Tyler Cowen: Is There a General Glut?

Tyler Cowen argues that:

Is there a general glut?, by Tyler Cowen: ... Reading the Keynesian bloggers, one gets the feeling that it is only an inexplicable weakness, cowardice, stupidity, whatever, that stops policies to drive a more robust recovery.  The Keynesians have no good theory of why their advice isn't being followed, except perhaps that the Democrats are struck with some kind of "Republican stupidity" virus.  (This is also an awkward point for Sumner, who seems to suggest that Bernanke has forgotten his earlier writings on monetary economics.)  The thing is, that same virus seems to be sweeping the world, including a lot of parties on the Left.

Romer, Geithner, Summers, et.al. know all the same economics that Krugman and DeLong and Thoma do.  If a bigger AD stimulus would set so many things right, they'd gladly lay tons of political capital on the line to see it through and proclaim triumph at the end of the road.

Except they expect it would bring only a marginal improvement. ...

I still think they should try to do it -- through more aggressive monetary policy -- but it's a judgment call and that's why they are more or less staying put. ...

I don't get the claim that since the administration's economists are not pushing for a large, new stimulus package, it means they don't think it would work. In fact, I don't even agree with the basic premise that they have been silent on this issue. For example, I recently noted an op-ed by Christina Romer that appeared in the Washington Post where she argues for more fiscal stimulus, particularly measures that prevent teacher layoffs (but she also calls for more help generally when she says "Further targeted actions to speed the recovery and reduce unemployment... are good for the economy and good for families...") This was written at a time when Congress was considering a meager amount of additional stimulus. The politics were clear, Congress was not about to increase the amount of additional stimulus, instead they were considering reducing it. Romer was trying to stop them from doing this by pointing our how harmful such reductions would be, and if she is successful, it will be far from a "marginal improvement." So, contrary to the claim Tyler makes, the administration is pushing for more stimulus -- but, understandably, only when they think there is some chance it might do some good.

The mere fact that the administration can read the writing on Congressional walls, that the administration has decided that using political capital to push forcefully for more stimulus is tossing valuable political capital down a sinkhole, does not imply that the administration's economic advisors see no large benefit from further stimulus. Beating dead horses does not get you anywhere, it simply wastes valuable time and resources. It's not that they are unwilling to "Put their reputations behind policies which might backfire or irritate Congress" as Tyler suggests as one reason they are reluctant to push for more fiscal stimulus, it's that they don't think there's any real chance of getting the votes needed to pass the legislation. Call it ignorance among members of Congress, "weakness, cowardice, stupidity, whatever," but the votes simply aren't there.

As for Tyler's (and others') call for monetary policy instead of fiscal policy, here's the problem. It relies upon changing expectations of future inflation (which changes the real interest rate). You have to get people to believe that the Fed will actually be willing to create inflation in the future when it comes time to do so. However, it's unlikely that it will be optimal for the Fed to cause inflation when the time comes. Because of that, the best policy is to promise that you'll create inflation, then renege on the promise when it comes time to follow through. Since people know that, and expect the Fed will not actually carry through, it's hard to get them to change their expectations now. All that credibility the Fed has built up and protected concerning their inflation fighting credentials works against them here.

Fiscal policy does not have these problems. Maybe monetary policy would work in spite of the time consistency problems, I'm willing to try and there are creative ways around this problem that might work (see here for how to credibly commit to irresponsibility). But I'm not willing to put all my faith in this one policy basket, particularly since I think fiscal policy is the superior tool in deep recessions (but not in normal times). Fiscal policy must be part of the mix as well, and since the economy is not expected to return to full employment for several years, there's more than enough time for further fiscal stimulus directed specifically at job creation to work.

In a subsequent post, Tyler Cowen posts an excerpt from Kevin Drum:

Kevin Drum on fiscal stimulus, by Tyler Cowen:

But despite all this, there's one pretty good reason to think that Tyler is basically right: tax cuts. Lefty economists might generally believe that increasing spending is a more efficient way of stimulating consumption than reducing taxes, but they'd almost certainly accept a big tax cut as an almost-as-good substitute. And tax cuts have two big advantages over spending. On the substantive side, they work faster. Spending takes time to work its way through the economy, but a tax cut (for example, a payroll tax holiday) boosts the economy almost immediately. And on the political side it's quite doable. Republicans would be persuadable because they love tax cuts and Democrats would be persuadable because it would help the economy. For Obama, then, it would be the best of all worlds: a fast stimulus that gets bipartisan support, something that boosts the economy while dampening the inevitable criticism he'd get for blowing up the deficit.

But he's not pushing for this. Not even quietly. And this suggests that Tyler is right: Obama's advisors might be in favor of further fiscal stimulus, but not by much. And the best explanation for this is that lefty or not, they're genuinely afraid, as Tyler says, that it would bring only marginal improvements at the cost of significant problems down the road.

The full link is here.

First, a payroll tax cut is a supply-side policy that has demand side effects (as do all supply-side tax cuts). Increasing AS when AD is too low is a bad idea, it cause deflation which raises the real interest rate and slows the recovery. So the AS effects of these policies can be troublesome -- better to use AD side policies like government spending.

Second, what evidence is leading them to conclude that temporary tax cuts have a strong impact on demand? I argued that tax cuts can be helpful here, but not because they have large AD effects, the evidence suggests they are mostly saved (see the two graphs in the post). Better targeting could improve that, and I'm not opposed to well-targeted tax cuts being part of the mix (consistent with Drum's claim), but Congress has very poor aim and it's unlikely that tax cuts will be well-targeted. Again, we have several years before employment recovers -- even if tax cuts can produce an immediate impact, there's plenty of time for fiscal policy to be used as part of the mix.

Finally, again I don't understand how making a political calculation that there is no chance Congress will sign on to a package providing significantly more help implies that "they're genuinely afraid ... that it would bring only marginal improvements," and I certainly don't see why it implies that it would come at "the cost of significant problems down the road." Where's the evidence for that? And why aren't costs balanced against benefits? Is the worry that interest rates will go up? Then solve the medical cost escalation problem driving the long-run debt, further stimulus is a drop in the bucket compared to that. A credible plan for the deficit over the long-run is the key here, but that plan has little to do with whether or not more fiscal stimulus is put into place now and everything to do with how we rein in health care costs in the future.

There are probably all sorts of policies that the administration's economic advisors believe would be beneficial to the nation, but they know there's no chance that Congress will approve them so they don't even bother to bring them up. The mere fact that the administration's economists aren't out using up Obama's political capital says very little about what they think it the correct policy at this point. They are constrained by political advisors who determine what will and won't be pursued. The economists make their impassioned pleas behind closed doors, we do not get to witness this, and then decisions are made independently of them as to what they administration will and will not push for. It is not up to the economists to determine how political capital will be spent, and more than economics goes into this decision. Maybe Tyler's right and they don't think the policies will help much, or maybe they made an impassioned plea that more is necessary that, in the end, did not persuade the political advisors. Christina Romer's recent op-ed suggests that the administration's economists do see large benefits from further stimulus, but in any case, the fact that they are not out pushing for this forcefully does not tell us much about their beliefs concerning the benefits of further stimulus.

What the administration's economists truly believe I can only speculate about. But I know what I think. The economy, the labor market in particular, needs more help and fiscal policy -- and here I mean government spending targeted at job preservation and creation first and foremost -- has an important role to play in giving the economy the boost it needs.

[See also, Brad DeLong, Nick Rowe, and Scott Sumner.]