August 31, 2011
Recommendations for economic policy
Under the current economic circumstances, what mix of fiscal and monetary policy do you think would be desirable?
And here's the best answer I could come up with:
You ask an interesting hypothetical question, which I construe to be, if there were no constraints of political feasibility, what should the U.S. do? Although I think this question is worthy, I have trouble finding traction to analyze it. As far as monetary policy is concerned, the most fundamental ingredient is what the public expects to happen in the future-- managing those expectations is the basic tool that the Fed could rely on in this situation. Given the way the Fed's opponents have been reacting, I see no way the Fed could effectively approach this other than what I lay out above-- namely, the Fed will have to wait for more convincing evidence of deflation or financial freeze-up before acting. But if you'll let me wave a magic wand to dispense with that complication, the answer is easy-- the Fed should credibly announce a 2.5% inflation target over the next 5 years.
As for fiscal policy, I'd give a similar answer. I see a dysfunctional political process and serious long-run debt management issues. I worry that the current actions of both the Fed and any fiscal stimulus could interact negatively with that for simple issues such as the logistics of weekly Treasury auctions and containing fears that are currently bouncing around Europe like a ping-pong ball. Again, if you give me a magic wand to dispense with all this, what I'd call for is a clear political consensus as to when and how the long-run debt problem is going to be controlled, and given that, I would favor a carefully targeted and explicitly temporary fiscal stimulus.
Given the lack of such wands, what I have instead proposed is that the President focus on the modest tools for job creation that are at his immediate disposal. Alas, this too seems too much to hope for.
Posted by James Hamilton at August 31, 2011 08:03 AMdigg this | reddit
Could we not, in just one teeny-weeny, backward country, try tying politicians' compensation to maximizing sustainable growth? Maybe Libya or Egypt? Syria (coming soon)? Gaza? Pakistan? I'd kill to try it in Hungary. There isn't a fascist there who wouldn't sell their mother for an IMF-approved bonus.
You see, if politicians were paid in the US for maximizing GDP growth subject to budget balance, all this deadlock talk might not disappear, but the problem would be resolved with remarkable speed--just as it was in California. There is private sector precedent; indeed, virtually any company worth its salt anywhere in the world uses this kind of incentive. To propose it for the public sector though is, well, revolutionary. (And, of course, incentives for the government sector work fine in Singapore, but hey, they are clearly from another planet there and therefore have no applicability to us.)
But if we could try it on just one teeny-weeny backward country (that's not an Asian fast growing liberal kind-of dictatorship), well, who knows, maybe it could work. And if it works there, then maybe after 20-30 years, we might tentatively try it just a little bit here.
And then we'd solve the deadlock in a couple of weeks, just like they did in California.
Posted by: Steven Kopits at August 31, 2011 09:46 AM
Can you explain what the Fed could do to drive inflation broadly? That is, the CPI and most people's wages both going up at 2.5% per year. A narrow inflation -- say that drove only commodities, or only stock prices, or the CPI but not wages -- would not seem to accomplish what you want.
Posted by: Michael Cain at August 31, 2011 09:55 AM
Per monetary policy recommendations, I think the Fed could also slowly lower the interest rate that they currently pay on bank reserves.
Consider this graph:
The Fed has purchased securities from financial institutions. And those institutions have deposited ALMOST ALL of their receipts back at the Fed. Granted, QE has succeeded in lowering interest rates both short term and long term. However, what better way to stimulate the economy than to give banks further incentive to lend money to the public? That is, unless we believe a) that the banks will proceed to take unreasonable and excess risks b) that banks need to hold these excess reserves as a buffer against further losses. Both of these possible problems, however, should be manageable if - and this is a sizable "if"- we can implement effective regulation of financial institutions.
Posted by: Daniel at August 31, 2011 10:16 AM
The word "dysfuncional" takes a snapshot in time and assumes that it is all there is. The phrase "wave election" indicates a process that is evolving as fast as our system of elections will allow, given that there is no provision in this country for a lower-house "vote of no confidence" that would trigger early elections.
What is clear is that the GOP class of 2010 was elected with explicit orders to stop the current administration's policies in its tracks. Another way of looking at dysfunctional politics would be if newly elected politicians were to ignore the voters that elected them and instead did whatever they pleaseed. This would undermine democratic legitimacy. One can see these tendencies in Europe where the mainline political parties hide behind the walls of unaccountable bureaucracies. There, various radicals stage riots, bombinga, mass killings and assassinations of their political opponents - in other words, terrorism. In this country, the radicals demonstrate noisily, organize and get out the vote.
It was not too long ago that the major complaint about our political system was voter apathy. Now that voters are energized and demanding that elected officials honor the policies they campaigned for, the complaint is dysfunction. But if the voters continue to express the same will in 2012, we may see a completion of the wave of 2010. In that case Washington will be less "dysfunctional" and the complaint will then be that we are now being ruled by a group of dangerous know-nothings.
I listened to a speech by Natan Sharanksy in which he said that, before six-day war, Russians called Jews cowards. After the war they began calling them thugs. One sign of success is when your opponents change their epithet from one that shows contempt to one that shows fear. Even within the GOP the establishmentarians are expressing their fear of the choices of the voters in code words such as "unelectability." One sign of a functioning political system is that the ruling political classes of both parties fear the judgment of the voters.
I am not saying I suppport the policies that might be implemented by a solid new majority expressing the will of the voters, merely looking at the term du jour describing politics in Washington.
Posted by: colonelmoore at August 31, 2011 10:22 AM
"But if you'll let me wave a magic wand to dispense with that complication, the answer is easy-- the Fed should credibly announce a 2.5% inflation target over the next 5 years."
I see NO reason why this would raise wages. What if that just makes most of the lower and middle class person's budget worse in real terms (negative real "earnings" growth)? IMO, that is how this "economic mess" developed, negative real earnings growth on the lower and middle class and debt to make up the difference.
Why can't economists understand budgets?
And, "Again, if you give me a magic wand to dispense with all this, what I'd call for is a clear political consensus as to when and how the long-run debt problem is going to be controlled, and given that, I would favor a carefully targeted and explicitly temporary fiscal stimulus."
The solution to too much lower and middle class debt is not more gov't debt. I believe you are making the mistake of assuming this is an aggregate demand shock. Lastly, where is the retirement market in your model?
Posted by: Get Rid of the Fed at August 31, 2011 10:25 AM
These Questions Are Too Easy!
The Fed should announce: QE3-at least a trillion $, new inflation target of 4% and drive the 10 year T-Bond under 2%. Hoarding money would no longer be the best option for consumers and investors.
Pres. Obama should propose new tax incentives to spur consumer spending which the GOP would endorse as tax cuts. This is just what Keynes prescribed:
"If it is impracticable materially to increase investment, obviously there is no means of securing a higher level of employment except by increasing consumption. . . . I should support at the same time all sorts of policies for increasing the propensity to consume. For it is unlikely that full employment can be maintained, whatever we may do about investment, with the existing propensity to consume. There is room, therefore, for both policies to operate together; — to promote investment and, at the same time, to promote consumption, not merely to the level which with the existing propensity to consume would correspond to the increased investment, but to a higher level still."
The General Theory of Employment, Interest and Money, p. 325
Posted by: Paul at August 31, 2011 10:43 AM
The best cure for America would be to reset every mortgage to 3.875% fixed for 30 years, period. This would stop the bleeding and is as fair as one can get in terms of folks who whine about debt forgiveness. The debt will be paid, but the interest will reflect the cost of money. I'm talking about those who still in their homes and have paid the price to stay there. Next, eliminate all income and payroll taxes. Institute a tax on any US corporation which does not produce 75% of it's product in country. Tax foreign product at the same level as a U.S. corp that doesn't meet the 75% rule. Institute a new tax on consumption and transactions, to replace the old tax system. Social Security and med. must also be paid from the new taxes. With the increase in cash flow to the American household and a manufacturing base rebuilt to accomodate a new economy based on productive pursuits what emerge. The tax coffers would overflow and the worker would be emancipated from the current economic slavery.
Posted by: Steve at August 31, 2011 11:26 AM
Some in the Founders' generation criticized our Constitution for not in some way linking the "self-love" of the Congressmen to low taxes & debt.
I presume they had something in mind like: 'Congressmen, Senators, & the President shall receive half pay for any year in which the govt must borrow money.'
Imagine what a different country it would be.
Posted by: Bryce at August 31, 2011 12:48 PM
Pessimism has already done the Fed's job for it (lowering long term risk free rates), so no need to give monetary policy a second thought. It's dead.
As for fiscal policy, it's dead too - not because it wouldn't work, but because the powers that be are scared that their taxes will go up in the future to "pay for" the deficits, or alternatively that inflation will erode their savings. Most people aren't misanthropes, but perceived self-interest trumps concern for the unemployed.
Posted by: Max at August 31, 2011 01:35 PM
The Fed should announce: QE3-at least a trillion $, new inflation target of 4% and drive the 10 year T-Bond under 2%. Hoarding money would no longer be the best option for consumers and investors.
I strongly agree. The Fed should not let the US nominal GDP go below a certain growth rate (say, 5%). When most of that 5% is from Real growth, great, but barring real growth, inflation is a second choice.
Most people with mortgages care more about nominal GDP going up so that they can service their debt. Real GDP is less important than nominal GDP, in a debt-deleveraging world.
Posted by: GK at August 31, 2011 02:00 PM
JDH said: "the Fed should credibly announce a 2.5% inflation target over the next 5 years.
Since the Fed is presumably already operating under a 2.5% inflation target and consistently missing that target, I'm assuming that JDH intended to put the emphasis on the adverb "credibly." And there's the rub. I think we're looking at a Kentucky windage problem. If the Fed wants to hit 2.5%, then they probably need to announce an incredible 4% target.
Meanwhile, there are some things that the President could do that would not require any magical wand waving. Fannie and Freddie could get about the business of adjusting loans for people who would otherwise have been acceptable risks were it not for the macro collapse of the housing market. Anything that repairs balance sheets is a good idea. IRS could unilaterally adjust withholding schedules to backload most of next year's income tax payments towards the end of the year, with the idea of juicing the economy at the beginning of the year; and then forgive penalties for those taxpayers who end up owing on 15 April 2013. And how about some recess appointments to fill critical vacancies in Executive departments...especially those authorized under Dodd-Frank? As to proposals, how about proposing a capital budget for crumbling infrastructure? How many water mains have to break each day before we realize we have a problem? (Note: over the weekend another main broke at my office's Army base...becoming a regular thing.) If the deficit is a problem, then how about selling off some of the SPR to pay for the infrastrucure? Selling a week's worth of SPR could generate almost $10B. A $10B investment in weatherization and painting roofs white would have greater social utility than letting it sit in old salt mines.
Posted by: 2slugbaits at August 31, 2011 02:43 PM
GK said: "Most people with mortgages care more about nominal GDP going up so that they can service their debt."
What if prices go up, but wages don't?
And, "Real GDP is less important than nominal GDP, in a debt-deleveraging world."
What happens to employment if real GDP is +1.0% to +1.5%, price inflation is +4.0% to +3.5%, and productivity growth is +2.0% to +2.5%?
Posted by: Get Rid of the Fed at August 31, 2011 02:51 PM
Indeed. The experience of California last month shows that withholding pay will lead to a quick resolution of seemingly intractable political differences.
But I'm still a classical (free market) liberal first and foremost, and that means you get what you pay for. The value of a Congressman or Senator to the economy is huge. For Congress as a whole, the difference between pretty good and pretty medicore governance is on the order of hundreds of billions to perhaps a trillion dollars per year. In (not-at-all-comparable) Singapore, they seem to be able to deliver a similar set of services to ours at half the cost in terms of GDP. So, even if I estimate conservatively, the value of good governance is probably still on the order of $1 bn per member of Congress / year.
Now how much should I pay for that? If I, as a taxpayer, pay them say, 2% of the incremental value of good governance, then that would seem a pretty good deal to me--it's still less than the private sector. So they'd be worth $20 million in bonuses per year per member of Congress. And then they're underpaid compared to their private sector counterparts!
Would I then pay them, say, $2 million per head per year ($10 / US household per year for the whole Congress)? Absolutely. And suddenly, the whole game would be changed. Then it's all about efficiency and optimization, which plays to the strength of economics. Every single economics blog would be different. Guys like Menzie and Jim would be in great demand, because politicians would have every incentive to get every ounce of insight and knowledge out of them. Economists would become the sought-after consultants to the decision-makers--the McKinsey's of the policy world--which is what they really should be.
Posted by: Steven Kopits at August 31, 2011 04:03 PM
Those of you advocating inflation as the cure are irrational. You will destroy the accumulated savings of tens of millions of Americans in order to bail out debtors!
JDH advocating more temporary stimulus is also irrational. We need jobs growth. Those jobs must be real, long lived jobs. Employers can spot temporary stimulus a mile away. They will not create new jobs based on temprorary stimulus. Will some jobs be saved and some temp jobs created ? Sure, just like 3 years ago. How did that go?
2slugs talking about using slight of hand adjustments to the timing of income tax payments is also irrational. Give me a few extra dollars in spring and then take them away in the fall? You really think the US economy will be strong enough in the fall to withstand a tax increase (relative to the spring)?
We need permanent policy changes that incent the supply side to hire and the demand side to consume. The most likely area for such permanent policy change is the U.S. tax code.
I cannot believe that after 3 years of failed temporary stimulus, many of you are still in love with it!
Posted by: tj at August 31, 2011 04:16 PM
Get Rid of the Fed I think your imagination would have to be working overtime to dream up a plausible scenario in which all three of those things happen at the same time. If you're looking at sustained inflation of 4%, then you pretty much have to see wage growth of 4%.
But the main point is that the risks of inflation and deflation are not symmetric. Inflation has to operate within certain bounds. An inflation rate that is too high is not stable and runs the risk of accelerating inflation. Deflation is also unstable, and here I mean unstable in the sense of a phase diagram that diverges away from any equilibrium position. The critical point is that deflation tends to manifest itself as an output loss. That's why Uncle Ben is a lot more worried about deflation than inflation. If only he could convince the three knuckledraggers on the FOMC.
Posted by: 2slugbaits at August 31, 2011 04:18 PM
tj It essentially amounts to a govt loan for the liquidity constrained. And note that the repayment really wouldn't be due until April 15th of the following year. That's essentially a 15 month loan. And note also that the IRS can, at its discretion, waive penalty fees if underpayment of taxes was due to the way things work out if you're following their withholding schedules. In other words, it's an interest free loan.
Posted by: 2slugbaits at August 31, 2011 05:13 PM
While the content of this blog typically proves substantive and sensible, the overflow of cranks in the comments advocating bizarre policies like "shut down the fed" damages the overall effect.
The overall effect is similar to a blog in which cosmologists debate about the origins of dark matter while people in comments insist that grey reptoids from a hollow earth are responsible.
Posted by: mclaren at August 31, 2011 06:11 PM
You may get what you pay for in a competitive market, but Congress is the antithesis of a market process. Public [govt] schools results, for instance, do not correlate in the least with how much you pay per student. Congress is a similarly unaccountable institution.
(Additionally, how do you compute the psychic income Congressmen derive from being big shots?)
Better to concentrate on punishing bad behavior (Congress' natural tendency) with some sort of institutional rule. What exactly did California do?
Posted by: Bryce at August 31, 2011 06:24 PM
2slugbaits, 1st paragraph. It seems to me that could very well happen if some of the NGDP targeting people like scott sumner have their "NGDP futures" market. About the 4% and the 4%, it seems to me there are scenarios that involve private debt, gov't debt, net exports, and NGDP targeting.
2nd paragraph, that actually sounds like a medium of exchange argument.
mclaren, are you referring to me?
Posted by: Get Rid of the Fed at August 31, 2011 08:13 PM
"If the Fed wants to hit 2.5%, then they probably need to announce an incredible 4% target."
Keep in mind what an "inflation target" really is. The Fed can't directly set inflation. All it can do is promise not to raise interest rates if inflation occurs. This means that even a ridiculously high and credible target may not significantly move inflation expectations, if people view near term inflation as unlikely.
Posted by: Max at September 1, 2011 05:06 AM
I agree with the practical realities of fiscal stimulus, however I think the fears bouncing around Europe are widely misinterpreted: its not a fiscal issue its a growth issue. If the market believed growth would resume then spreads would decline because debt becomes more sustainable in the long run. Look at the differenial performance of countries not Europe as a whole.
Second as for the FOMC, there is far too much emphasis on consensus. If I could wave a magic wand I would de-emphasize consensus at every meeting and make policy simple majroty rule. The decision should be made at the median, not governed by the veto of a minority (whether its hawks or doves). Why do decisions have to be unanimous? It's purely political, not grounded in economic theory or even sound policy. Who cares if its a simple majority anyway?
Third, again if I could wave a magic wand, I would want a tax policy that runs a very slight surplus at full employment. Why a slight surplus? Assymmetry relative to the output gap: Unemployment spends more quarters worse than full employment than better (whatever you think full employment is, the distribution is skewed). Also, the fiscal consequences are nonlinear. So, given the skewed distribution and nonlinearity, you want a tax policy that is balanced probably around 6%-6.5% unemployment (about 1% greater than whet you think the full employment unemplyment rate is) - and produces surpluses when under and deficits when over. This is also good macro policy because (whether you think that full employment means UE=5 or 5.5%) there will be surpluses at 6 or 6.5%, providing some countercyclical dampening. Right now, my regressions show the budget is not balanced until UE reaches about 4% and at 5.5% the deficit is about 3% of GDP. This is different than the 90s, where the budget was about balanced at 5.5%. Structurally, tax rates have to go up. I would argue, even somewhat higher than 90s rates. Of course, incomes could go up faster at full employment with higher productivity growth, but I am not banking on that.
Not new ideas of course, just my personal wish list.
Posted by: dwb at September 1, 2011 06:03 AM
There has been very little introspection among economists about this prescription:
Again, if you give me a magic wand to dispense with all this, what I'd call for is a clear political consensus as to when and how the long-run debt problem is going to be controlled, and given that, I would favor a carefully targeted and explicitly temporary fiscal stimulus.
The problem with this analysis is that it ignores the following, which is the definition of animal spirits:
Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities."
So the question I would ask is simple: Since the short term program is unsustainable given the long term fiscal situation, why do we think such measures will create a "spontaneous urge to action"? The last time we ran fiscal deficits this large (as expressed as % of deficit to GDP) was during WW2 - and no one had any idea how long the War was going to last.
In short, I think some Keynsians (and I am one) are talking out of both sides of their mouths. The idea that we can run deficits now and fix it later simply isn't align with any political reality I know of, and such a proposed program may fail to restore confidence, which is, after all, what Keynsian economics is all about.
In this sense the writings of many economists over the last few years has an air of unreality. They acutally support two contradictory policies (albiet at different times) but never discuss how one might interfere with the other.
Posted by: fladem at September 1, 2011 06:04 AM
Based on Fladem's comments about animal spirits, I would add to my comments about the political scene. Some of the flagging animal spirits may have to do with the failure of government fiscal intervention to stem the tide of unemployment.
The most recent high profile job loss occurred at Solyndra. With the combination of the President's visit to Solyndra one year ago touting green jobs and the state of California's high-profile efforts to promote green power, Solyndra's bankruptcy and the resulting pink slips are doubly disappointing to those who hoped that government could wave a magic wand. Those short term jobs came at the cost of $1 million of wasted taxpayer dollars per worker hired. And I can imagine what all of the current green jobs trainees are thinking about their futures.
If it becomes clear that the GOP will win control of the Senate and the Presidency, investment dollars will turn away from the sorts of industries that can only be sustained for a short time through massive spending, including other high profile failures such as Range Fuels or outright frauds such as Cello Energy.
It is difficult to predict whether refocusing investment away from politicians' pet projects will result in any increase in hiring. But it would be an improvement over the depression in animal spirits resulting from the massive failures of such pet projects.
Posted by: colonelmoore at September 1, 2011 08:19 AM
I agree with Paul's comment that this is not a hard question even though people are pretty confused about it. First, as economists, our job should be to give the best possible advice and leave it to the politicians to try to implement it (we shouldn't try to second guess what is politically possible, which I agree in the present climate is pretty much nothing).
So the short answer is fiscal policy, fiscal policy, fiscal policy. We need big time expansionary fiscal policy, and government spending (giving money to the states is probably the single best policy at this time) is more effective than tax cuts. All of this was true in January 2009, so a lot of deficit water has needlessly gone under the bridge (still far better than having done nothing).
As for the deficit, we should do the fiscal analog of Operation Twist. We should reform Social Security (and Medicare if anyone can figure out how) so our long term debt position improves and hopefully gives confidence to investors, but we should raise the short term deficit a lot.
Some of our best minds (James Hamilton, Paul Krugman, Olivier Blanchard to name a few) seem confused, from my perspective, about the inflation target. Surprisingly for many of these economists, they seem to have forgotten that we are in a liquidity trap and that labor and product markets are very weak. I do not believe that the Fed can credibly raise its inflation target - I do not believe that in this environment the Fed has the capability of raising the inflation rate. There is virtually no amount of money the Fed can create that will raise the inflation rate (look at all the money it has created and the inflation rate has not moved). I do agree with Daniel that the Fed needs to stop encouraging Banks not to lend, but its policies are a small disincentive (it's not the main reason banks aren't lending). So the only solution is fiscal policy, fiscal policy, fiscal policy.
Posted by: Mark Kuperberg at September 1, 2011 08:54 AM
In California, the legislators were not paid until the budget was passed. They did it on time for the first time in 25 years, as I recall.
This has risks, however, that legislators become more focused on balancing a budget than making good choices. I prefer we focus on creating sustainable value.
Politicians get perks. But if that were enough, then Mubarak's bank account would be thin. It's not, and it's not for most politicians who can get away with it. I have a relative who was Minister of Infrastructure in Hungary, and he commented that literally everyone who came through his door tried to bribe him. He found it so stressful, he literally left the government and has refused to be a minister since. Don't kid yourself: money matters.
It matters most to back-benchers, who do not have access directly to graft in many cases. They often have meagre salaries and are highly dependent on leadership for patronage.
Now if these folks got a substantial bonuses, their attitude toward leadership would be quite different. So, an incentive system changes the nature of power within a legislative body.
Posted by: Steven Kopits at September 1, 2011 08:54 AM
"You see, if politicians were paid in the US for maximizing GDP growth subject to budget balance, all this deadlock talk might not disappear, but the problem would be resolved with remarkable speed--just as it was in California."
Steven Kopits - Of course you know that the Clinton Administration did exactly what you suggest, they goosed the economy by allowing investment banks to raid the commercial banking industry and its vast pool of savings through "deregulation". Congress and successive administrations did it for thirty years by allowing tax shelters for foreign operations, trading low import prices (low inflation) with the loss of US manufacturing.
There is no end to the damage that can be done to the economy by all sorts of short term expediencies, trading the country's future for a hamburger today. STOP THE ROT, stop the subsidies to the financial sector, stop the market manipulation by the central bank, ALLOW the bankruptcies and resulting deleveraging that have to occur for the economy to recover.
Posted by: MarkS at September 1, 2011 09:03 AM
Mark Kuperberg Some of our best minds (James Hamilton, Paul Krugman, Olivier Blanchard to name a few) seem confused, from my perspective, about the inflation target. Surprisingly for many of these economists, they seem to have forgotten that we are in a liquidity trap and that labor and product markets are very weak. I do not believe that the Fed can credibly raise its inflation target
My interpretation of this holy triumvirate's view is that the Fed is unlikely to successfully issue a credible inflation threat, but that is no reason not to try. In fact, Krugman has been quite explicit about the Fed's credibiilty problem. FWIW, that's why I referred to the need for an "incredible 4% target." I don't expect much from QE3, and my reading is that JDH, Krugman and Blanchard don't expect it to accomplish a lot either. OTOH, you could probably make a reasonable case that QE2 at least fended off deflation even if it didn't stimulate growth; and that's not a trivial achievement. I agree with you that the emphasis ought to be fiscal policy, fiscal policy, fiscal policy; but right now we need to be thankful for even the smallest efforts.
Posted by: Anonymous at September 1, 2011 02:02 PM
Obama just cancelled the new EPA smog reg's. Progressives are finally starting to get the idea that you can't heap a costly social agenda on society when the economy so weak.
Posted by: tj at September 2, 2011 09:53 AM
I'm rather disappointed that even a temporary and targeted set of fiscal stimuli is "unwandable." To mix metaphors, this is tree-hugging of the worst sort. Of course, wands cannot be cut from the trunk; and any branch one climbs out upon these days is likely to be sawn off. Inaction though, since no leaves grow on the trunk, is a recipe for ongoing starvation. We should have long realized that the 2012 election of a congress willing to undertake economic initiatives is the only hope for renewal. In order to do that our only option is climb out upon every branch, shake off the sound chestnuts, and bury the branch-sawyers. Cost-benefit analyses to the max, any proposals where benefits exceed costs should be forwarded. Any general principles for accurate forecasting might be extremely useful.
Posted by: Ronald Calitri at September 2, 2011 06:02 PM
tj Progressives are finally starting to get the idea that you can't heap a costly social agenda on society when the economy so weak.
This is a very strange statement and reflects, I think, a profound misunderstanding of basic economic principles. Your statement has the ring of common sense to it, but if you stop and think about it for a moment it's pretty clearly junk economics. First, cancelling new smog regulations does not reduce costs, it simply shifts the costs. Second, the new regulations would not have been implemented for several years out, so it's a bit hard to see how that has much to do with today's job problem. Third, if you honestly believe uncertainty over govt regulations is what's lengthening the recession, then cancelling EPA rules is counterproductive because it adds more confusion, not less. No one honestly believes that the new smog rules will not eventually be implemented, so all that Obama's action accomplished was to make the actual implementation date less certain. Finally, I don't know if you're familiar with optimal control theory, but since policy must eventually traverse to the same terminal state (that's because the terminal state is a function of physics, chemistry and biology), Obama's decision effectively gums up the control variables. It gets the shadow prices all wrong. Look, given that the EPA rules are going to be implemented eventually and all this does is postpone the inevitable, today's decision effectively creates perverse incentives. It makes a lot more sense to invest in new capital when interest rates are virtually zero than in the future when interest rates will be higher. The government should be backing up investment in clean air today when there is too much saving relative to investment demand. The only way this policy decision makes sense is if you're worried about Medicare and Social Security; and that's because cancelling the new EPA regulations means more people die younger, which will take some of the stress off those two programs.
Posted by: 2slugbaits at September 2, 2011 08:49 PM
I think we can both agree this was nothing more than a cheap political move, coincidentally made on the same day that we get a terrible jobs report. Pure politics. That's the problem with our government, politics trumps 'we the people'.
As far as the actual policy goes - I agree, we need cleaner air. However, shoving most of the country's power plants into a non-compliance category which prohibits expansion is certainly a short run loser for the economy. All that would happen is that the costs of brining the power plants up to the standard would be shifted onto households. Rate boards might limit proposed rate increases then what happens? Power companies go bankrupt. Fewer new power plants are built, high tech or low tech. The result? Progressives price home heating and cooling out of the reach of the lower and middle income households and the elderly.
Opotimal control theory is fine, but you think we are on an optimal trajectory now? How does shifting the cost of these regs that will cause household energy bills to 'necessarily skyrocket' lead to a jump from a no growth trajectory to normal growth trajectory? Isn't the current trajectory one of the trajectories that crashes into the horizontal axis?
Posted by: tj at September 3, 2011 08:28 AM
2slugs, I wish I were as good as you at predicting the future. Why is it guaranteed that the new regulations will be implemented in the future? Do elections only have consequences when one side wins?
I am not familiar with the degree to which current levels of ozone and other emissions are causing morbidity and mortality. So I don't know how much the proposed reductions in current levels of airborne pollutants will affect human health indicators. If these are significant then certainly there are ongoing costs that should be considered.
However, the EPA has a nasty habit of crying wolf. I was speaking with a career EPA regulator a few years ago. It turns out that a reevaluation of the carcinogenicity of PCBs showed that the original studies were scientifically flawed and a review of the best studies showed that the dangers of ingestion of small amounts of PCBs (as opposed to pouring it in high concentrations into rice consumed by Japanese) did not warrant the extensive, $30 billion dollar clean up that was undertaken.
Under normal protocol, this would trigger new regulations. But no one wanted the political fallout, least of all the utilities, whose clean up efforts were nearly completed and were paid for by ratepayer assessments anyway.
I did a quick survey of studies of workers who experienced high levels of PCB exposure at manufacuring plants. There is still no conclusive evidence of excess mortality. Given this, it is unlikely that people exposed to low doses of PCBs through environmental pathways are experiencing ill effects.
By the way, PCBs were instrumental in stopping transformer fires, which were the biggest killers next to electrocution in the electric system. They have been replaced by the old standby mineral oil, which can vaporize and cause an explosion. No one measures the premature deaths and morbidity caused by the elimination of PCBs.
While current efforts to undermine EPA are probably overreach, the cost of not implementing proposed regulations may be overstated.
Posted by: colonelmoore at September 3, 2011 09:44 AM
tj and colonelmoore Both of you view the implementation of EPA clean air regulations as luxuries that we can only afford in a booming economy. This is fundamentally wrong for two reasons. First, government policy should be countercyclical, not procyclical. Government is not a household. This is something that a lot of conservatives have a hard time grasping. For example, Rep. Eric Cantor claimed that we could afford deficit financing of the wars during the Bush years because the debt was lower, but not now because debt is higher. This has it exactly backwards. Interest rates are near zero, so any public investment that makes sense during boom times makes even more sense during a recession. The second reason you're wrong is that dirty air is itself a cost. Deciding not to implement clean air regulations does not make the cost of dirty air and ozone depletion zero. Again, conservatives do not understand that cost shifting is not cost reduction. Ideally we would want to impose some kind of effluent tax on smog and ozone pollution, but there's no way Congress would go along with it, so we're stuck with second best solutions like regulations.
You also might want to revisit your claim that imposing higher energy costs would kill job recovery. This sounds like common sense economics, but think again. According to the Dept of Commerce estimates for industries, a 1% rise in energy costs increases the cross-price elasticity of demand for labor by 0.03%. Basically no change. And the Morishima substitution elasticity estimate is that a 1% rise in the price of energy increases the labor/energy ratio by 3.6%, which suggests a highly elastic substitution effect. Hold output constant with an increase the price of energy and business will respond by increasing investment in new capital and by hiring labor to make the plant more energy efficient. Of course, the key is to hold output constant, and that's where the govt should come in and increase govt purchases of goods and services. Currently govt is cutting back demand for goods and services. Now reverse the process and ask yourself what happens if output falls given those elasticity numbers??? Conclusion: Obama's decision hurts job growth. And you knew it had to be a bad idea because the usual GOP suspects are praising it.
Posted by: 2slugbaits at September 4, 2011 07:25 AM
Your borrow today advice is fine if we finance that borrowing with 30 year debt, but what is the average maturity on government debt issued for NEW spending in the past 10 years? If we borrow today at low rates, we roll it over at ever increasing rates. You seem to be confused by the fact that we never reduce our national debt. Even when Bush had a surplus it was not used to pay down existing debt. So your point is moot.
Regarding your elasticities, those are too simple. It's like reporting the correlation between stork sightings and births. Variation in other explanatory variables is assumed away. Energy prices rise during booms, employment rises during booms, so what?
Posted by: tj at September 4, 2011 10:10 AM
tj There is no reason Treasury could not finance spending with a 10 year or 30 year maturity. In fact, the market is screaming for Treasury assets, which is why the nominal 10 year is a whisper over 2%. Do you understand that the market is telling us that it wants more Treasury assets, not less? Do you get that? That's because there is too much desired savings relative to demand for that savings. If government doesnt' soak up that savings, then we end up with a permanent loss in output.
As to reducing the debt, the last time the country had zero debt was under Andrew Jackson...and it led to one of the worst depressions in the country' history. In any event, the debt held by the public did go down in both absolute and relative terms all the way from 1997 through early 2002. And the only time Bush had a surplus was his first year after Clinton's surpluses. So you're just wrong on the basic facts.
Your comments on elasticities are the sorts of things I hear from people who don't really understand the subject matter, but can't bring themselves to concede a point so they just make up a bunch of junk that sounds good. Basically, you're faking it and it shows. What the Dept of Commerce's elasticity estimates show is that the man-on-the-street view is just wrong. The man-on-the-street view is that energy, labor and capital inputs are complements, so an increase in the price of energy must reduce demand for labor and capital. That view is simply incorrect. It may be true that a sharp increase in the price of energy creates a temporary supply shock as the economy adjusts, but the long run effect of energy price hikes is to increase the labor/energy ratio. The EPA regulations would not have represented a short term supply shock because they were well known. OTOH, because the EPA regulations were postponed to some indefinite time in the future (and they will eventually have to be implemented), there may very well be a strong supply shock down the road. If you think that postponing execution of the EPA regulations reduces their overall welfare cost, then you are sadly and badly mistaken.
Posted by: 2slugbaits at September 4, 2011 02:39 PM
2slugs, actually all I said is that you are better at predicting what will happen in the future than I am given that there will be elections, and also that EPA has a habit of crying wolf.
In the case of PCBs the stricter regulations were unnecessary. There are other cases where EPA did not follow good science, such as in the case where it pushed for regulation of endocrine disrupters on the basis of a published study that had to be retracted from Science after its results could not be replicated and the author was forced to admit that his statistical analysis was flawed. There are some endocrine disrupters that should not be in children's toys for example but EPA would have gone far beyond what the science warranted had its hasty push not been undermined by sound science.
I am not claiming that EPA scientists are repeating these errors with ozone. As we know, the moral of the wolf fable is that the wolf really does come but no one listens. In the case of the EPA the public deserves careful reviews of its conclusions based on its track record of rushing ahead of careful science.
This has nothing to do with cost-benefit analyses.
Posted by: colonelmoore at September 4, 2011 10:56 PM
'treasury could' could is the key word.
I admitted that energy prices and labor are postively correlated. I explained it for you. You ignored it.
Posted by: tj at September 5, 2011 05:43 PM
A good article in the Saturday USA Today had comments from several economists on ways to boost jobs. The mix varied from spending on infrastructure to schools to helping the states to avoid layoffs. These all require money as new taxes or new debt or shifting existing funds. Many are sure fire job adders/loss avoiders. The more sketchy idea to cut corporate taxes and loose $81B in revenue (supposedly to be made up elsewhere) has only a chance of new jobs versus just more corporate profit (funds to support election of candidates). So each idea needs to be modeled with a risk profile of the number of jobs added versus the net cost from taxpayers. But most of all, politics that cuts spending on the direct job creation, gives out corporate tax reductions and and then needs to cut more jobs, will be the sure way to show more job losses in time for the November elections. What will our "leaders" choose from the options in this article?
Posted by: Bennie at September 6, 2011 08:30 AM
To the individual above saying government debt can not or should not replace private debt, Krugman has a response:
One of the common arguments against fiscal policy in the current situation – one that sounds sensible – is that debt is the problem, so how can debt be the solution? Households borrowed too much; now you want the government to borrow even more?
What’s wrong with that argument? It assumes, implicitly, that debt is debt – that it doesn’t matter who owes the money. Yet that can’t be right; if it were, we wouldn’t have a problem in the first place. After all, to a first approximation debt is money we owe to ourselves – yes, the US has debt to China etc., but that’s not at the heart of the problem. Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth – one person’s liability is another person’s asset.
It follows that the level of debt matters only if the distribution of net worth matters, if highly indebted players face different constraints from players with low debt. And this means that all debt isn’t created equal – which is why borrowing by some actors now can help cure problems created by excess borrowing by other actors in the past.
To see my point, imagine first a world in which there are only two kinds of people: Spendthrift Sams and Judicious Janets. (Sam and Janet who? If you’d grown up in my place and time, you’d know the answer: Sam and Janet evening / You will see a stranger … But actually, I’m thinking of the two kinds of agent in the Kiyotaki-Moore model.)
In this world, we’ll assume that no real investment is possible, so that loans are made only to finance consumption in excess of income. Specifically, in the past the Sams have borrowed from the Janets to pay for consumption. But now something has happened – say, the collapse of a land bubble – that has forced the Sams to stop borrowing, and indeed to pay down their debt.
For the Sams to do this, of course, the Janets must be prepared to dissave, to run down their assets. What would give them an incentive to do this? The answer is a fall in interest rates. So the normal way the economy would cope with the balance sheet problems of the Sams is through a period of low rates.
But – you probably guessed where I’m going – what if even a zero rate isn’t low enough; that is, low enough to induce enough dissaving on the part of the Janets to match the savings of the Sams? Then we have a problem. I haven’t specified the underlying macroeconomic model, but it seems safe to say that we’d be looking at a depressed real economy and deflationary pressures. And this will be destructive; not only will output be below potential, but depressed incomes and deflation will make it harder for the Sams to pay down their debt.
What can be done? One answer is inflation, if you can get it, which will do two things: it will make it possible to have a negative real interest rate, and it will in itself erode the debt of the Sams. Yes, that will in a way be rewarding their past excesses – but economics is not a morality play.
Oh, and just to go back for a moment to my point about debt not being all the same: yes, inflation erodes the assets of the Janets at the same time, and by the same amount, as it erodes the debt of the Sams. But the Sams are balance-sheet constrained, while the Janets aren’t, so this is a net positive for aggregate demand.
But what if inflation can’t or won’t be delivered?
Well, suppose a third character can come in: Government Gus. Suppose that he can borrow for a while, using the borrowed money to buy useful things like rail tunnels under the Hudson. The true social cost of these things will be very low, because he’ll be putting resources that would otherwise be unemployed to work. And he’ll also make it easier for the Sams to pay down their debt; if he keeps it up long enough, he can bring them to the point where they’re no longer so severely balance-sheet constrained, and further deficit spending is no longer required to achieve full employment.
Yes, private debt will in part have been replaced by public debt – but the point is that debt will have been shifted away from severely balance-sheet-constrained players, so that the economy’s problems will have been reduced even if the overall level of debt hasn’t fallen.
The bottom line, then, is that the plausible-sounding argument that debt can’t cure debt is just wrong. On the contrary, it can – and the alternative is a prolonged period of economic weakness that actually makes the debt problem harder to resolve.
Posted by: DarkLayers at September 8, 2011 09:20 AM
in regrard to ColMoore's PCB discussion above: your 'EPA contact,' does not appear to have had correct information, and likely has not even read any of the published scientific work on health effects and PCBs. I am one of the scientists who has published animal studies showing that ingested PCBs caue dysregulation of neurochemical release, but there are lots of published studies showing that PCB exposure is linked to a host of health and neurodevelopmental problems in humans. Many of these effects do not lead to imminent death, but is that the only appropriate benchmark for deciding that a chemical is causing adverse effects? One study of fish-eating populations near the Great Lakes shows an association with autism and retarded development in children. We are spending more to correct or ameliorate those adverse effects right now, and we can spend less on these things if we minimize chemical content in our soil and waterways. Not only do regulations not kill jobs, as 2slugs points out, but we can avoid future costly spending on nonlethal effects of pollutants if we simply treat them as the contaminants they are NOW.
Posted by: 4InOhio at September 10, 2011 02:22 PM