows is that ... spending cuts appear to have done even more harm than most analysts — including those at the I.M.F. itself — expected.

Which brings us to the question of what form economic policies will take after the election.

If Mr. Obama wins, he’ll presumably go back to pushing for modest stimulus, aiming to convert the gradual recovery ... into a more rapid return to full employment.

Republicans, however, are committed to an economic doctrine that has proved false, indeed disastrous, in other countries. Nor are they likely to change their views in the light of experience. After all,... the ... party remains opposed to effective financial regulation despite the catastrophe of 2008; it remains obsessed with the dangers of inflation despite years of false alarms. ...

And here’s the thing: if Mitt Romney wins the election, the G.O.P. will surely consider its economic ideas vindicated. In other words, politically good things may be about to happen to very bad ideas. And if that’s how it plays out, the American people will pay the price.

'Underestimating Fiscal Policy Multipliers'

Antonio Fatás argues that fiscal policy multipliers are larger than the ideologues have led many people to believe:

Underestimating Fiscal Policy Multipliers, by Antonio Fatás: The October edition of the IMF World Economic Outlook is out with very strong warnings about risks to growth (full report can be found at the IMF web site). In Chapter 1 there is a nice analysis about whether in our most recent growth forecasts we have recently underestimated fiscal policy multipliers. ...

And the answer is yes and here is my reading of what has happened. About eleven years ago there was a series of academic papers that estimated fiscal policy multipliers. The conclusion of the earlier papers is that multipliers were somewhere in the range 1-1.5. ... This was the conclusion I reached together with my co-author back in 2001 (paper is available at my web site).  This was also the conclusion of the paper written by Oliver Blanchard and Roberto Perotti written around the same time and available here. The academic literature on this issue grew very fast with a large number of papers confirming the earlier estimates but also with a set of other papers that challenge the size of fiscal multipliers. In particular, papers that used events such as wars tended to find smaller multipliers. Because this is about fiscal policy, the debate has not gone away and there are still those who believe that multipliers are close to zero or even negative...

Despite the debate, my reading of the literature up to that point was that there was a significant amount of consensus around multipliers being around or slightly above 1.

As soon as the 2008 crisis started the debate went from a simple academic discussion to an urgent policy issue. ... Since then the debate has become much more ideological than academic. We have had a series of additional academic papers that, if anything, suggest that multipliers are even larger than the initial estimates because of the special circumstances we are in (monetary policy stuck at the zero-lower bound and a deep recession caused by develeraging forces that reduce private demand).

But these new (and old) academic results have simply be displaced by the ideological debate that followed the fiscal policy stimulus of the 2008-2009 period, which somehow led to the conclusion that those policies did not work and that what we now needed was more austerity. And when over the last two years we forecasted GDP growth rates in the face of coordinated austerity by many governments we somehow forgot to consider that multipliers can be large.

This is what the IMF suggests now in their analysis, which, by the way, is also self critical. They look at their recent forecasts for global growth and they suggest that their model was implicitly using fiscal policy multipliers around 0.5 when measuring the impact of fiscal consolidation. Given that their GDP growth forecast has been overestimating growth, the IMF now wonders whether multipliers are higher than 0.5. The analysis in the current World Economic Outlook suggests that multipliers might be within the range 0.9 to 1.7. A range which happens to be very almost identical to the one produced by the early papers and confirmed by the most recent academic literature. It is also not far from what most economic models would predict given current economic conditions.

Stiglitz: Monetary Mystification

Busy day today -- so a quick one. Joe Stiglitz argues that recent monetary policy initiatives by the Fed and the ECB won't be anywhere near enough to produce an economic revival, and that "the stimulus that is needed – on both sides of the Atlantic – is a fiscal stimulus":

Monetary Mystification, by Joseph Stiglitz, Commentary, Project Syndicate: Central banks on both sides of the Atlantic took extraordinary monetary-policy measures in September: the long awaited “QE3”..., and the European Central Bank’s announcement that it will purchase unlimited volumes of troubled eurozone members’ government bonds. Markets responded euphorically... Others, especially on the political right, worried that the latest monetary measures would fuel future inflation...

In fact, both the critics’ fears and the optimists’ euphoria are unwarranted..., the stimulus that is needed – on both sides of the Atlantic – is a fiscal stimulus. Monetary policy has proven ineffective, and more of it is unlikely to return the economy to sustainable growth. ...

Of course, marginal effects cannot be ruled out: small changes in long-term interest rates from QE3 may lead to a little more investment; some of the rich will take advantage of temporarily higher stock prices to consume more; and a few homeowners will be able to refinance their mortgages, with lower payments allowing them to boost consumption as well. ...

For both Europe and America, the danger now is that politicians and markets believe that monetary policy can revive the economy. Unfortunately, its main impact at this point is to distract attention from measures that would truly stimulate growth, including an expansionary fiscal policy and financial-sector reforms that boost lending. ...

I'm a bit more optimistic than he is about what monetary policy can do. But I also think that fiscal policy is needed to really make a difference, and, like Stiglitz, I worry that too much faith and emphasis on monetary policy has let fiscal policymakers off the hook.

'This is Not Structural, This is Cyclical'

Dear Stephen Roach (and Jeff Sachs, who has been similar things). Please listen to Antonio Fatás:

Cyclical Zombies: Stephen Roach argues in this article that the "current medicine being applied to America's economy" is wrong. The real disease is a "protracted balance-sheet recession that has turned a generation of America’s consumers into zombies – the economic walking dead. Think Japan, and its corporate zombies of the 1990’s. Just as they wrote the script for the first of Japan’s lost decades, their counterparts are now doing the same for the US economy".

This is an argument that has been used before during the current crisis: we are trying to fix a structural problem with medicine that can only deal with cyclical misalignments. Using Roach's words: "Steeped in denial, the Federal Reserve is treating the disease as a cyclical problem – deploying the full force of monetary accommodation to compensate for what it believes to be a temporary shortfall in aggregate demand."

There is no doubt that asset bubbles and excessive optimism during the pre-crisis years are now reflected in weak balance sheets that will take time to fix and will represent a drag on growth. And this clearly is not a mere cyclical issue. But there is something else that is going on: advanced economies have gone through a deep recession and are still producing below potential. This is not structural, this is cyclical. And finding a solution to the structural problem in the middle of a recession is not easy. While households have to reduce spending to repair their balance sheets, doing so at the same time that income is below potential just becomes more painful. Monetary and fiscal policy cannot eliminate the effort that is associated with deleveraging but they need to ensure that this happens in the least painful way. And this requires producing a path for output and income in the short run that is as close as possible to the level of potential output. We can debate about what this level should be but it is hard to argue that given current economic conditions and high levels of unemployment we are close to potential.

'Paul Ryan’s Magic Budget Caps'

Ezra Klein on budget caps:

Paul Ryan’s magic budget caps, by Ezra Klein: I’ve gotten some confused e-mails over David Rogers’ report on Paul Ryan’s ... decision to cap the growth of Medicare spending at GDP+0.5 percentage points (a rate that is slower than health-care costs typically grow) to make the rest of his budget numbers add up. ...

Ryan needs these caps because there’s no good evidence that any of his premium support plans will actually save much money in Medicare. ... So he includes these caps and tells the CBO that if his premium support plan fails, he’ll save the money in a different way. In his 2011 budget proposal, that’s through shifting costs to seniors. In Ryan’s most recent budget, it’s left blank. But the CBO has no choice. They have to assume Congress will abide by the cap.

This isn’t a trick unique to Paul Ryan. President Obama’s budget proposal also includes a GDP+0.5 percentage point cap on Medicare’s spending growth. ... The Simpson-Bowles plan is also thick with spending caps. ...

One of our worst tendencies in Washington is to debate budget plans ... dependent on these kinds of caps. The question ... isn’t whether it says it will save money, but whether the policies in it will actually save money. If Ryan’s fond hopes for premium support don’t pan out, then his budget has no chance of meeting its targets. Similarly, if Medicare proves incapable of saving money by paying for quality, Obama’s numbers aren’t going to happen. And for all that you hear about how Congress should “just pass Simpson-Bowles,” if Congress can’t figure out the right mix of policies to hit those caps, then Simpson-Bowles won’t solve our deficit problems. 

These questions, in the end, require a judgment about what’s actually the best way to save money in the health-care system, how we can raise more tax revenue, or what will move the needle on growth. But too often, when we say we’re debating budget policy, we’re actually just debating budget caps. And budget caps don’t work if the underlying policies fail.

From a footnote that shouldn't be overlooked, more on Paul Ryan's budget wonkery (or maybe it should be wankery):

Ryan also caps other forms of spending, and his most recent budget implausibly assumes that all non-entitlement spending will fall from 12.5 percent of GDP today to 3.75 percent of GDP in 2050. This is more important to his numbers than his Medicare plan, and it’s also a complete joke. See page 13 of the CBO report for more.

I think people take the budget promises issued in campaigns with a grain of salt. It's the underlying philosophy behind the promises that's important. Who are the winners and losers under each of the plans? That's one thing I'd like to see the press pay more attention to. But even more important, I think, is for the press to stop playing along with fear-mongering over the deficit designed to force cuts to programs that will do little to address the long-run problem. We do have debt problems, but do people understand the precise nature of the problem, when the big budget problems are likely to arise, and why? How many people think our long-run budget problem has something to do with the stimulus package, for example, when that is simply not the case? I'm all for more precision in the discussion of budget plans, and for being clear about credible versus non-credible assumptions that the CBO must honor. But I also think the public needs a much better understanding of the problem before they can evaluate the efficacy of proposed solutions.

Summers: Britain Risks a Lost Decade

Larry Summers says Britain needs to change course, or risk prolonged stagnation:

Britain risks a lost decade unless it changes course, by Lawrence Summers, Commentary, Financial Times: It ... is fair to ask economists a fundamental question: what could happen that would cause you to revise your views of how the economy operates and acknowledge that the model you had been using was flawed? As a vigorous advocate of fiscal expansion as an appropriate response to a major economic slump in an economy with zero or near-zero interest rates, I have for the past several years suggested that if the British economy – with its major attempts at fiscal consolidation – were to enjoy a rapid recovery, it would force me to substantially revise my views about fiscal policy and the macroeconomy.

Unfortunately for the British economy, nothing in the past several years compels me revise my views. ...

Britain must change the pace of fiscal consolidation to stand a chance of avoiding a lost decade. Rather than starving public investment, now is the time to add to confidence by making plans for structural reforms to contain the growth of public consumption spending over time. It is also time to take overdue measures to promote exports and, after years of appropriately low investment, to restart housing investment. But when demand is needed for growth and the private sector is hanging back, the first priority must be for the public sector to stop exacerbating the contraction.

If we follow Britain, as many in the "Mitt for President" camp would have us do, we face the same risk.

Paul Krugman: The iPhone Stimulus

The economic boost expected from the iPhone 5 shows that "the government should spend more, not less, in a depressed economy":

The iPhone Stimulus, by Paul Krugman, Commentary, NY Times: Are you, or is someone you know, a gadget freak? If so, you doubtless know that Wednesday was iPhone 5 day...

What I’m interested in ... are suggestions that the unveiling of the iPhone 5 might provide a significant boost to the U.S. economy... Do you find this plausible? If so, I have news for you: you are, whether you know it or not, a Keynesian — and you have implicitly accepted the case that the government should spend more, not less, in a depressed economy. ...

The ... reason JPMorgan believes that the iPhone 5 will boost the economy ... is simply that it will induce people to spend more.

And to believe that more spending will provide an economic boost, you have to believe — as you should — that demand, not supply, is what’s holding the economy back. ... And the solution is to find some way to increase overall spending so that the nation can get back to work.

So where can more spending come from? Businesses are sitting on lots of cash but, for the most part, have seen little reason to do a lot of investment. ... And because businesses aren’t spending a lot, incomes are low, so consumer demand is low, which perpetuates those low sales. ...

Why not have the government step in and spend more, say on education and infrastructure, to help the economy through its rough patch? Don’t say that the government can’t add to total spending, or that government spending can’t create jobs. If you believe that the iPhone 5 can give the economy a lift, you’ve already conceded ... that more spending is what we need. And there’s no reason this spending has to be private.

Yet far from using public spending to support the economy in its time of trouble, our political system — driven by a combination of ideology, exaggerated deficit fears and Republican obstructionism — has moved to make the depression worse. Yes, unemployment benefits and food stamps are up, because so many more people are in need; but government employment has plunged, as has public investment.

Now, despite all this, we will eventually recover. Over time there will be more equipment that needs replacing, more iPhone-like innovations that boost spending, and, in the long run, we will exit this economic trap. But, as Keynes famously pointed out in another context, in the long run we are all dead. To borrow a phrase from myself, why not end this depression now?

Republicans on Infrastructure: We Won’t Build That

A column from two weeks ago (new one tomorrow):

We Won’t Build That, by Mark Thoma: Once the Republican National Convention in Tampa Bay, Florida ends, all eyes will turn to this year’s Federal Reserve conference in Jackson Hole, Wyoming. At the 2010 conference, Chairman Ben Bernanke gave a speech that paved the way for a second round of quantitative easing, and this year’s speech will be closely watched for hints that the Fed is about to ease policy further in an attempt to help the economy recover.

Discussion in the minutes from the last monetary policy meeting points in the direction of further easing, and most analysts expect that Chairman Bernanke will set the stage for further action. I hope they are correct. The unemployment rate is still far too high, there’s no sign that more aggressive policy would cause inflation to become a problem, and the economy can use all the help it can get. Given the slow pace of the recovery, it’s puzzling why the Fed hasn’t done more to help already.

But I also worry that monetary policy has been oversold. It cannot, by itself, cure the economy’s problems when the downturn is as large as the one we have experienced. In severe recessions, fiscal policy is also needed.

Presently, there are two ways that fiscal policy could be used to promote a faster recovery. The first is infrastructure spending. We cannot afford to fall behind the rest of the world in terms of our infrastructure development, but that’s exactly what we are doing. At a time when interest rates are as low as we are likely to see, when labor and other costs are minimal due to lack of demand during the downturn, and when the need is so high, why aren’t we making a massive investment in infrastructure, which is ultimately an investment in our future? There are many, many public investments we could make where the benefits surely exceed the costs – these are things the private sector won’t do on its own even though they are highly valuable to society – so what are we waiting for?

The second thing that is needed is debt relief for households. Losses in home equity, stock investments, and job opportunities have taken a significant toll on household balance sheets. As households attempt to rebuild what has been lost, they save more and consume less and the loss of consumption is a drag on the recovery. So long as this rebuilding continues, and it can take many years to rebuild after such large losses, the economy will continue to be sluggish. Debt relief, or anything else the government can do to help households overcome their losses, would shorten the recovery.

We have used both monetary and fiscal policy to battle this recession, and without the Fed’s actions to limit the downturn things would have been much worse. Fiscal policy in the form of the stimulus package, though too little, too late, and too tilted towards tax cuts, also helped to limit the damage to the economy. But when it comes to promoting a faster recovery, both monetary and fiscal policymakers have failed to do enough to help the economy return to full employment.

Which brings us back to the Republican National Convention. The economy will be the focus at the convention, and we will hear about the supposed failures of the Fed. For example, one of the biggest applause lines at Ron Paul’s rally in Tampa on Sunday was that “Ben Bernanke is a traitor and dictator,” and Mitt Romney has said he will replace Bernanke, presumably with someone anxious to undo the policies the Fed has put into place rather than expand upon them to promote recovery.

We will also hear claims that, despite growing evidence to the contrary, the fiscal stimulus didn’t work. Criticism about the government debt will surely follow, and it will be clear that there’s no room in Republican plans for infrastructure or debt relief programs to speed the recovery.

If there’s any policy Republicans ought to be able to support, it’s infrastructure spending. It’s inherently a supply-side policy, it helps to promote future economic growth, and it’s an investment with large, positive net benefits. But Republicans see a “we won’t build that” approach to infrastructure spending, an approach that is harmful to our prospects for recovery and to our prospects for future economic growth, as a way to reclaim the presidency.

Romney continues to use the “you didn’t build that” quote – misleadingly – to try to argue that Obama is against business, and that this is one of the key factors holding back the recovery. But the real problem has nothing to do with Obama’s view of business. The real problem is the Republican’s opposition to using monetary or fiscal policy to help the economy in any way, and their “we won’t build that” stance on infrastructure spending is a good example of the extent to which their political aspirations stand in the way of a speedier recovery.

Paul Krugman: Obstruct and Exploit

Republican obstructionism is real, and it's hurting the recovery:

Obstruct and Exploit, by Paul Krugman, Commentary, NY Times: Does anyone remember the American Jobs Act? A year ago President Obama proposed boosting the economy with a combination of tax cuts and spending increases, aimed in particular at sustaining state and local government employment. ... Macroeconomic Advisers estimated that the act would add 1.3 million jobs by the end of 2012. ... The Jobs Act would have been just what the doctor ordered.

But the bill went nowhere, of course, blocked by Republicans in Congress. ... Think of it as a two-part strategy. First, obstruct any and all efforts to strengthen the economy, then exploit the economy’s weakness for political gain. If this strategy sounds cynical, that’s because it is. Yet it’s the G.O.P.’s best chance for victory in November.

But are Republicans really playing that cynical a game? ... As anyone who was paying attention knows, the period during which Democrats controlled both houses of Congress was marked by unprecedented obstructionism in the Senate. The filibuster, formerly a tactic reserved for rare occasions, became standard operating procedure... In ... reality ... most of Mr. Obama’s time in office U.S. fiscal policy has been defined not by the president’s plans but by Republican stonewalling.

The most important consequence of that stonewalling ... has been the failure to extend much-needed aid to state and local governments. Lacking that aid, these governments have been forced to lay off hundreds of thousands of schoolteachers and other workers, and those layoffs are a major reason the job numbers have been disappointing. Since bottoming out a year after Mr. Obama took office, private-sector employment has risen by 4.6 million; but government employment, which normally rises more or less in line with population growth, has instead fallen by 571,000.

Put it this way: When Republicans took control of the House, they declared that their economic philosophy was “cut and grow” — cut government, and the economy will prosper. And thanks to their scorched-earth tactics, we’ve actually had the cuts they wanted. But the promised growth has failed to materialize — and they want to make that failure Mr. Obama’s fault.

Now, all of this puts the White House in a difficult bind. Making a big deal of Republican obstructionism could all too easily come across as whining. Yet this obstructionism is real, and arguably is the biggest single reason for our ongoing economic weakness.

And what happens if the strategy of obstruct-and-exploit succeeds? Is this the shape of politics to come? If so, America will have gone a long way toward becoming an ungovernable banana republic.

A 'Complete Straw Man Mischaracterization of Keynesian Views'

I'm getting tired of Jeff Sachs acting like he is the only one telling the truth about the economy, the problems are all structural we are told despite considerable evidence to the contrary, and -- surprise!!! -- his "truthtelling" somehow leads him to advocate the same pet projects he's been pushing for years.

Krugman covered this in July:

Brad DeLong is baffled by Jeff Sachs, and so am I. Sachs is opposed to fiscal stimulus; I get that. But his argument is a series of non sequiturs. Unfortunately, those same non sequiturs play a fairly significant role in policy debate.

Leave aside the complete straw man mischaracterization of Keynesian views. As far as I can tell, the Sachs-and-others argument comes down to the claim that we must not seek to remedy a shortfall in demand because the economy has long-term structural problems. What sense can this possibly make?

Consider the extended version of the “magneto trouble” metaphor I use in my recent book. Keynes argued that the Great Depression could be thought of as a failure in the car’s electrical system; so let’s think of it as a situation where your car won’t run because it has a dead battery — that is, you could get it running again with a fairly trivial and easy intervention: just buy a new battery, which costs only a tiny fraction of the expense of a new car.

In saying this I am not denying that there may be other problems with the car, perhaps even big ones. Maybe it needs new brakes, or a new transmission, and these had better be dealt with soon.

Still, what sense can it possibly make to say that therefore you shouldn’t start by replacing that dead battery?

I really don’t get it.

I think "getting it" starts with Sachs adopting a view of the world that supports the types of projects and initiatives he's been pushing for years, and the fact that standard Keynesian policy and the deficit spending that comes with it makes it much harder for those projects to be realized. [Never waste a crisis, etc.] I'll also note he is, in essence, calling for infrastructure projects which is precisely what many of us in the Keynesian camp have been calling for as well. So unless it's becasue we haven't spefically named the projects he supports, it's not even clear there's a big disagreement here.

'Zero Lower Bound Denial'

Simon Wren-Lewis makes a point I've tried to hammer ever since I first started writing about how to respond to the crisis, monetary policy alone is not enough when the economy is in a deep recession:

Zero Lower Bound Denial, mainly macro: ...While I believe macroeconomists practicing demand denial represent a minority (albeit still a distressingly important minority), I think what I might call Zero Lower Bound (ZLB) denial is far more prevalent. What I mean by this is a belief that somehow monetary policy alone can overcome the problem of the ZLB. It is in many ways a perfectly understandable belief, reflecting what I have called the consensus assignment developed and implemented during the Great Moderation, which was (rightly) seen as an advance on the bad old days where fiscal policy was routinely used for demand stabilization. Nevertheless the belief is incorrect, and damaging.

It is incorrect for two reasons. ... Monetary policy that involves temporarily creating money to buy financial assets is of an order less effective and reliable than conventional monetary policy, or fiscal policy. The second is ... just as important. Even if you follow the Krugman/Woodford idea of using commitments about future interest rate setting to mitigate the recession today (which is equivalent to permanently creating more money), this does not mean that you can forget about fiscal policy. To put it another way, fiscal policy would still be a vital stabilization tool at the ZLB even if the central bank targeted nominal GDP (NGDP). It is reluctance to accept this last point which is a particular characteristic of ZLB denial. ...

I have elaborated on this second point before... First, the ZLB still matters. NGDP targets help reduce (but not eliminate) the cost of the ZLB today, but only by incurring costs in the future. Second, fiscal policy could in principle eliminate all of these costs. A fiscal stimulus today could eliminate the ZLB constraint, allowing desired output and inflation to be achieved today and tomorrow. Equally, fiscal austerity today moves inflation and output further away from desired levels both today and tomorrow, even if we have NGDP targets.

This is why I keep irritating some by going on about fiscal policy when commenting on the current conjuncture. Apart from a few academic caveats, I’m a fully paid up member of the ‘monetary policy is all you need’ club outside of a potential ZLB or monetary union.  My views on monetary policy targets are very similar to, and have been heavily influenced by, those of Michael Woodford. But the ZLB does make a difference. It is a feature of the real world, not a consequence of any particular monetary policy strategy. ZLB denial, particularly in the hands of independent central banks, leads not just to wishful thinking, but encourages governments to make bad fiscal policy decisions.

Ryan's Request for Stimulus Dollars

There's a controversy over what Paul Ryan knew about requests for stimulus from his office, and when he knew it:

Paul Ryan Claims He Didn’t Know He Signed Letters Asking For Stimulus Funds, Think Progress: During an interview with Fox News’ Carl Cameron on Saturday, Paul Ryan tried to explain why he denied requesting stimulus funds for a local energy company in 2009 after voting against and demagoguing the Recovery Act. “My office sends tens of thousands of letters to various federal agencies. This went through what we call my case work system, where it was treated as a case work request for a constituent,” Ryan said. “It wasn’t my intention to send letters supporting the stimulus” ...

But the letters — at least five in total — are all signed by Ryan in different ways, suggesting that he or an aide hand-signed the documents. “Recovery Act” is also prominently written in the very first line...

I just want to note that this isn't the first time this controversy has come up, and there's no doubt that Romney's office knew about the letters requesting stimulus. And in the past, unlike now, Ryan's office said the intention was, in fact, to send the letters because Ryan "does not believe flawed policy should get in the way of doing his job and providing a legitimate constituent service to his employers."

This is from February 16, 2010:

Ryan supported some stimulus spending, by Don Walker, Journal Sentinel: Republicans in Congress have attacked the Democratic-sponsored $787 million economic-stimulus plan, but that hasn't stopped them from trying to get a piece of the action.

Today's Wall Street Journal has a story about a dozen or so Republicans who supported stimulus-funding requests submitted to various federal agencies.

One of those Republicans is U.S. Rep. Paul Ryan (R-Wis.), who has labeled the stimulus a "wasteful spending spree."

Using the Freedom of Information Act, the Wall Street Journal obtained letters from some Republicans supporting funding proposals.

In Ryan's case, he wrote a letter to the Department of Labor in support for a grant application that was submitted for an Energy Training Partnership Grant.

Ryan, who is traveling in the Middle East, could not be reached for comment. But a spokesman provided this statement: "If Congressman Ryan is asked to help a Wisconsin entity applying for existing Federal grant funds, he does not believe flawed policy should get in the way of doing his job and providing a legitimate constituent service to his employers."

As it happens, the grant application was rejected, the spokesman said.

So it wasn't a mistake as he claims, the spokesman from his office says it was an attempt to get a piece of the pie.

I find it hard to believe that nobody from his office mentioned this to Ryan, nobody asked him about it, etc.

Ryan on Stimulus: As Usual, He fell Off Both Sides of the Horse

Paul Ryan voted for a $715 billion stimulus package:

Paul Ryan and the Stimulus: A Match Designed to Make My Head Explode, by Michael Grunwald: My main obsession these days is President Obama’s misunderstood stimulus bill..., but I’m also fascinated by ... Paul Ryan and his absurd reputation as a brave deficit hawk. So I thought I’d check out Ryan’s positions on the stimulus. Let’s just say they won’t surprise those of us familiar with his work. ...

Ryan did oppose the Obama stimulus, as did every other House Republican. But as I describe in my book, there was an interesting behind-the-scenes debate going on within the GOP caucus about what Republicans should support instead, and it’s telling to see where Ryan ended up. ...

The ... Republican leadership, as former Democratic congressman David Obey put it, decided to fall off both sides of the horse. The official $478 billion Republican stimulus alternative was an ideological bill, consisting entirely of tax cuts and unemployment benefits, with not a penny for infrastructure or other spending. But Republicans also crafted a second $715 billion substitute that was almost as expansive as the $787 billion bill Obama signed into law. It slashed spending on Obama priorities like energy efficiency, the smart grid, summer jobs programs, and aid to help cash-strapped states avoid massive layoffs of teachers and cops, but it actually increased spending on highways and the environmentally destructive water projects of the Army Corps of Engineers.

Republicans never explained how $715 billion worth of tax cuts and spending could be good public policy while $787 billion worth of tax cuts and spending was freedom-crushing socialism. ... And Paul Ryan? As usual, he fell off both sides of the horse. He voted for the ideological tax-cut bill that would have increased the deficit, and the political spending bill that would have increased the deficit. And then he railed about Obama and the Democrats increasing the deficit. ...

There's this too.

Fed Watch: Second Policy Failure of the Week

Travel day for me -- here's Tim Duy:

Second Policy Failure of the Week, by Tim Duy: This week's policy and communication failures of ECB President Mario Draghi border on epic. It would almost be funny if it wasn't so sad, not just for the ECB, but for the ever-increasing number of unemployed in the Eurozone. Teetering on the abyss with record high unemployment putting the lie to his claims about the strength of the Eurozone, Draghi chooses to play mind games with financial markets. This marks a new low in European crisis management.

Who am I kidding? This doesn't just border on epic. It is epic. And one wonders why I have so little confidence.

As is now widely known, last week, in the midst of surging bond yields in the periphery, Draghi delivered some what now appear to be off-the-cuff remarks signaling the ECB was prepared to do whatever it takes to save the Euro. This was interpretted by market participants as capitulation on the part of the ECB, as it is generally believed that saving the Eurozone, at least with any semblance of economic dignity, requires the ECB to acknowledge its role as lender of last resort for sovereign debt. This follows naturally from the realization that only the ECB has the firepower to snuff out the debt crisis that engulfs one European nation after another.

Draghi, however, did not intend to send such a signal, showing a phenomenal lack of cognizance about the fragile state of financial market confidence in Europe. From the Wall Street Journal live blog:

At the conclusion of their meeting today, the ECB failed to meet the unintentionally ramped-up expectations of financial market participants. Indeed, the ECB did exactly nothing. No new policies, just vague promises about policies that may or may not be implemented in the future. On such policies:

The Governing Council extensively discussed the policy options to address the severe malfunctioning in the price formation process in the bond markets of euro area countries. Exceptionally high risk premia are observed in government bond prices in several countries and financial fragmentation hinders the effective working of monetary policy. Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible.

This, I think, is critical to understanding the level of support the ECB is willing to provide. They are not prepared to eliminate default risk by serving as a lender of last resort; they are only willing to eliminate the risk premia associated with a nation's exit from the Euro. I increasingly think that you can't separate the two, that only by serving as a lender of last resort can you eliminate the exit premia. But the ECB doesn't see it that way, and as such I suspect is willing to do much less than needed to resolve their end of the crisis. the more optimisitc interpretation is that Draghi is really just repackaging all the risk premia, default or otherwise, as reversibility risk to limit resistance from the Bundesbank. See Joseoh Cotterill at FT Alphaville.

Then comes the expected push for more sustained fiscal austerity:

In order to create the fundamental conditions for such risk premia to disappear, policy-makers in the euro area need to push ahead with fiscal consolidation, structural reform and European institution-building with great determination. As implementation takes time and financial markets often only adjust once success becomes clearly visible, governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist – with strict and effective conditionality in line with the established guidelines.

When all you have is a hammer, everything is a nail. The ECB will not do anything until European rescue funds are activated under traditional guidelines. On the role of subsequent role of the ECB:

The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions. The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed. Furthermore, the Governing Council may consider undertaking further non-standard monetary policy measures according to what is required to repair monetary policy transmission. Over the coming weeks, we will design the appropriate modalities for such policy measures.

Translation, I think: After the rescue fund is activated, and if the risk premia related to reversibility of the Euro remains high, then and only then will the ECB, reluctantly, buy bonds of affected nations. It is interesting that they acknowledge the seniority issue. Here I assume that the ECB intends to signal that they would share in any subsequent debt restructurings. It seems, however, that this might limit their willingness to buy said bonds, implying a less-than-aggressive response.

Relatedly, the IMF lends support, via the FT:

Spain is already doing what the International Monetary Fund would demand in return for a bailout, said Christine Lagarde, IMF managing director, in an endorsement of the country’s economic policy.

Her comments both argue that Spain should not need an IMF rescue but also suggest that it might obtain one without much change to its domestic economic policies.

There is speculation that Spain admitted to Germany last week that Spain would need a formal bailout, which would entail a traditional restructuring program. The IMF is saying that Spain already has such a program in place, and thus could ask for a bailout without fear of embarrassment.

Of course, one might add that if Spain is doing everything they can, why is the economy still sinking? Because they are pretending the the traditional IMF medicine of currency devaluation can be substituted one-for-one with internal deflation. Good luck with that.

Also, if I am reading this correctly, if the ECB will only buy Spanish debt after Spain has asked for and received a EFSF/ESM program, then I think they intend to let the financial crisis engulf Italy until that nation also asks for an EFSF/ESM program. Is this correct? Because if it is, it doesn't sound like much of a firewall. And if they encourage the idea they will only help after the crisis intensifies to the point in which a bailout is necessary, won't such a policy increase the already troublesome financial fragmentation in the Eurozone?

I will let others assess the economic outlook. I will leave the first shot for Joe Gagnon:

Yes, insane indeed.

As for the market fallout, the Euro and European equities were generally stronger as the morning progressed, but then plunged as Draghi started talking and the lack of ECB action became evident. Spanish and Italian equities were particularly hard hit, down more than 5% and 4%, respectively. Bonds were something of a mixed bag. Long bonds were pummeled, especially in Spain:

But 2-year Spanish bond extended gains, although at 4.8% are still well above the the 2.5% range seen earlier this year. I think the message here is that market participants believe Spain can be limped along in the short-run, but there is much less confidence in the long-run. No surprise, given the devastating impacts of fiscal austerity coupled with a ongoing collapse of the financial system.

Bottom Line: An epic policy failure by the ECB. Not only is the ECB willing to let the Eurocrisis simmer for another month, but their communication strategy is abysmal. Draghi very desperately needs to be more aware of the impact of his comments. As for the ECB statement, I think it says that the ECB is a second line of defense, and they will act reluctantly only after the EFSF/ESM fund is activated. This seems to imply to imply a formal bailout request as a precondition to ECB action. We really need to see more clarification in the weeks ahead about what the ECB sees as the ordering of policy actions in the Eurozone. The order implied in this statement seems to me like a commitment to continued economic stagnation.

'Jobless Generation'

Policymakers need to do more about the unemployment problem:

Jobless generation puts brakes on US, by Shannon Bond, FT: ...The share of American 18- to 24-year-olds who were employed fell to 54 per cent last year, the lowest since the labor department began tracking data in 1948, according to the Pew Research Center. The share who are in college has risen, but the researchers say this only partly explains the drop. The jobless rate for Americans age 16 to 24 is above 16 per cent, more than twice the national rate.

Youth unemployment has reached crisis levels around the world, with almost 13 per cent of the global youth labor force out of work this year... But the problem has a unique flavor in the US, where the weak job market has collided with record levels of educational debt – about $25,000 for the average graduate. Together, they pose a threat to the future earning power of young Americans ... and could have long-lasting effects on US growth. ...

DeLong: Hopeless Unemployment

Brad DeLong also has a column today (and I no longer have this complaint):

Hopeless Unemployment, by Brad DeLong, Commentary, Project Syndicate: ...At first, the long-term unemployed in the Great Depression searched eagerly and diligently for alternative sources of work. But, after six months or so passed without successful reemployment, they tended to become discouraged and distraught. After 12 months of continuous unemployment, the typical unemployed worker still searched for a job, but in a desultory fashion, without much hope. And, after two years of unemployment, the worker, accurately expecting to be at the end of every hiring queue, had lost hope and, for all practical purposes, left the labor market.

This was the pattern of the long-term unemployed in the Great Depression. It was also the pattern of the long-term unemployed in Western Europe at the end of the 1980s. And, in a year or two, it will be the pattern again for the long-term unemployed in the North Atlantic region.

I have been arguing for four years that our business-cycle problems call for more aggressively expansionary monetary and fiscal policies, and that our biggest problems would quickly melt away were such policies to be adopted. That is still true. But, over the next two years, barring a sudden and unexpected interruption of current trends, it will become less true.

The current balance of probabilities is that two years from now, the North Atlantic’s principal labor-market failures will not be demand-side market failures that could be easily remedied by more aggressive policies to boost economic activity and employment. Rather, they will be structural market failures of participation that are not amenable to any straightforward and easily implemented cure.

Starving the Beast in Recessions

We are, as they say, live (this is a different title, the title they chose doesn't do a very good job of conveying what the article is about):

Starving the Beast in Recessions

Unwavering Republican commitment to lower taxes and smaller government -- policies favored by wealthy campaign backers -- makes it impossible for Congress to do more to help middle and lower class households struggling with the recession.

Helping Households Also Helps Banks

Mathew Yglesias discusses a dispute about whether recovery from the recession would have been faster if we had provided more help for households, and less help for banks:

This gets us to the actual dispute. Team Tim [Geithner] would say that they're trying to create a well-capitalized banking system in order to bolster the broader economy. Team Neil [Barofsky] counters that the broader economy would be better-served by a policy that imposed steep losses on banks and instead repaired household balance sheets. Beneath all the anger and accusations and counter-accusations is a fairly wonky policy disagreement about the relative importance of household balance sheets versus the credit channel to laying the preconditions for growth.

Here's my take (from December 2010). As others have noted, we needed to help both banks and households, and it didn't have to be one or the other. But there was no need to bail out banks directly, at least not on the scale that it was done, banks could have been helped indirectly by helping households:

...recovery from these “balance sheet recessions” is notoriously slow. As households rebuild their balance sheets, resources are directed away from consumption, and the reduction in aggregate demand is a drag on the economy. It takes a long time for households to recover what is lost, and the recovery will be slow so long as this rebuilding process continues. Fiscal policy attempts to restore the lost aggregate demand, and that is important, but it does very little to directly address the household balance sheet issue.

The same cannot be said about bank balance sheets. The effect on bank balance sheets also varies with the type of recession, and a financial collapse brought about by bad loans is particularly severe. The present recession is an example of this, and policy has done a good job of preventing even worse problems from developing by rebuilding financial sector balance sheets through the bank bailout and other means.

But household balance sheets have not received as much attention. We could have helped households rebuild their balance sheets, and this would have helped banks by lowering the default rate on loans. Instead, we left households to mostly solve their problems on their own, and then helped banks when households could not repay what they owed.

When a balance sheet recession hits, one of the keys to a quick recovery is to use the federal government’s balance sheet as a means of offsetting the deterioration in the private sector’s financial position. But we shouldn’t just focus on banks. Household balance sheet problems are every bit as severe, and in total every bit as systemically important as the balance sheet problems of banks. We’ll recover faster from balance sheet recessions if we pay attention to all private sector balance sheets instead of focusing mainly on the problems of banks.

To be more concrete, the government could have given households help in the form of a voucher that could only be used to repay loans (e.g. mortgage, student loan, or credit card debt incurred prior to this program). Banks still get the money they need to stay liquid and solvent, but households get help at the same time (an alternative, and what we essentially did, is to write off the loans and foreclose, etc. on households, then give the banks money to offset the losses). There are still political problems associated with using taxpayer money to bail out people with bad credit, so how the program is designed would be important (for example, there might be less objection to helping people who are having difficulties due to job loss from the recession, but are otherwise decent credit risks), but the point is that helping banks does not require handing them money. The help can be funneled through the household sector allowing both sets of balance sheets to be rebuilt at the same time.

[Brad DeLong also comments.]

Frankel: The First World’s Fiscal Follies

Pro-cyclical fiscal policy should be avoided, "Yet many politicians in the United States, the United Kingdom, and the eurozone seem to live by it":

The First World’s Fiscal Follies, by Jeff Frankel, Commentary, Project Syndicate: ...Keynesian macroeconomic policy lost its luster mainly because politicians often failed to time countercyclical fiscal policy – “fine tuning” – properly. ... But that is no reason to follow a destabilizing pro-cyclical fiscal policy, which piles spending increases and tax cuts on top of booms, and cuts spending and raises taxes in response to downturns.

Pro-cyclical fiscal policy worsens the dangers of overheating, inflation, and asset bubbles during booms, and exacerbates output and employment losses during recessions, thereby magnifying the swings of the business cycle. Yet many politicians in the United States, the United Kingdom, and the eurozone seem to live by it. They argue against fiscal discipline when the economy is strong, only to become deficit hawks when the economy is weak.

Consider the positions taken over the last three decades by ... Ronald Reagan..., George H.W. Bush ..., Republican congressmen...,George W. Bush..., Republicans... In my view, the government spending cutbacks of the last two years are the most important reason why the economic recovery that began in June 2009 subsequently stalled in 2011.

Here ... are three generations of politicians who favored fiscal expansion during booms (1982-1989, 1992-2000, 2002-2007) and austerity during recessions (1980, 1981, 1990, 2008-09). ...

But the pattern is understandable: when the economy is booming, there is no political support for painful spending cuts or tax increases. There is a hole in the roof, but the sun is shining. Then, when the thunderstorms roll in, sinners suddenly get religion and proclaim the necessity of reforming – just when it is most difficult to fix the problem.

Historically, it used to be developing countries whose dysfunctional political systems produced pro-cyclical fiscal policies. ... But things have changed..., a majority of the governments that have pursued countercyclical fiscal policies since 2000 are in emerging-market or developing countries. They figured out how to achieve countercyclical fiscal policy during precisely the decade when so many politicians in “advanced countries” forgot.

Chris Sims on Monetary Policy

Chris Sims explains why he got a Nobel Prize:

Tapp: So, if I asked you to describe the main contribution of your work to the field of economic modeling and maybe relating back to the traditional model, how would you describe that?

Sims: I think that what the Noble Prize people were singling out was that my work helped sort out the dispute between the monetarists and Keynesians. They, in part by introducing new approaches to statistical modeling in the '60s and early '70s, monetarists were claiming that the main source of business cycle fluctuations was bad monetary policy. The monetary authority was making mistakes, making the growth rate of money vary a lot, and all those variations resulted in recessions and booms, and if only we could force the monetary authority to stop messing with the economy and just keep money growth steady, the business cycle would be greatly reduced or even vanish.

And then the Keynesians were saying that can't be true, but they didn't have statistical models in which they could each put forward their position and ask, well, what did the data say? There were lots of attempts to do that, but with very awkward statistical modeling.

Over the course of about 10 years, things that I did and other people followed up on managed to sort out what the effects of monetary policy changes are and distinguish those from co-movements in money and prices and income that didn't have anything to do with policy. There's now pretty much a consensus on how monetary policy affects the economy, and on what the size of that effect is. The general conclusion is that it accounts for maybe somewhere between zero and 20 or 25 percent of the fluctuations we see, but if you try to trace out historically, you can't blame any recession on monetary policy.

Now we need Chris Sims, or someone like him, to lead the charge against the idea that the problem with the economy is bad fiscal policy. Even better would be if they could overcome the objections to the use of fiscal policy in severe recessions -- i.e. the type of recession that monetary policy alone cannot cure even if the interest rate is lowered to zero and non-traditional policies are put into place. In this case though, the empirical evidence is already mounting, what is needed are strong, respected voices to counter the objections to fiscal policy coming from the right (particularly, though not exclusively, objections to infrastructure investment). The politics of fiscal policy will always be a problem, but it would be less so if economists had the same unity on fiscal policy, particularly its ability to help the economy is severe recessions, that they have on monetary policy.

DeLong: What Is to Be Done Now?

One more from Brad DeLong -- here he wonders why Jeff Sachs is dismissive of policies that can address the short-run problem of deficient demand, and instead focuses on long-run structural remedies that do nothing to help with our most immediate prolems:

What Is to Be Done Now?: Jeff Sachs Appears to Miss the Point by a Substantial Margin..., by Brad DeLong: Jeff Sachs:

Move America’s economic debate out of its time warp: In Krugman’s simplified Keynesian worldview, there are no structural challenges, only shortfalls in aggregate demand. There is no public debt problem. There is no global competitiveness challenge, since “competitiveness” is a myth when applied to national economies. Fiscal multipliers are predictable, timeless, persistent, and large. All growth reversals can be solved through larger deficits. Politicians can be trusted to design short-term stimulus spending programmes of hundreds of billions of dollars. Tax cuts are about as good as increases in government spending, and short-term boosts in spending are about as good as long-term public investments.  Not one of these conclusions stands scrutiny. 

Why have we come to this vacuous debate between a free-market extremism and a Keynesian superficiality that addresses none of the subtleties, trade-offs, and uncertainties of the real situation?… [T]he world is facing novel problems at the global level, and novelty is hard to factor into economics, which is a rigid, ideological, theoretically based, and largely backward-looking field…

I find very little here that I can agree with.

Krugman's line--Krugman's consistent line--has never been that we do not have structural problems. Krugman's consistent line has been:

• We have an urgent and dire aggregate demand shortfall problem.
• We know how to cure our urgent and dire aggregate demand shortfall problem.
• Our structural problems are a lot more manageable and a lot less daunting at full employment than in a deep depression.

It makes absolutely no sense to say that we should not solve a dire and urgent problem we can easily solve because solving that problem does not solve all of our problems. ...

What we have is a rejection of simple Keynesian remedies--Jeff calls for us to do magic ingredient Y minus simplistic Keynesian remedies.

But what is magic ingredient Y. What remedies does Jeff propose in his column?

These:

education, skills and active labour market policies… we are in the age of the Anthropocene, where global growth is limited by natural resources, climate change and hazards… a long-term financial outlook and new approaches to pensions and healthcare delivery…. Well-designed public investments (eg in infrastructure) can unlock significant private investments as well…. [W]e need new economic strategies to overhaul broken systems of finance, labour markets, taxation, ecological management, budget management and investment incentives…. The new approaches must be long-term, structural, sensitive to inequalities of skills and education, aligned with the need for more sustainable technologies and “smarter” infrastructure (empowered by information technology) and congruent with long-term demographic trends…

Would any policies to deal with any of these structural challenges be hindered by policies to boost aggregate demand up to potential output? No. Would every policy I can think of to deal with any of these structural challenges be helped by policies to boost aggregate demand up to potential output? Yes.

And are there any action items on Jeff's list? We aggregate demand types tend to call for things like:

• Give every homeowner the opportunity to refi at the conforming loan rate, with an equity kicker if their mortgage does not meet conforming-loan standards.
• Spend an extra $100 billion a month on roads, bridges, teachers, police officers, public health workers, and tax cuts targeted at the cash-strapped until (a) the economy recovers or (b) long-term interest rates feel upward pressure pushing them above normal-time levels.
• Declare that it is the policy of the Federal Reserve to push nominal GDP up to its pre-2008 trend growth line.
• Buy $100 billion a month of long-term risky bonds until market expectations of nominal GDP have it quickly returning to its pre-2008 trend growth line.

Then we can start dealing with our other structural problems. ...