The recent blow-up surrounding Niall Ferguson's comments on Keynes' concern for long-run issues prompted my latest column:
Seven Myths about Keynesian Economics
The claim that Keynesians are indifferent to the long-run is one of many myths about Keynesian economics.
We are, as they say, live:
Let the Punishment Fit the Crime of the Recession, by Mark Thoma: As Paul Krugman observed recently, “the urge to see depression as a necessary and somehow even desirable punishment for past sins, while inveighing against any attempt to mitigate suffering — is as strong as ever.” Many of those who see our economic problems in these terms believe the sin we committed is too much debt fueled consumption and government spending. According to this view punishments such as austerity and high levels of unemployment provide a moral lesson that helps to prevent us from making the same mistakes again.
This is bad economics and it has the moral lesson all wrong. ...
We are live:
Why Don’t Politicians Care about the Working Class?, by Mark Thoma: If we want to ensure that our children and grandchildren have the brightest possible future, the national debt is not the most important problem to address. Reversing the polarization of the labor market – the hollowing out of the middle class and the associated rise in inequality over the last thirty years or so – is much more important. But money driven politics and a political class that has all but forgotten about the working class – Democrats in particular have forgotten who they are supposed to represent – stand in the way of progress on this important problem. ...
We are, as they say, live:
Our Real Worry Isn’t the Debt, It’s Our Politicians
The political environment, particularly today's Republican Party, is the biggest threat to future economic growth.
My latest column begins with Eric Cantor's call for Republicans to talk about "helping folks":
For Obama, State of the Union Means State of the People, by Mark Thoma: House Majority Leader Eric Cantor believes that Republicans must show their concern for those struggling in this economy if they want to regain their political footing. “We’ve got to be talking about helping folks,” he said Sunday on Meet the Press, “You’ve got so many millions of Americans who feel that they have become an afterthought.”
There’s a reason people feel that way. Republicans have refused to support any of the jobs proposals president Obama has put forward...
What do Republicans really want?:
Pretending to be on the side of the middle class while enacting policies that help businesses and the wealthy has worked well in the past, so it shouldn’t be surprising to see Republicans try this again. Remember the failed promises of trickle-down economics?
But if Republicans -- and Obama -- want to steer the conversation away from the debt, I'm all for that:
President Obama also wants to change the conversation toward the needs of the millions of Americans who feel abandoned by politicians, and he intends to emphasize jobs and the economy in his State of the Union address. This is a welcome change. Instead of focusing on the debt, we should be discussing what we want the government to do. What are our priorities, what will they cost, and what can we, as a nation, afford? In the short-run, is there room for us to do more to help the unemployed? In the longer run, should government be bigger or smaller...? Can the composition of spending and taxes be improved? How fast does the debt need to be reduced, and should it be reduced through tax increase or spending cuts? As we get richer as a society – income doubles every thirty years or so – should the share of GDP devoted to helping people increase, or should government’s share of output be limited to historical averages as many conservatives argue?
As we discuss these important questions about the size and role of government, we need to remember something that has been forgotten too often amid Republican attempts limit government intervention into the economy. The government has an important role to play in overcoming market failures... The private sector, on its own, will not provide the correct amounts of infrastructure, retirement security, health care spending, protection against monopoly and corruption, unemployment insurance, national defense, environmental regulation, education, food and drug safety, bank regulation, innovation, anti-trust action, safe working conditions, support of basic research, stabilization policy, and so on. Fixing these market failures through government action does not distort private sector economic activity away from the optimal outcome as many on the right would have us believe, it moves us closer to the ideal textbook economy. ...
Full column here.
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.
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.
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 ThomaBut maybe the tax cuts were about something else?
We are live:
The Bigger They Are, The Harder They Fall on the Rest of Us
The title at the link is about breaking up big banks, but one of the points is that the growing problems associated with size/interconnectedness, including those associated with too big to fail, occur in more than just the financial sector. These problems are getting worse, and the question is, what are we going to do about it?
A few things on the election I posted elsewhere:
And, at both sides:
We are, as they say, live:
Hurricane Sandy’s Lesson on Preserving Capitalism: With long gas lines and other shortages putting people on edge in the wake of Hurricane Sandy, the usual post-disaster debate over the economics and ethics of price-gouging is underway. However, while the question of whether it is okay, even desirable, for businesses to raise prices after natural disasters is certainly important, there is a larger lesson that can be drawn from this debate. ...
The lesson is about when support for price-allocation systems -- the heart of capitalism -- breaks down. More here.
Here's my contribution to the debate over China bashing:
We Should Stop Blaming China for our Economic Problems: The second presidential debate featured Mitt Romney and Barack Obama going nose to nose over who would be tougher on China and other countries over their unfair trade practices. But by adopting a narrative that places the blame for our problems on other countries, President Obama is playing into the hands of those who’d like to make significant cuts to social insurance programs that protect working class households. ...
Here's the bottom line:
Blaming our troubles on external causes and implying that all will be well once these causes are eliminated allows the wealthy winners from globalization to escape the taxes that are needed to provide the social protections workers need in the global economy, and to ensure that the gains from globalization are shared equitably. President Obama needs to make it clear that helping the working class will take a lot more than just forcing China to change its ways... [It] will require us to look inward at our own character as a nation instead of blaming others.
Pointing fingers at other countries and demanding change may be politically effective, but the real change begins at home.[Read more]
We are, as they say, live:
How Much Trust Should We have in Economic Data?: Perhaps it’s not surprising that a political party unable to come to grips with the scientific evidence on global warming would extend its claim that the evidence is politically manipulated to other inconvenient truths. But the attack on the Bureau of Labor Statistics by some Republicans last Friday over its report of an improvement in the unemployment rate was still a bit of a shock.
The charge that employees at the BLS manipulated the employment numbers to favor Obama is nonsense as anyone familiar with the calculation of these numbers can attest, but it does bring up a good question. What factors should be considered when assessing the reliability of economic data? ...[continue reading]...
I have a new column I hope you'll want to read:
Romney's Misleading Attack on Social Insurance
[I shoul dnote that the embedded links are, for the most part, added by the editors.]
A new column:
The unemployed have, it appears, been hiding from politicians.
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.
I couldn't resist commenting on the economic policies being promoted at the Republican National Convention:
Republicans: We Won't Build That
(The discussion of Republican policy is at the end of the article.)
We are live:
RomneyRyanomics: The Not So Grand Bargain
Romney is doing his best to hide it, but large costs to middle class households cannot be avoided under his economic plan.
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.
A defense of some, but not all economists:
Why Some Economists Failed
I assert that some economists got things mostly right about the recession and what was needed to fix it, but they have been ignored in policy discussions. Conversely, those who got things mostly wrong were given prominent seats at the policy-setting table where they continued to make errant forecasts even as the evidence piled up against them. One attempt at rebuttal is, I suppose, is to ask how we know who was correct? The answer is that unlike the economists who continue to promote austerity, fear of inflation, and so on, the assertion is based upon the empirical evidence on these issues. [See Paul Krugman for a related issue, why fear of inflation, deficits, and so on "resonates with a lot of people no matter how often and how badly the worldview fails in practice." Part of my point is that I don't think economists are free of blame for this.]
New column:
Physicists Can Learn from Economists, by Mark Thoma: After attending last year’s Economics Nobel Laureates Meeting in Lindau, Germany, I was very critical of what I heard from the laureates at the meeting. The conference is intended to bring graduate students together with the Nobel Prize winners to learn about fruitful areas for future research. Yet, with all the challenges the Great Recession posed for macroeconomic models, very little of the conference was devoted to anything related to the Great Recession. And when it did come up, the comments were “all over the map.” And some, such as Ed Prescott, were particularly appalling as they made very obvious political statements in the guise of economic analysis. I felt bad for the students who had come to the conference hoping to gain insight about where macroeconomics was headed in the future.
I am back at the meetings this year, but the topic is physics, not economics, and it’s pretty clear that most physicists think they have nothing to learn from lowly economists. That’s true even when they are working on problems in economics and finance.
But they do have something to learn. ...
A recent column:
The Political Empowerment of the Working Class is the Key to Better Employment Policy, by Mark Thoma: The high unemployment rate ought to be a national emergency. There are millions of people in need of jobs, the lost income as a result of the recession totals hundreds of billions of dollars annually, and the longer the problem persists, the more permanent the damage becomes.
Why doesn’t the unemployment problem get more attention? Why have other worries such as inflation and debt reduction dominated the conversation instead? As I noted at the end of my last column, the increased concentration of political power at the top of the income distribution provides much of the explanation.
Consider the Federal Reserve. Again and again we hear Federal Reserve officials say that an outbreak of inflation could undermine the Fed’s hard-earned credibility and threaten its independence from Congress. But why is the Fed only worried about inflation? Why aren’t officials at the Fed just as worried about Congress reducing the Fed’s independence because of high and persistent unemployment?
Similar questions can be asked about fiscal policy. Why is most of the discussion in Congress focused on the national debt rather than the unemployed? Is it because the wealthy fear that they will be the ones asked to pay for monetary and fiscal policies that mostly benefit others, and since they have the most political power their interests – keeping inflation low, cutting spending, and lowering tax burdens – dominate policy discussions? There was, of course, a stimulus program at the beginning of Obama’s presidency, but it was much too small and relied far more on tax cuts than most people realize. The need to shape the package in a way that satisfied the politically powerful, especially the interests that have captured the Republican Party, made it far less effective than it might have been. In the end, it had no chance of fully meeting the challenge posed by such a severe recession, and when it became clear that additional help was needed, those same interests stood in the way of doing more.
Republican policymakers give us all sorts of excuses for blocking further action to help the unemployed. We are told the problem is structural – there is a geographical or talent mismatch between labor availability and labor needs – and nothing can be done to help. But something can be done. We can help workers move to where the jobs are, encourage firms to locate in areas where workers are readily available, and help with job retraining. If mismatches are really the problem, why aren’t Republicans leading the charge on these policies? If they care about the unemployed rather than the tax burden of the wealthy, then why are they allowing community colleges – one of the best ways we have of providing job training for new and displaced workers – to be gutted with budget cuts?
We are also told that the deficit is too large already, but there’s still plenty of room to do more for the unemployed so long as we have a plan to address the long-run debt problem. But even if the deficit is a problem, why won’t Republicans support one of the many balanced budget approaches to stimulating the economy? Could it be that these policies invariably require higher income households to give something up so that we can help the less fortunate? Tax cuts for the wealthy are always welcome among Republicans no matter how it impacts the debt, but creating job opportunities through, say, investing in infrastructure? Forget it. Even though the costs of many highly beneficial infrastructure projects are as low as they get, and even though investing in infrastructure now would save us from much larger costs down the road – it’s a budget saver not a budget buster – Republicans leaders in the House are balking at even modest attempts to provide needed job opportunities for the unemployed.
The imbalance in political power, obstructionism from Republicans designed to improve their election chances, and attempts by Republicans to implement a small government ideology are a large part of the explanation for why the unemployed aren’t getting the help they deserve. But Democrats aren’t completely off the hook either. Centrist Democrats beholden to big money interests are definitely a problem, and Democrats in general have utterly failed to bring enough attention to the unemployment problem. Would these things happen if workers had more political power?
When we talk about leveling the playing field, it is generally in terms of economic opportunity. However, leveling the political playing field is just as important, and in the past unions provided workers with a powerful voice in the political arena. But unions have largely faded from the scene leaving workers with very little organized power. Correcting the political imbalance this has created through the renewed political empowerment of the working class must be part of any attempt to improve our response to serious recessions.
The political power of the working class has diminished in recent decades, and that helps to explain why politicians have not paid enough attention to the unemployment problem:
It also suggests a solution -- renewed political empowerment of the working class -- but that's easier said than done.
Republicans didn't always oppose the use of monetary and fiscal policy to stabilize the economy, but they do now. Why the change?:
Why Have Politicians Neglected the Unemployed?
If inflation begins to increase before the economy has fully recovered, the Fed shouldn't panic:
Federal Reserve Policy: Exceptions Improve the Rule: At some point during the recovery, the Fed may face an important decision. If the inflation rate begins to rise above the Fed’s 2% target and the unemployment rate is still relatively high, will the Fed be willing to leave interest rates low and tolerate a temporary increase in the inflation rate?
Probably not. Even though higher inflation can help to stimulate a depressed economy, Ben Bernanke, Chairman of the Federal Reserve, is not in favor of allowing higher inflation because it could undermine the Fed’s “hard-won inflation credibility.” And recent Fed communications seem to be setting the stage for the Fed to abandon its commitment to keep interest rates low through the end of 2014. This adds to the likelihood that the Fed will raise interest rates quickly if inflation begins increasing above the 2% target even if the economy has not yet fully recovered.
As I’ll explain in a moment, that’s the wrong thing to do. But first, why does the Fed put so much value on its credibility? ...[continue reading]...
Jonathan Portes says the IMF is improving its advice about fiscal policy, but the OECD and the European Commission still have a lot to learn:
Who wants to tax and spend? The IMF, that’s who, by Jonathan Portes: I noted at the turn of the year that the IMF, since Christine Lagarde took over, had made it more and more obvious that it thought a number of countries including the US, Germany and (by implication) the UK, were tightening fiscal policy too fast. ...
Today the Fund has released the full WEO [World Economic Outlook]. It makes it still more obvious that the Fund thinks that, in the short-term, the problem is above all a lack of demand, and that excessive austerity is, as Paul Krugman and Brad DeLong have argued, self-defeating...
In other words, the Fund wants us, for standard Keynesian reasons, to spend more on infrastructure (and housing) and increase welfare benefits for poor people (who will spend them), and pay with it by taxing the rich (those with a lower “marginal propensity to consume”. This would raise demand in the short term, without worsening the fiscal position. For those who see the Fund as being both anti-Keynesian on macroeconomic policy, and classically “liberal” on microeconomic policy, this will come as something as a shock. ...
In this the Fund’s approach stands in sharp contrast to the economic illiteracy and political supineness of both the OECD and the European Commission. Although the OECD continues to lead the world in the quality of its comparative microeconomic analysis (especially on labor market policy and immigration), its macroeconomic policy judgment has proved absolutely abysmal – remember that as recently as last May they were advising us all to raise interest rates. As for the European Commission, my thoughts on the people who brought us Spain and Greece – and youth unemployment over 50% – are here and here.
I think it's also important to recognize that much of the push for austerity is ideological. The real goal is smaller government by whatever means and the (failed) confidence fairy economic argument -- the idea that cutting the deficit would increase our confidence in the future and cause enough spending to more than compensate for the austerity measures -- is used to justify cutting government spending. This is why those who push for austerity only want to talk about cutting government spending. Increasing taxes, another way to close the budget gap and call the mythical confidence fairy, is completely off the table.
What I think the Fed should do:
Why does overshooting the inflation target in the short-run induce such fear in so many members of the Fed's monetary policy committee?
We are live:
Is the Distribution of Income Fair?
Warning: Marx is mentioned. [This post from Tim Taylor provides a good backdrop for the column: Labor's Declining Share of Total Income.]
[Busy day today -- teaching then travel -- so another quick "hit and run" post.]
A column from a couple of weeks ago:
How Did the Fed Get Things So Wrong?, by Mark Thoma: The public’s faith in the Fed’s ability to protect the economy from economic problems has been shaken by the Fed’s failures before and during the Great Recession. The recent release of the transcripts from 2006 monetary policy meetings where Federal Reserve policymakers discuss and ridicule the suggestion that the economy is threatened by a dangerous housing bubble has undermined its reputation even further.
How did the Fed get things so wrong? How can policy be improved?
The first step in the policy process is for policymakers to be aware that there’s a problem in the economy, and access to reliable, timely, and informative data is critical. Unfortunately, there are substantial lags in the availability of data that indicate where the economy is headed, and it can be six months or longer before key variables such as GDP are known. This is a problem that doesn’t get enough attention, and in the information age we ought to be able to do better.
The fact that these data are not very timely, and are often revised substantially after they are released is not the Fed’s fault. But that doesn’t mean that the Fed can’t do more on its own. The Fed needs to do a much better job than it did before the crisis of using the data at its disposal to construct stress indices, measures of network reliability, price-rent ratios, credit measures, and so on to figure out what is happening in financial markets.
Prior to the crisis, policymakers were not asking the right questions and hence saw no need to collect such data, or to believe what the data they did have was telling them. Policymakers did not believe a severe financial meltdown was possible in modern economies featuring modern policy tools –those problems had been overcome long ago – so they hardly bothered to look for signs of bubble trouble. They are beginning to bring these measures into play now, and seem to have a better understanding of their importance, but only time will tell if they’ve truly learned their lesson.
But even if the Fed recognizes that a problem exists, how it responds to trouble depends critically upon the relative weights it attaches to its goals of low inflation, low unemployment, and financial stability.
When the public looks at the Fed’s recent policy choices, it sees a Fed that appears to place worries about inflation – which is a big concern of finance and business – over the high levels of unemployment that have caused so much misery for the working class. Is there a reason why financial and business interests, banking interests in particular, might be overrepresented at the policymaking table?
Yes, there is. The problem, in large part, is the way in which the presidents of the twelve Federal Reserve District banks are chosen. The district bank presidents, who are an important part of the monetary policymaking committee, are chosen by the Board of Directors for individual banks. The make-up of those boards is dominated by wealthy business and banking leaders, and that leads to suspicions that these interests are overrepresented in monetary policy decisions. The Dodd-Frank legislation recognizes this problem, but it’s not clear that the proposed solution of eliminating bankers from the selection process goes far enough.
A final problem policymakers must confront is the time it takes for policy to have an effect after it is put into place. It can take several months for policy to fully impact the economy after it is enacted, so it’s important for the Fed to react quickly in response to changing economic conditions. Unfortunately, policymakers were far too slow and timid in reacting to problems they encountered as the crisis unfolded. Had the Fed been more concerned about unemployment and less concerned about inflation, there might have been more urgency in its response.
The Fed’s errors can be placed into two broad categories, the failure to ask the right questions before the crisis, and the failure to act quickly and aggressively enough once the crisis began. The first problem had a lot to do with economists’ undue faith in their own models and abilities – the financial meltdown problem had been solved so no need to worry about that – while the second problem is at least partly due to the way in which the public interest is represented on the Fed.
I don’t know how to insulate economists from themselves, every few decades we seem to have the need to declare that we have solved important problems only to be spectacularly wrong, but the representation of the public interest in policy decisions can certainly be improved. That won’t fully overcome the Fed’s tendency to hesitate and take small steps when bold action is needed, but better representation would certainly give more weight to the public’s desire for the Fed to do its utmost to bring an end to the many problems that households face when the economy is operating at subpar levels.
We are, as they say, live:
How Did the Fed Get Things So Wrong?
It's about the Fed's mistakes before and during the crisis, and how it might improve going forward.
A recent column (on the claim that Democrat are anti-market, socialists, see here too):
Democrats are Not Anti-Market, by Mark Thoma: Republican hopefuls are attempting to portray the coming presidential election as a battle between people who believe in free markets and those who want to turn the U.S. into a socialist state. Michele Bachmann has been quite explicit with this charge, and Mitt Romney, Newt Gingrich, and the other leading Republican candidates have made similar claims.
There are certainly those on the left who call for radical change, including the elimination of the market system, just as there are those on the right who have extreme views on a variety of topics. But the Democratic Party is not calling for the overthrow of capitalism, and the claim that Democrats prefer a socialist state is false. Democrats support markets too. The disagreement is about the best way to bring about a well-functioning market system, and whether that system produces an equitable distribution of income and opportunity.
Conservatives believe that markets work best when government involvement is minimal or absent altogether. They don’t deny that individual markets can fail for a variety of reasons, and they acknowledge that the aggregate economy is subject to cyclical swings that bring periods of high unemployment. However, with patience markets and the macroeconomy will fix themselves. If the government steps in and tries to help, on net it will make things worse, not better. Thus it’s almost always best to wait for the economy to heal itself, even if the wait is a long one.
Democrats have different ideas about what it takes for markets to fully realize their potential. They believe that individual markets work best when government takes an active role to prevent market failures. They also believe that monetary and fiscal policies are useful tools to offset cyclical swings in the aggregate economy.
Democrats also differ from Republicans on the need for government to redistribute income. Republicans believe that redistributing income reduces the incentive to pursue economic gains, and this lowers long- run economic growth. Democrats believe that a more equitable distribution of income is desirable in some instances, and that worries about the impact redistribution will have on economic growth are overstated. Democrats also believe there are significant concentrations of political power and market failures that distort the distribution of income, and these distortions should be corrected through government action.
Which of these two visions is correct? Republicans have tried to blame the financial crisis on the government, in particular government programs to support housing for low-income households, but the evidence overwhelmingly refutes this claim. The problem wasn’t too much government, it was that government did not do enough.
We would be much better off today if government had ignored Alan Greenspan and other advocates of deregulation who argued that financial markets are self-policing, and had instead provided strong regulatory oversight of both the traditional and shadow banking sectors. We would also be better off if the Fed had intervened and popped the housing bubble as it was inflating rather than denying there was a bubble and arguing it could always clean up the mess quickly and neatly in any case.
And in assessing the two views, it’s important to note that the things the government did do were helpful. Though the design of the Bush administration’s bailout of the financial sector left much to be desired, it prevented a much worse outcome. There’s also little doubt that the fiscal stimulus put in place during the Obama administration helped the economy. Things would be better today if we had resisted the austerity minded and done even more to stimulate output and job creation.
In the coming year, we will have to choose between these competing views of the government’s proper role in the economy. The Republican view is that the economy can take care of itself. There’s no need for government to intervene, and the distribution of income – no matter how skewed – should also be left alone.
We’ve already tried Republican policies in recent decades and the promised economic growth, stability, and widely shared prosperity did not materialize. Instead we had a Great Recession, inequality widened substantially, and market and political power became more and more concentrated.
In addition, the recent recession challenges the GOP’s “markets are magic” point of view. During the time when the housing bubble was inflating, markets misdirected resources and too much of our intellectual talent, labor, and raw materials were drawn into housing and finance. Markets also failed to optimally hedge against risks, they have been very slow to self-correct – labor markets in particular – and the fact that the extraordinarily high profits in the financial sector have not been eroded away through new entry is a sign of excessive and persistent market imperfections.
The other view, that of Democrats, speaks directly to these problems. It embraces active oversight of markets to ensure they are operating to maximize social good, it encourages the use of countercyclical monetary and fiscal policies to stabilize output and employment, and it advocates correcting the inevitable inequities in income and opportunity that arise in imperfect, real world market systems.
Thus, contrary to the charge from Republicans that Democrats are anti-market, there’s a strong argument to be made that it’s the policies of Democrats rather than Republicans that do the best job of allowing markets to reach their full potential.
New column: Republicans charge Democrats with advocating socialist, anti-market policies, but Democrats would do a better job of allowing markets to reach their full potential than Republicans:
Markets work best when government adopts an active rather than a passive stance.
I have a new column:
The Great Economic Divide Makes Everyone Poorer
A divided society is a poorer society.
How to avoid public anger over bank bailouts, e.g. the recent uproar over the report from Bloomberg that too big to fail banks made $13 billion on loans from the discount window:
Better than a Bank Bailout: A Federal Lottery
(I'm not sure if I'm serious about this or not, the point is that we need to focus policy on people, not banks.)
I have a new column:
I am not happy with the Democrats.
I have a new column (my title was "Help Households and the Banks Will Be Just Fine"):
The Financial System Is Rigged in Favor of the Rich
This passage from Luigi Zingales is a good intro:
...nothing upsets people like the perception that the rules don’t apply equally to everybody..., what many people felt after the 2008 bailouts of the financial system. The system was certainly at risk, and some government intervention was just as certainly necessary. Yet it ... didn’t escape most Americans that TARP was the largest welfare program for corporations and their investors ever created in human history. ... TARP wasn’t just the triumph of Wall Street over Main Street; it was the triumph of K Street over the rest of America.
The way the bailout was conducted damaged Americans’ faith in their financial system, in their government, and in the market economy. ... Their altered feelings weren’t the consequence of any ideological bias against government involvement; on the contrary, a majority of respondents believed that the government should regulate financial markets. They objected, rather, to the specifics of what the government was doing. One reason they objected was their perception that lobbying interests had influenced the intervention: 50 percent of respondents, for instance, thought that Paulson had acted in the interest of Goldman Sachs, not the United States.
But a stronger reason, presumably, was that the bailout made the system suddenly look fundamentally unfair. Why should outsourced workers, whose only fault was to have entered the wrong sector, bear the burden of market discipline, while rich bankers were offered a government safety net? ...
New column:
It's on inequality and economic mobility.
New column:
Why America Should Spread the Wealth
I have a new column on the need for Federal Reserve independence:
I expect disagreement on this one. The emphasis is on the long-run, but I wish I would have had the space to talk more about the short-run, i.e. that the Fed could be more aggressive in the short-run and allow inflation to rise temporarily without abandoning its commitment to long-run price stability. That's implied by the statement that "I don’t think the voice of the unemployed is adequately represented in monetary policy decisions," but it may not be clear. I also wish I would have had the space to talk about why a return to the gold standard -- which is behind some of the attacks on the Fed -- is a bad idea.
New column:
Why a Working-Class Revolt Might Not Be Unthinkable
The main point is about how unbalanced political power has tilted policy away from the needs of the unemployed, and the need for that to change.
Some thoughts after attending the 4th Meeting of the Nobel Laureates in Economics:
Update: I should note that I originally ended the column on a slightly more positive note, but then cut this part to make the word limit (the conference is intended to bring young economists together with the Nobel laureates so that the young economists can benefit from their wisdom):
But I do have hope. The young economists I talked to are eager to move things forward, and refreshingly free of the theoretical and ideological divides that exist in the older generation of economists. I have little faith that the older generation will ever acknowledge the models they spent their lives building are fundamentally flawed. But the disappointment I felt listening to the older and supposedly wiser economists at the conference give conflicting advice based upon failed models was absent in these conversations with the next generation. Some day they too will dig in their heels and defend their lives’ work against challenges, but for now it's up to them to forge a new way forward.
This just posted:
Balance the Budget -- but Tie it to the Business Cycle
I toy with the idea of a requirement to balance the budget over the business cycle, but can't overcome reservations and fully endorse it.
I have a new column:
Congress: The Inmates Are Running the Asylum
[I would have chosen a different title, but mine isn't great either.]
We are, as they say, live:
Inequality and the Desire to Cut Government Programs: Has rising inequality coupled with misperceptions about who benefits from government programs undermined support for spending on social services?
The column I mentioned on Sunday is now up:
"Does anyone think that uncertainty has been reduced since Republicans gained a majority in the House of Representatives?"
This just posted:
I'm getting more and more worried about a double dip.
We are, as they say, live:
Trading Tax Cuts for Working Class Misery
I explain that:
What we did, in essence, was trade tax cuts for the wealthy and spending on wars for increased working class misery – higher unemployment, insufficient social service support, and a slower recovery from the recession.
The website that tracks the stimulus spending, Recovery.Gov, is currently featuring the following story on its front page:
Recovery Transportation Projects Completed around the Country
They could emphasize all sorts of things, the number of people helped by spending on social services, the way in which the spending saved jobs by offsetting contractions at the state and local level, the impact of the tax cuts, how extended unemployment compensation helped families, etc., etc., but instead they chose to emphasize economic growth. If you click on the About tab, one of the main goals of the legislation was to
Spur economic activity and invest in long-term growth
In a recent column, I argue that this reliance on a "growth test" for fiscal expenditures (and tax cuts to a large extent) was necessary to get the legislation passed, but constrained our ability to pursue more direct job creation policies. (I think I oversold the actual reliance on the growth test a bit, but not in terms of how it was presented and sold to the public):
The Growth Test for Fiscal Policy Hurts the Unemployed: In the wake of the Great Recession, why has employment been so slow to recover? One answer is that an important but widely unrecognized change in fiscal policy has taken place.
Due largely to the influence of supply-side Republicans and many Democrats who embrace growth policies, policies that were originally intended to stimulate innovation in the private sector were applied to the government sector and infrastructure spending. This change in policy that puts growth at the forefront has shifted resources and attention away from traditional policies that could have reduced joblessness at a more rapid rate.
To understand the change in policy, it’s useful to divide fiscal approaches into two broad categories: supply-side policies designed to enhance the economy’s long-run growth prospects and demand-side policies designed to stabilize short-run business cycle fluctuations.
Supply-side policies, which almost always involve tax cuts and tax credits, attempt to stimulate the three factors that determine economic growth: technological innovation, growth in the capital stock, and growth in the labor force. Examples of these policies include tax credits for R&D; capital gains and dividend tax cuts to increase investment; and income tax reductions to boost both labor supply and entrepreneurial activity.
Demand-side polices are used when the economy strays off of its optimal long-run growth path. In recent decades we have relied mainly on monetary policy-- and secondarily on changes in tax rates--to offset business-cycle fluctuations and stabilize the economy. But in the Great Recession, government spending has played a more prominent role.
What’s different is that government spending has, in large part, been devoted to infrastructure spending and other policies to enhance economic growth. In fact, around 75% of the spending on goods and services in the American Recovery and Reinvestment Act (ARRA) was devoted to policies that help the economy grow, and the ability to enhance long-run economic growth was a key factor in the selection of projects to include in the stimulus bill.
In past recessions, fiscal policy operated differently. The main goal was to increase aggregate demand through additional government purchases of goods and services, tax cuts, or even through government- created jobs that provided people with the income they need to go out and purchase goods and services themselves. Infrastructure spending was part of the mix, but the main goal was to stimulate demand and boost the economy; the impact on long-run economic growth was not the important consideration.
For this reason, in the past we were much more likely to consider “make-work” as a stabilization tool. Make-work is generally summarized as “paying half the unemployed to dig holes, then paying the other half fill them in again.” But that is a bit unfair since the goal is always to spend money where it does the most good, for example, to clean up a city park that has fallen into disrepair even if that doesn’t directly have an impact on long-run growth.
But as noted above, in the most recent recession, due largely to the influence of Republicans devoted to supply-side economics and to many Democrats who embrace growth policies, supply-side policies that were originally intended as a means of stimulating innovative activity in the private sector were extended to the government sector and infrastructure spending. Republicans would not have approved any other type of policy to combat the recession, particularly policies of the “make-work” variety. Growth had to be at the forefront, and Democrats accepted this approach to stabilization policy. The result was that, contrary to past policy where growth and stabilization policy were independent, present policy addressed both supply-side and demand side concerns simultaneously.
There are advantages to requiring short-run stabilization policy to pass a long-run growth test, but there are also costs. If we are going to move policy in this direction in the future – and it looks like we are – it’s important to know what these costs and benefits are.
One of the main benefits of the emphasis on long-run growth is that it makes government spending to fight recessions politically viable – it’s a type of spending both sides can agree is needed. Another benefit is that unlike, say, tax cuts used to fight recessions, which tend to become permanent and hence create a permanent hole in the budget, infrastructure projects eventually come to an end. And, of course, there’s also the benefit of the additional growth these policies produce.
But there are costs too, and one big cost is evident in the recovery from the current recession. The focus on long-run growth and the shunning of anything that so much as resembles a “make-work” project has made it difficult to deal effectively with the unemployment problem. There are still 11 million people who need jobs, and we are doing very little to help with this problem.
Long-run growth projects are slow to come online, especially when the projects must make it through the political process, and if they are not big enough initially it’s difficult to find the political will to go through the process of implementing another round of spending. Tax cuts are an alternative, but the current stimulus package was just shy of 40% tax cuts and we still have an unemployment problem.
Monetary policy is another option, but the effectiveness of monetary policy is limited when interest rates bottom out as they generally do in severe recessions. Thus, more direct methods of dealing with the unemployment problem are needed.
In the past, we did not pay enough attention to whether the policies used to fight a recession would also help with long-run economic growth. But in the present the pendulum has swung too far in the other direction – long-run growth should not be the only consideration when selecting stabilization policies.
In the future, we must do a better job of attacking the unemployment problem when recessions hit the economy even if it means implementing policies that do not directly have an impact on long-run economic growth. Those who promote supply-side policies above all else might be surprised at how much growth will be helped nonetheless by policies that avoid the long-term problems associated with high and persistent unemployment.
I have a new column:
The Growth Test for Fiscal Policy
The emphasis on growth above all else makes it harder for us to address the unemployment crisis.
In a column back in December on balance sheet recessions, I noted that:
... When combined with the loss of jobs due to the recession, and the fact the debts do not decline with the fall in asset values, the effect on balance sheets can be devastating – much larger than, say, the balance sheet impact of an oil price shock. Households have no choice but to set aside part of their income to both rebuild the asset side of the balance sheet and to pay down their debts.
This is one of the main reasons why 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..., policy has done a good job of ... 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. ...
One of the main points was that helping households rebuild their balance sheets will also shorten the recession. (This is one reason I changed my mind about tax cuts. If tax cuts are spent, they stimulate the economy immediately. If they are saved instead, then they restore balance sheets faster thereby bringing a quicker end to the recession. In the latter case we won't see much in the numbers until balance sheets have been rebuilt -- the saved funds will not stimulate output and employment -- but it would be a mistake to conclude that the policy was useless since the balance sheet rebuilding is an important component of recovery.)
As Paul Krugman writes more about this topic, I hope he picks up on some of these themes:
It’s Not A Banking Problem, by Paul Krugman: I’ll need to write more about this, but I thought I should put this up for now: one theme you still find running through many policy discussions, especially about things like taking action on foreclosures, is the constant warning that you mustn’t be mean to the banks — because things are fragile, you know, and we don’t want another financial crisis.
So I thought it might be worth pointing out that this long ago ceased being a banking problem.
The St. Louis Fed has an indicator of financial stress (it’s the first principal component of a vector of different financial measures; aren’t you sorry you asked?). It looks like this:
You can clearly see the oh-God-we’re-gonna-die period following Lehman’s fall; you can also see that it’s over, and stress is more or less back to normal.
So what’s holding back the recovery? Housing and household debt.
And so the priority in financial policies should be helping to clear up the housing mess and helping arrange debt relief. This is not the time to worry a lot about the banks — and especially not to worry about what bankers say.
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