…The specter of fiscal mindlessness
I’m just back from two weeks in Europe. During that time, growth indicators have signaled a slowdown [0] in the midst of a massive negative output gap [1], while a substantial bloc in the Congress refuses to think in a sensible fashion about fiscal policy. This point is most forcefully illustrated by the inability of the Senate to move forward on extending unemployment insurance. (It makes me wonder if some were asking the question, “Are there no poorhouses?”)
Slack in the Economy
First, a recap of the output gap, as estimated by the Congressional Budget Office, and the projected gap using the latest available Macroeconomic Advisers’ forecast. In log terms, the output gap for 2010Q2 is 5.57% (5.42% in level terms).
Figure 1: Log GDP, in bn. Ch.2005$ (blue line), Macroeconomic Advisers’ forecasted GDP as of 2 July (red line), and potential GDP as estimated by CBO in January 2010 (bold gray line). Gray shaded area indicates recession, assuming trough at 2009Q2. Sources: BEA, 2010Q1 3rd release, Macroeconomic Advisers, CBO, NBER, and author’s calculations.
Consistent with the Administration’s forecasts as well as CBO’s, considerable slack will exist in the economy for at least another year. And yet, I often hear calls for monetary restraint because of incipient inflationary pressures, which I haven’t seen any evidence of (see also Figure 3 in Rudebusch’s discussion). Fiscal restraint makes a lot of sense, and in fact in my 2005 Council on Foreign Relations report, I made strenuous argument for fiscal restraint to pull output back to potential — that is, getting the cyclically-adjusted budget deficit close to zero. But cutting back on fiscal stimulus at a time of substantial slack is pro-cyclical fiscal policy, something that makes little sense. (Note that the actual and cyclically adjusted budget deficit differ substantially, according to the CBO [2])
What If the Forecasts Are too Optimistic?
The recent employment situation release for June suggests that we should err on the side of caution, and worry more about deficient aggregate demand than inflation.
Figure 2: Log nonfarm payroll employment, seasonally adjusted (blue line), private sector employment (red line), private sector aggregate weekly hours index (green line), all seasonally adjusted, normalized to 0 at 2007M12. Gray shaded area indicates recession, assuming trough at 2009Q2. Source: BLS via FRED, NBER and authors calculations.
Figure 2 makes clear that private sector employment is growing, but growing slowly. Even (private sector) aggregate hours are no longer rebounding strongly. Figure 2, rebased to 2007M12 levels, highlights the fact that hours remain more than 8% below peak. As a consequence of the June release, I suspect that forecasters are revising downward at least their short term forecasts (see WSJ RTE).
Overall Government Spending
The failure to implement more transfers to the states as part of an additional stabilization package seems extremely foolhardy to me, given that the estimated multiplier for such transfers is quite high. [3] We know that spending is now declining in real terms, and hence exerting a negative impact on GDP growth.
Figure 3: State and local government consumption contribution to GDP growth in percentage points, SAAR (blue line, left scale), and state and local government consumption in billions of Ch.2005$, SAAR, in logs (red line, right scale). Gray shaded areas indicate recession, assumes trough for last recession at 2009Q2. Source: BEA, 2010Q1 3rd release, NBER, and author’s calculations.
Moreover, state and local government employment is now decreasing. See also WSJ RTE, and Aizenman and Pasricha (2010).
Figure 4: Total government employment, in thousands, seasonally adjusted (blue line), excluding temporary Census workers (red line), state and local government employment including education (green squares). Gray shaded area indicates recession, assuming trough at 2009Q2. Source: BLS via FRED, BLS, NBER and author’s calculations.
The Fiscal Situation, Misunderstood
I think a certain self-flagellating approach to fiscal policy has taken hold in policy circles, both here and in the euro area (see the Economist‘s discussion; see also WSJ RTE). Sometimes, fiscal restraint in a downturn is unavoidable; for instance Southern European countries that have investors fleeing their debt do need fiscal consolidation, augmented by other measures.
But in the case of the United States, we have faced a long term fiscal challenge for a long time. The biggest portion of the challenge comes not from provisions of the stimulus package, or TARP, but rather from our refusal to deal with long term cost trajectories in the entitlement programs, and our refusal to tax ourselves, as exemplified by the tax cuts of 2001 and 2003.[4]
Spending cuts in the short run, and the refusal to fund unemployment insurance and transfers to the states, is certainly counterproductive to the extent that they throw the economy into another downturn, or condemn us to stagnant growth. Such cuts provide the patina of “fiscal responsibility”, while failing to address the core budget busting problems, as laid out in CBO’s recent Long Term Budget Outlook. Much better to pin down long term expectations regarding the debt by dealing with entitlements, and maintain current aggregate demand by avoiding ill advised cuts that will do little to impact long term debt sustainability. (See Giavazzi (2010) for more).
The International Dimension
There are additional reasons to consider additional stimulus. In my presentation at a Euro50 Group/Reinventing Bretton Woods Committee conference, discussing the implications for the rest of the world of the euro area’s debt-related travails, I did not see a big impact from the euro’s depreciation. However, I did worry that excessive fiscal retrenchment on the part of the Northern euro area countries could have a large negative impact on the US, insofar as euro area growth suffered from the contractionary fiscal policy.
The international connection is also important in terms of context, especially in reference to discussion of “expansionary fiscal contraction” a la Giavazzi-Pagano (1990). Fiscal contraction might or might not have a positive impact on output; much depends on the initial conditions, how the policy is effected, and so forth. One supportive factor that is missing in this case is a buoyant international economy. To the extent that the rest of the G-20 — particularly the advanced countries — is not expanding rapidly, the prerequisites for expansionary fiscal contraction in the US are less applicable to the current situation (see Krugman for a discussion).
Update: 6 July, 7:15am Jeff Frankel has more details on the issue of addressing the deficit over the long term.
J. Calmes/NYT describes the internal WH debate on further stimulus.
Menzie,
I while back you argued the stimulus had been successful. I noted that a successful stimulus should be defined as one that sparks self-sustaining growth. By that measure, it has, apparently, failed. Your solution is more stimulus to counteract the headwind of “fiscal contraction”. If it fails to produce self-sustaining growth again, you might argue for yet more stimulus. In some circles, the inability to remove stimulus without tanking the economy is known as a “structural budget deficit”, one which is likely to be financed by the central bank.
We desperately need tax hikes.
The best tax hike would be cap and trade placing a good solid tax revenue generation on all fossil fuel consumption, but I’d settle for just the future expectation of high taxes on carbon. The result will be Wall Street driving investment to avoid paying the carbon tax, for investors will invest in money losing deals to reduce taxes.
Failing that, then the expiration of the failed Bush tax cuts is the next best hope. The problem is Romer has drunk the tax cuts stimulate job creation koolaide, continuing to sacrifice workers to the gods of “this time please make the tax cuts work.”
When have tax cuts ever created jobs? They failed in 1981 and do claim that the Fed tighten, which is crap because money was stable and predictable for Reagan’s first too years than for Carter’s last two years when the money supply tightened abruptly along with a spike in oil prices – the job losses from that were less than when the money supply grew steadily after Reagan’s tax cuts.
And the tax cuts have certainly failed to produce any real growth in the past decade.
Why does it make sense to not tax those who are doing as well in the recession as they did in the expansion? What is the virtue of bidding up th stock prices? That results in no addition to the productive capital stock. With the economy slowing, what is the reason for investing in a new business and new productive capital?
The only thing that happens is the stock indexes go up, as the employment rate goes down and the amount of surplus labor and surplus productive capital increases, increasing the wasted capacity.
A capitalist see surplus labor and capacity as an opportunity to produce added productive capital to reduce the resources or labor required for present or future consumption.
We have a constantly increasing demand for energy, and the cost of fossil energy is increasing from an already expensive level where the cost is has not been paid. The obvious place to use the surplus labor and capacity is making sustainable energy capital.
That the public policy is to not use the surplus labor and then debate even keeping the surplus labor from losing all accumulated savings and assets to that they are even less prepared for retirement, so that in the future, they become part of the welfare burden.
The current policies are almost intentionally designed to not use surplus labor to produce productive capital that will generate returns in the future, but to instead turn the surplus labor into decapitalized human capital that will be a liability in the future. The only solution then is Soylent Green, or the creative destruction of excess human capital to meet the demand for organ transplants.
How can there be a deficient aggregate demand? The middle and upper classes have everything they can use, and then some. Do you really suffer when you don’t replace your car every two years? Do you really suffer when you buy only one new phone a year for your family? Does your computer stop working after two years? Five? It is extremely easy for most western households to cut back on consumption, and even the most aggressive advertising is going to have an uphill battle convincing people that they are missing out.
The wall the US economy (and to a lesser degree, Europe’s) ran into is hard. Not only can people not consume more because they’re broke, but people with income to spare just don’t need anything at all (aside from the kind of things that only government can fix: a better infrastructure, better work rules, better public schools, better or at least cheaper access to healthcare, …).
So where is the demand going to come from? I can’t imagine it coming from anywhere inside the US (or Europe, for that matter). If anything, western economies will contract further as demand first starts to match income, credit cards get paid off and savings increase in the face of doubt about the future.
“Fortunately”, the world needs plenty of stuff, as the vast majority of humans live in squalor. It would be great if we could put our excess production capacity to use in fulfilling the needs of the needy, in stead of trying to cram more unnecessary crap down the throats of the overindulging. Regrettably, neither our economic nor our political organisation allows for this to happen.
But if we can’t find a way to use our excess capacity to provide products that are actually needed, production capacity will simply contract to meet demand. That is a vicious circle, as everyone knows: reduced capacity means reduced employment, meaning reduced income, meaning reduced demand. Where it ends is unclear (it’s even unclear whether humanity as a whole would be worse off, although certainly the western world would be), but unless we find a way to rearrange our global economy, I don’t see how it can be stopped. It took trillions of dollars to just slow the decline down (which is a good thing), but the decline itself is pretty inevitable.
Mr. Chinn,
You seem to be a proponent to extending unemployed benefits; so, since they are currently extended to 99 weeks, how long do you suggest we extend them to? Perhaps forever? You seem to over look the notion of human nature and the moral hazard, that is, for the most part people take no steps to decrease their living standards while on unemployment to make each dollar go as far as possible.
No doubt they are exceptions, but at what point does one realize that the jobs these people lost are not coming back? These same people need to learn new skills, but people tend to not do this until they have to, holding out for the economy to pick up, and thus be rehired at their old jobs. That I do not think is going to happen.
However, simply saying we should keep extending unemployment benefits is not a plan either, it’s just a blind shot in the dark, and a blind faith hope. These plans have no chance of working, just as everything done so far hasn’t worked, but only delayed the day of reckoning–except according to your colleague, Mr. Hamilton, we’ll somehow, some way, avoid a double dip (I think that claim will come back to haunt him).
In all these analysis, there seems to be a profound lack of direction and imagination, and that includes the supposedly great Paul Krugman, whose ideas appear to be bland as well. Perhaps it’s irrelevant as there’s a complete lack of political will to carry anything out with any significance.
However, if one is going to argue for increased fiscal policy, the first step is addressing the elephant in the room: public employee wages and overly generous health and pension plans–until one also brings up deflation in the public sector pay and benefits, it really is hard to take any notion of government intervention and spending seriously.
Which resources are available for more fiscal deficits or stimuli in Europe,when government debts in euro area have jumped from 69.1 % of GDP in 2003 to 78.6 % in 2009 (please see P26 ECB statistics pocket book may 2010)
Econbrowser posts have documented a multiplier less than 1 as impact on economy for the marginal fiscal expenditures,when the IMF has statistics proofs, that beyond a threshold of 80/100 debt to GDP, the debts principal are not repaid but interest only. P Rogoff C Reinhard evidenced (P5) at this debt level, 50 % of the sovereign risks were in default in the post war 2 period (average tenor of default 15 years).
The same document underlines the fact that be they domestic or external, government debts defaults occurred the same way. I wonder how the on going stress tests on European Banks is going to factor these probable (statistical sense) events.
“The failure to implement more transfers to the states as part of an additional stabilization package seems extremely foolhardy to me, given that the estimated multiplier for such transfers is quite high.”
Ah, but didn’t you hear what the Maestro told CNBC last week? The fact that large macro models can’t forecast well represents evidence that the coefficients are wrong. If the coefficients are wrong, then we don’t know what the fiscal multipliers actually are. If we don’t know what the fiscal multipliers are, then we shouldn’t try more fiscal stimulus – QED.
Seriously, that’s what he said. It was an amazing performance, but also just shocking. He didn’t even try to justified the leap from “don’t know know the precise coefficient” to “do nothing”. He just hoped we’re all stupid enough to think his little hand-wave was a real justification.
Due to the aging of the population, we are in a wind-down mode… plus the production levels of the bubble years were wasteful and unnecessary. There’s no reason to expect much growth. There is also no reason to want it; we really should not return to those levels.
Another spectre is haunting us as well. That of the uninformed voter. The tea party fringe especially here in the south are passionate, angry, and amazingly uninformed.
I’m running for State Senate down here in GA and I can tell you that without a doubt 9 out of 10 people I speak with get basic facts about the economy wrong.
There is so much flatearth society economics running around in the media that its created an echo chamber of nonsense. I personally blame liberal media bias for this state of affairs. But good economic policy is never going to get a fair shake in the real world of politics until demos either cools off or can be reached out to by politicians.
I’m an undergraduate in the GSU econ department and I can tell you the debates and discussions going on in the halls of academia and the discussion going on at community forums are light years apart. Until the intellectuals dig in and engage people (part of the reason I love your blog) “feels good sounds good” policy will continue to be the norm at the voting booth.
Viewing the great recession as arising from too much debt misses the other side of the coin, pressure to lend from too much savings. Borrowing has to equal savings. Three factors contributed to a large savings pool seeking returns through lending. An (1) increased consumer savings pool partly arose from tax cuts for which government had to replace with borrowing. The (2) financial system magnified savings. (3) Trading partner mercantile policies contributed diverted savings from emerging economies to the US.
[edited for length — MDC]
If four cohorts act as net savers, funding of innovation is not a problem of not enough savings, it is a problem of savers willing to provide the savings to innovators. A tax reduction probably will not motivate this willingness. Perhaps a directed tax credit would.
If there is not sufficient borrowing for the amount of savings available, wealth destroys savings to equilibrate to the level of borrowing. This equilibration creates deflation. Borrowing has to equal savings. If borrowing declines, the savings decline shows up in the form of wealth decline. Some businesses would be unable to pay interest obligations. Incomes and employment would be reduced. Government tax revenue would decline which might defeat any effort to reduce deficits. Some consumers would be unable to meet obligations such as mortgage payments. If business contracts, the value of business equity which is the present value of future dividends would decline. Wealth would decline until savings and borrowing are again equal.
Looking at the two consumer cohorts, consumer savers (C10%) who have most of the wealth would suffer the most wealth loss. Consumer borrowers (C90%) would suffer increased unemployment and reduced incomes.
Other direct forms of wealth such as net house equity and durables would decline more and faster in a deflationary environment that they would do otherwise.
Pensions are dependent on business health and would suffer reduced returns or losses. Social Security and Medicare are funded from trust funds but trust funds have been a net provider of revenue to government. With reduced government revenue in a deflationary environment, pressure to reduce Social Security and Medicare payments would be intense.
“The middle and upper classes have everything they can use, and then some.” [!]
Fascinating! And here I thought that I was a member (if just barely) of the Middle Class with a family imcome of about $45K per year. I see now that I was wrong, according to endorendil. We’re living with furniture that a frat house would throw out, in a house that is gradually falling apart, simply because I cannot manage to find the savings to pay the bills and property tax and still properly fix the myriad of house and car problems and replace the various decrepit pieces of sitting-on and eating-off-of furniture that are held together with duct tape and lots of bits of wood, wood glue and screws. A rough estimate tells me that if I had $10K more a year, it would all be spent on local contractors, furniture and appliance stores and car repair shops for at least the next two, and probably three, years. That money would then presumably return to the community through the usual channels, thus building the economy from the ground floor. I realize, of course, that this utopian vision of mine is childishly naive, but it still seems to make sense to me.
David Pearson: I don’t think I said the stimulus was “successful”; rather I said the stimulus package mitigated the downturn. You then use your definition of success to define the ARRA as a failure. Well, that’s your perogative, but it doesn’t illuminate the debate.
You are also free to use whatever definition of “structural budget deficit” you wish. In the interest of avoiding confusion, I will use the textbook definition (a.k.a. cyclically adjusted budget deficit).
Brian: I don’t overlook human nature and moral hazard. I wonder about the quantitative magnitude of the effects you highlight. See this (long) post.
ppcm: You might wish to consult the post, and then break down the net debt levels of Northern euro area countries vs. PIIGS.
Menzie,
I believe I said, back then, that we won’t know the true cost of the stimulus until we try to remove it. My argument is that setting us on the path of dependency on stimulus can be quite costly. The experience of Latin America shows what can happen when actors expect long-term structural deficits to be financed by central banks.
My question to you is, if we engage in repeated, unsuccessful stimulus, does it leave us better off than if we did not attempt to stimulate?
I suggest all those here that believe in Menzie’s prescription should immediately incur as much debt as their credit and income will allow in order to spend it and watch the multiplier affect pull us all out of the doldrums. Go max out every credit card you have and be comforted that spending that money will create more money in the future to pay it back with. Not enough credit? Just raise taxes also. Other people’s money has a bigger multiplier when the government spends it then when they are allowed to spend it themselves. It’s a proven fact. Transfer more borrowed money to the states to help them avoid making any financially responsible decisions? The only thing multiplied by government spending is more irresponsible government spending. Why don’t you post your address Menzie. I will come throw a rock through your window to help stimulate the economy and multiply the effect of your replacing it.
Mr Chinn,
America is not alone- EU and IMF advocate austerity. But why do you think the ADB harps on imbalances when that is now often being used as a codeword for austerity? It seems that Asia would want some demand from US and Europe- even if in the long-term that demand should be supplied by domestic markets. 100 years ago the poor wanted growth and the rich wanted a gold standard. Now most- except for frustrated economists- eschew growth measures. What is the point of Asia having a voice if they do not use it?
David Pearson: Operating in a linear framework (and pretty much all macro models — whether RBC, DSGE, old-style Keynesian — are approximately linear in effects or are linearized for solution), I would say it is better to stimuluate if the benefit-cost ratio exceeds unity. I think I’ve said that before.
Departing from a linear framework, where one thinks of upswings as qualitatively different from downswings (consistent with a Markov-switching approach in growth rates) would lead to a different conclusion.
Hitchhiker: Mischaracterizing my position is hardly a constructive way to pursue this debate. I have a record on what I have advocated on this weblog; I wish you would refer to that instead of threatening to break my windows. Otherwise, people will lump you in with the folks stocking up on ammunition for the coming of the “black helicopters”.
Not tempted to break windows I looked at the breach of contracts.Northern, countries are much closer to the Maestrich treaty (53 % debt to GDP)than the others.
PS Should amendments to the treaty of the Union being passed I assume them to be publicly known and explained.
David Pearson,
Your points are well taken, but remember that you are arguing within a framework of monetary illusion. The result is the Democrats, as represented by those like Menzie and Paul Krugman, will always see stimulus as the solution and if stimulus does not work it is because it is not large enough. What is large enough? Enough to work. If it doesn’t work it isn’t large enough. Remember the definition of insanity.
But then there are the Republicans, strangely being represented right now by Euroland and the IMF. They are interested in taking the grossly obese government, fed on never-ending stimulus, and putting it on a crash diet. They want to immediately cut essential government services that were confiscated from the private sector and they want to increase taxes on those private sectors, not yet confiscated, to balance the budgets sent out of control by stimulus.
What we have is central planners promoting stimulus and central planners promoting austerity both throwing the entire economy into a confusion of uncertainty.
In short we have two sides of the same coin presenting prescriptions that are both totally destructive of the economy.
Sadly, these illusionists can’t even comprehend the economic policies that actually work and they totally confuse stimulus and austerity with policies that will lead to recovery.
Recovery is simple. First, return sectors that the government has confiscated back to the private tax paying sector. Who do I mean? How about GM, Chrysler, Fannie, and Freddie, and that is just the low hanging fruit. Second, stop taking resources from the productive private sector through destructive taxes. Finally, stabilize the currency so that economic actors can calcualte with some sense of continuity. If this were done, the uncertainty that is strangling our economy would simply pass away.
Fiscal stimulus is meant to be a bridge across the depths of a recession trough. The credit-cruch combined with an historically high proportion of permanent layoffs means the recession gorge is wider than normal. Government revenue will be slow to recover. The risk we run is that continued government borrowing in the name of stimulus will continue until our weak recovery morphs into another recession a 2-5 years down the road. It seems that most simulus proponents are banking on a standard recovery to restore tax revenues to normal levels. What if tax revenue stays anemic for the next several years and then recession returns? Debt/GDP will be at the tipping point and foreign lenders will demand better terms before lending to the U.S. How will the U.S. respond to the same austerity measures we/IMF demand from the typical debt-laden country?
While I think that there is a strong humanitarian argument for extending unemployment benefits (and the moral hazard argument in the current situation is as ridiculous as the Mulligan claim that current unemployment reflects “laziness” on the part of workers), I think more useful for preserving employment, if not necessarily expanding it, would have been continuing to extend aid to state (and local) budgets. With 46 states facing serious fiscal situations, we are looking at likely major layoffs in the near term from both state and local governments, which is most definitely not going to help the economy.
Cutting ‘entitlements’ has a cost – lower pensions and health-care spending. By all means do this if the tax revenue is not there to pay for it, either now or in a possible world, but it doens’t magically remove the growing number of pensioners or need for healthcare. All it will mean is private spending on these will have to rise, very quickly, and by the same amount, although there will be distributional effects.
In other words I’d be wary of cutting ‘entitlements’ without honestly pointing out that people will have to make private provision, and the poor are likely to be hit worse.
Mr. Chinn,
I recall having read your linked post, and I thought what you presented was excellent, however, your proposal to extend transfer payments is just that: simply an extension–it appears that what you give with the right hand you take with the left.
What I think is being over looked is the political dissatisfaction that is being overlooked here is the behavior of the productive classes. The reason why these policies of simply handing out transfer payments at some point become unattainable is that the productive class that has to pay for them at some point begins to feel cheated–after all, governments do not have any wealth, they only redistribute through taxation and transfer payments.
What is being over looked is that the problem may not come from the bond market, especially since I believe we’re not going to avoid deflation, but instead it will come from the production class that is being taxed; and at some point this class may begin to simply quit, either through stop working because they now have enough to support themselves, tax avoidance, or through the political process enact change (and hopefully it doesn’t come to an outbreak of violence). This is the real problem we’re seeing in Europe: that productive countries don’t want to pay for the unproductive countries; and we’ll see it in the US in the mid term elections
SO it seems the problem on both sides of the coin is going unaddressed: the potential (or inevitable) negative reaction from the productive class paying for transfer payments, and how do resolve those on transfer payments. So far, all I’ve seen presented is to either simply cut all transfer payments or simply extend them indefinitely coupled with hope. Neither option is tremendously imaginative; yet, I suspect I know which side will more than likely win.
Wonderful! Even Soylant Green and black helicopters! Just when we were all losing hope, everyone is back out from under their rocks! Economics may be useless as a tool for forecasting but wow is it fun for flushing out the weirdos! The multiplier on finding nutters is certainly much more than one.
Now we just need PhD electrician back…
To make the learning experience more efficient the large state university creates two lecturer positions. The lecturers have specialized human capital not easy transferable. The lecturers salaries are reduced by a fee, a tax, which goes into an unemployment insurance program. Because of the Great Recession the state has lower tax revenue and enacts budget cuts. The state university eliminates the two lecturer positions. The quality of the education experience has declined, arguably reducing the future productive capacity of the students. Because of the costs of relocation and the limited opportunities for specialized human capital in a college town, one of the lecturers drops out of the labor force and is not considered unemployed. The rational choice for this lecturer is to retire and start collecting social security pension payments. The second lecturer enters a difficult job search, given the specialized human capital and the reduced hiring by universities. The lecturer probably will apply for unemployment insurance payments.
I had always thought that I was contributing to societys future. I thought that I had paid into an unemployment insurance program operated by the state. Now, I see many suggest that I was only receiving redistributions from the productive class.
Since the start of the recession 2.5 years ago, the economies of the OECD have shrank about 5% in aggregate.
But the economies of emerging Asia grew by 20%.
The pie chart has adjusted immensely.
We desperately need tax hikes.
I think you meant ‘cuts’ instead of hikes.
Tax cuts, combined with a shrinkage in the size of government, is the answer.
Tax hikes are already expected as of 1/1/2011, and note that the economy and stock market is already contracting in anticipation of these hikes.
David Pearson: “In some circles, the inability to remove stimulus without tanking the economy is known as a “structural budget deficit”
Huh? What circles? Tea parties? That is not even close to the definition of a “structural budget deficit.”
RicardoZ: “The result is the Democrats, as represented by those like Menzie and Paul Krugman, will always see stimulus as the solution and if stimulus does not work it is because it is not large enough. What is large enough?”
That’s easy. Romer’s own numbers showed that the stimulus needed to be ~$1.3T, or almost double what we got. If you will go back and look at the predictions of many economists such as Menzie and Krugman they were predicting that the stimulus would turn around GDP in mid-2009, but would peter out in mid-2010 without additional stimulus. That was predicted before the stimulus was ever passed. It’s easy to look up. What about the track record of the GOP opponents who were predicting rampant inflation?
You seem to think that the economy is in recession because of high taxes and govt ownership of GM, et. al. Excuse me, but taxes are too low. Taxes were too low before the recession and they were lowered even more as part of the stimulus. And the collapse of all those private sector companies preceded the govt takeover. You seem to think the govt was the cause of their collapse. You’re mistaken.
Look, today’s problem isn’t hard to understand. In economics there are two curves…a demand curve and a supply curve. Aggregate demand is weak. The kind of stuff you’re talking about is supply side remedies. Those might be fine if this were 1978, but it’s not. This is 2010 and today’s problem is weak aggregate demand.
Brian: “after all, governments do not have any wealth, they only redistribute through taxation and transfer payments.”
Wow. First, I think you meant to say “value” rather than “wealth.” Second, I didn’t know that people still believed in the labor theory of value. I thought that died with Karl Marx. And let’s be clear, the view that government does not add value comes out of the labor theory of value and not out of the modern understanding.
You seem to be advancing the same kind of politics of resentment that “tj” frequently makes. The issue here is whether or not unemployment insurance makes sense as a macroeconomic policy; it should not be based on your being mad because some “lucky duck” gets to lounge around all day doing nothing. That’s just a politically correct version of Reagan’s “welfare queen” caricature. In normal times there is a point at which unemployment benefits should be cut off, but what makes sense in normal times may not make sense in a severe recession. The idea that people are choosing unemployment because they’re shiftless moochers is nuts in today’s environment. So are you envious of those “lucky ducks” who are without jobs?
Maybe it’s time to review just what is the case for unemployment benefits during normal times. Unemployment taxes are nominally paid by employers, but the incidence of the tax falls on workers. And it falls particularly heavily on low skilled workers because they face a relatively elastic labor demand curve and their labor supply curve is highly inelastic. So saying that the most productive workers are the ones paying for unemployment benefits reflects a naive understanding of low labor demand and supply curves actually work. It reflects a failure to distinguish between the impact of a tax and the incidence of a tax.
During normal times you have to strike a balance between two costs. The obvious cost is the lost productivity of people not working. So you need some kind of incentive to get people motivated to find a job. On the other hand, it’s bad public policy to encourage people to take the first job that comes along. Optimal public policy should allow for an adequate job search time to make sure that people only accept jobs that will earn the highest marginal product. In other words, there is a social opportunity cost when unemployed workers are not discriminating enough in choosing jobs. Taking the first job that comes along may sound like the morally upright thing to do, but as economic policy it’s a disaster and makes everyone worse off. So you want to ensure an adequate search time. Lots of studies have more or less settled on 26 weeks as the maximum search time. But all of that assumes that the only problem is one of matching job skills to the highest available marginal product. None of that applies when the economy is in deep recession. The rationale for extended unemployment benefits during a deep recession is simply to maintain aggregate demand. The cost of providing benefits is relatively cheap because there is an excess of savings floating around with nothing else to do. Having the govt borrow the money from mattresses puts that idle cash to good use and at very little cost. A positive fiscal multiplier means that it is earning a higher return than it would be if it just sat in some bank vault.
Mr. Chinn,
I don’t resent anyone’s position, and I would further say that those on unemployment are being given a disservice in that their natural instinct to strive in the face of opposition become undermined–a parallel to this line of reasoning would be similar to statements found in the introductions that philosophers like Wittgenstein and Nietzsche give us: I have done my reader a great service by not thinking for them. These “transfer” solutions I would argue in the long run do more harm to recipients. One sees the same thing in law school where students just want the case precedents and the supposed valid interpretations, sparing them the painful yet rewarding of thinking. What we tend to see in your “lucky ducks” is weakening of their problem solving skills, that is, on a more practical level: how am I going to get myself out of this mess? Instead we’re training them to now think: how is someone else going to get me out of this mess? It is in situations like this, I have observed, that life is very counterintuitive: such as, the more safety one seeks, the less safe they tend to become. Should I be envious of taking a poison, even if it’s under the guise of an antidote?
I don’t believe many of the people on unemployment are moochers at all, and that many of them probably don’t want to be, I’m not making a moral argument, but one of human nature and how the the skill of problem solving is developed or undermined and incentive correlated with success and the role incentive plays. I could go on to show many of the faulty psychological assumptions made in modern thought, especially in Western thought where we’re still suffering from the misconception of mind/body separation–such as we still believe that consciousness plays a primary role in our thinking as opposed to conscious thought being a terminal point in thinking. Is this relevant to the present discussion? I think it is because no one operates in a void, and that goes for economists and the models they give validity to–simply coupling mathematical computation only gives it the make-up of seeming objective and absent of subjective thought (this in my opinion is a naivete). There was a study out of Georgetown that showed that convicts that represented themselves performed better than convicts represented by legal counsel to a ratio of 3:1–why do you think that may be?
However, the question still remains: what’s the goal? To keep extending unemployment benefits until…forever? Why not just then enact a bill that proclaim unemployment benefits will continue until someone either finds a job or becomes deceased? If 99 weeks isn’t enough time for someone to have made adequate adjustments, then what time frame do you propose? Or, what in addition to unemployment benefits should be added to solve the government’s burden here? That’s what I don’t see proposed.
What I’m pointing out concerning the rising resentment from the productive class is separate from my own personal views (although they may or may not at time over lap). What I’m pointing out is a social phenomena and an issue of human nature (which I understand is a minority position even in the psychological profession, addressed very aptly by Princeton professor Steven Pinker). I don’t understand here, is that you said you don’t ignore human nature, yet I brought up a sociological/psychological question regarding the reaction of the productive class (whoever them may be) and you reduced it down to it being my own personal feelings. Yet, I think this is a legitimate concern because it has political, social, and economic ramifications.
No I mean wealth. So what wealth does the government generate that is not funded by taxes, and where taxes are an involuntary obligation? The government may very well have value, and it certainly does; but to what extent and to what degree is difficult to tell when it’s source of funding is not voluntary–I could conjecture or make some reasonable guesses.
I could say the fire department is a great asset, but at what cost and to what extent, that is, how many firefighters should we have and what should their pay scale be, I would be hard pressed to say because the funding is through involuntary channels. What we do see in action is the abuse that typically arrives with revenue gained through involuntary means, that is, pay scales that do not necessarily match the labor market. For example, and some may be offended by this, but a typical police officer is fairly unskilled labor. Suppose I’m paying police officers around $120k each with full health coverage and prime defined pension plans, with minimal contribution. Is this efficient? What if I could easily replace those officers with a 21 year old with 6 months of training?
I could further argue that government official tend to be more of a drag on aggregate wealth then a plus. Suppose you go to traffic court and win your case. Are you compensated for the time you took to prove your case. Of course not, but what this does is subtract now from one’s time they could have spent being productive and on top of that, production needs to be tax to pay for the entire process. So at some point, there’s a line that’s crossed when government becomes a drag on the economy because they have to raise revenue through involuntary means on production and labor–so it goes to reason, if government has it’s own means of generating wealth, then why the necessity to tax? Just as it stands to reason: if the government really has the ability to create jobs, then why should there ever be a high unemployment rate? Personally, I don’t bother too much under which theory or school of thought these questions are categorized under, I’ll leave such discussions to scholastic organizers, nevertheless, I ask them because they seem fair straight forward and reasonable–if they are not, then I have fallen victim to my dull-wits, and this of course something I need to work on and improve my thinking.
You should consider asking people who either don’t agree with your points or don’t care much what you say because they’ll disagree anyway what they get from reading your posts. I’m serious. It would perhaps illuminate the real issue, which is described in the comment by, I believe, Jim Nichols.
I deal with idiots all day long. They make the strangest arguments, most are so wrong they are literally counter-factual, meaning they are beliefs held against fact.
You identify main points:
1. The long term deficit is the problem. The idiots don’t care. They have a weird belief that earmarks and maybe foreign aid and certainly waste amounts to the deficit. They think that cutting “benefits,” whatever that might be, means cutting benefits for undeserving freeloaders. They think, for example, that we should raise taxes on the poor because they don’t pay federal income taxes or pay only a little and the rich pay so much. They don’t care about withholding taxes because that is “something you get back.” They don’t care about rising income inequality because that’s their selfish definition of “fairness.”
2. The output gap. They don’t have a clue. They don’t understand that companies have no reason to expand when output is slack because they don’t understand concepts of aggregates.
3. They think that the unemployed should suck it up and take a job, whatever job. I’ve had people tell me there are jobs picking fruit in rural Washington because a few weeks of seasonal, manual labor should be enough for a man to move. To say their mindset is uncharitable is being charitable. They imagine the unemployed are all minorities living on welfare, that unemployment insurance actually pays a lot – they really believe that UI pays well – and that illegal immigrants are taking whatever jobs are left so get rid of them, by force if necessary.
4. As for support for the state, the attitude is “screw ’em.” Those jerks have been wasting tax dollars for decades and now they have to pull in their horns. Those civil employee unions are out of control – there is something to the argument that employee benefit costs are way out of whack. They don’t care that cuts hurt the poor, that cuts hurt cities and towns because that is the only way to force change.
The thread running through this is that cruelty is kindness, that the only way the poor will learn is to force them, that government needs to contract. They don’t connect the dots to the economy that affects them. They don’t understand that a depression may well cost them. They think all the bad stuff will happen to the others, to the undeserving poor and to all those illegal immigrants.
Your arguments are sensible economics but they don’t address the fundamental argument being made because that isn’t sensible. The only way, IMHO, that argument can be countered is a) by explaining in plain words that the entire economy goes down the toilet and that hurts them and their families so hold your nose and spend the money to keep it all afloat, and b) defining “austerity.” The definition of austerity being pushed is that of Mr. Potter from It’s a Wonderful Life: mean-spirited, needlessly cruel and counter-productive in the sense of cutting off one’s own nose to spite one’s face. Try defining “austerity” in a more humane way. In other words, take control of the semantics because facts and rational arguments couched in economic observation are useless.
jonathan,
The thread running through this is that cruelty is kindness, that the only way the poor will learn is to force them, that government needs to contract.
Socialists only say this when it is other people’s money. Socialists never donate their own money – they are very stingy in this regard.
The result is the Democrats, as represented by those like Menzie and Paul Krugman, will always see stimulus as the solution and if stimulus does not work it is because it is not large enough. What is large enough?”
Remember that when socialism invariably fails, their answer is always that there has to be MORE socialism.
A rigged game, if there ever was one.
On the regressiveness of unemployment insurance taxes it’s worth mentioning that FUTA is capped for wages above $7000 per quarter. The cap hasn’t been increased since 1983.
On the disincentive to work provided by unemployment insurance payments:About half of the unemployed AREN’T collecting UI. What’s their disincentive? As an example, one of my sisters (previously continuously employed from the age of 14 to 26) returned from her stay in Taiwan (on a student visa), to the U.S. in late 2008. She was unemployed (and not collecting or eligible for UI) for most of the time until she went back to Taiwan in early 2010 (to make $22/hr teaching English, while living in a $250/mo apartment). The best job she found here was a 2 month contract gig teaching English to Chinese flight school students (she’s fluent in Mandarin). My aunt is 62 and had been continuously employed for over 40 years until she was laid off in Dec 2008..she’s directly affected by the lack of renewal of extended benefits.
JohnR,
“And here I thought that I was a member (if just barely) of the Middle Class with a family imcome of about $45K per year. I see now that I was wrong, according to endorendil.”
Taking the US as a whole, you’re actually upper middle class. Depending on where you live, it may not feel like it, of course, and certainly being middle class in the US isn’t what it used to be.
From what you’re saying, you actually own a house. That’s more than I’ve ever done, and probably ever will. Renting is cheaper, but mainly it makes it easier to adapt to my ever-changing economic and familial circumstances. You can complain that you were deceived about the actual cost of home ownership in terms of mortgage, maintenance and opportunity cost, but you can’t take that as evidence that you just don’t have enough money yet.
To be sure, I do believe that the US middle class gets a bad deal, even if it is not nearly as bad as the poor in the US. But you still have all you *need*: shelter, safe food, safe water, access to education and healthcare (ok, I agree that the last two are a stretch in the US, but it’s all relative). The point I was making is that your situation is incomparably better than that of billions of people just like you, whose only crime was to be born in a different country. A billion people don’t have access to save drinking water, let alone healthcare or a decent education. You have your own house, probably more than one car, cellphone(s), a computer and internet access.
Please, have some perspective about your “predicament”.
Aid to state and local governments will certainly save jobs in the short-run. But in the long-run, many of those same jobs need to go away. They reflect a size of government that was appropriate for a larger population. In those states where population has been declining, government payrolls also need to decline. The budget crisis provides the cover needed to make the difficult decisions that are politically impossible in better times. So aid to state and local governments should be carefully targeted to those jurisdictions who actually need to keep government workers (places with growing population).
The assumption that debt spending is safe because government can borrow at low rates is destroyed by the shortening maturity of US debt obligations.
IF the stimulus leads to an economic recovery THEN how can interest rates stay at these low levels?
With any analysis at all, it is clear that annual debt payments as a portion of operating budget will be slow to change, and Dr Chin et al are talking about a continued rapid increase in annual debt payments as a portion of operating budget.
How is it going to feel in 2020 when 33c of every dollar is spent on benefits that are long gone- not spent on durable assets like roads and bridges, but on unemployment benefits and preserving police and fire salaries?
!
The word “structural” has different meanings. I suggest a relevant one is a deficit that is expected to persist through long periods of time.
Stimulus is not “deficit spending”. It is an increase in deficits. Assume that a deficit of 10% of GDP was incurred to stimulate growth following a deep recession. This stimulus fails to produce self-sustaining growth. At that point, reducing the deficit to, say, 5% is contractionary and will likely induce a downturn. Therefore, to maintain the economy on a stable path, the government must, at very least, maintain a deficit of 10% of GDP. This is what I call a structural deficit. And this is the situation we appear to be facing today.
My question for those who disagree: if we did not achieve self-sustaining growth in 2010, then how can we achieve that growth while reducing the deficit as a percent of GDP? And if we cannot, then isn’t the current deficit “structural”?
I am opposed to extending unemployment benefits because so many of the unemployed are not included in that system.
What kind of help is needed? To keep people from starving or dying from exposure to weather is a valid objective. A priest operating a flop house in Pittsburgh half a century ago assured me that the people he served would not take advantage of what he had to offer because he offered so little. Food kitchens and local charities need help. In Columbus, Ohio, they are getting it from local sources. Many people with means respond to human need.
DOES NOT SOLVE THE PROBLEM OF GDP GROWTH. Seperate problem requiring some work like Prof. Hall in above post.
David Pearson: “The word “structural” has different meanings. I suggest a relevant one is a deficit that is expected to persist through long periods of time.”
You can suggest that definition, but it’s not a very informative definition. A better and generally accepted definition of a structural deficit is that part of the deficit that would persist if the economy were operating at full employment. Better yet is a primary structural deficit, which is that part of the deficit that would persist if the economy were operating at full employment less debt servicing costs. It’s actually the primary structural deficit that matters most when you’re talking about the long run sustainability of a given level of debt and projected deficits.
“Assume that a deficit of 10% of GDP was incurred to stimulate growth following a deep recession.”
You can assume that, but wouldn’t it make for a better example if you used realworld data? The stimulus represented about ~$300B for FY2010, or roughly 2 percent of GDP. And of that $300B, a big junk went to offset reductions in state and local govt spending, and that portion had no net stimulative effect…it was just using the federal Treasury to tread water. Basically what we saw was a stimulus program of something a little south of 2 percent of GDP resulting in an increase of something a little north of 2 percent of GDP. As to the other 8 percentage points, it was a combination of lost revenues due to lower economic activity and (especially) the structural deficits that were built into the economy as a result of the Bush tax cuts. Those were structural because we still would have run very large deficits even if we weren’t in a recession.
“…if we did not achieve self-sustaining growth in 2010, then how can we achieve that growth while reducing the deficit as a percent of GDP?”
We needed a much bigger stimulus package to shock the economy back onto a self-sustaining growth plan. At that point the cyclical deficit due to lost revenues from lower economic activity will automatically correct itself. And we should then begin withdrawing the stimulus once the Federal Reserve is able to sustain aggregate demand through interest rates. What we will be left with is the structural deficit, which we will have to solve through a combination of higher taxes and cuts in spending. The big spending targets will have to be DoD, Medicare/Medicaid and farm subsidies because those are the only lines in the budget that are large enough to make a difference.
2slugbaits,
It seems we agree. A successful stimulus is one that creates self-sustaining growth (“shock(s) the economy into a self-sustaining growth plan”) and ultimately reduces the deficit. Therefore, if the stimulus is unsuccessful, the deficit becomes permanent (removal would exacerbate the downturn).
You assume success. I dwell on the tail on the tail risk of failure. Its possible the benefits of fiscal stimulus outweigh the risks. Wouldn’t it be great if economists argued, “I recognize the risks, but it is still worth it?” Instead, we typically get, “assume the stimulus is big enough and therefore successful…”
Oh no! But are you sure it’s not the specter of mindless loyalty to one’s own pet theory? Or to hackneyed cliche?
Tom: I expect no less of a comment from someone who agrees with Posner’s math (8/27/2009).
David Pearson: I don’t think fiscal stimulus is a sure thing, but it’s really the only thing we’ve got available. Ordinarily you would want to rely upon monetary policy to cushion a recession, but at the zero lower bound that’s not a viable option. The risks of doing nothing far outweigh the risk of added stimulus. The downside risk of too much stimulus is inflation; the downside risk of a do nothing policy is a prolonged economic slump. The two risks are not symmetrical.
“Therefore, if the stimulus is unsuccessful, the deficit becomes permanent (removal would exacerbate the downturn).”
No. If the stimulus is successful than you withdraw it and go back to relying up normal FOMC operations to manage the economy. Withdrawing the stimulus would not be contractionary if the economy returns to full employment and if the Fed manages things competently. As macro problems go this one would be fairly straightforward.
2slugs, we’ve had this discussion many time about going larger versus better directed. Your comment re: State and local stimulus proves one part of my point. Yes, we are treading water.
A recent study shows us that almost all new jobs come from businesse start ups. What portion of the stimulus was aimed at growing these new small businesses? What has been done since to grow them?
It’s the fault of “austerity” advocates for not being clear, but it’s not really about “inflation”. It’s about specific price inflation, the tendancy of expansion to exacerbate existing inefficies whether there is deflation or inflation.
Technically, I’m not for austerity. I think deficits are fine when money is free. I just don’t think we should borrow and consume, we should refinance our exising debt first. If rates remain low, then we can move on to spending. You don’t borrow money for gas for joyriding the car you bought with a 20% credit card before you pay it off. Nothing will provide a higher return right now than paying off existing private debt.
CoRev: State and local stimulus proves one part of my point. Yes, we are treading water.
But treading water is better than drowning, and that’s what would happen if we didn’t bail out state and local governments. My point was that a lot of the stimulus dollars didn’t actually provide any net stimulus because those dollars had to replace lost state and local govt revenues. That’s kind of an important point if you want to estimate the effectiveness of a fiscal multiplier.
“A recent study shows us that almost all new jobs come from businesse start ups. What portion of the stimulus was aimed at growing these new small businesses?”
You hear this from a lot of Chamber of Commerce types. They note that 80% of new jobs come from small businesses and conclude that therefore 80% at least 80% of the stimulus ought to be directed towards small business. That’s really a goofy argument. What counts is marginal response and not a comparison of the distribution of jobs. I have no idea whether the marginal response from small business is greater or less than the response from large business. But it is kind of a strange thing to hear you advocate what sounds like a full-throated socialist industrial policy for the US economy. Sounds like you want the govt to start picking winners and losers.
Ah, 2slugs, I knew you wouldn’t be able to resist. Quite a funny response, too, but it doesn’t deserve an answer. I really am giggling about the marginal response/distribution of jobs argument.
CoRev,
If you don’t understand or appreciate marginal responses, then you don’t understand economics since Alfred Marshall. It’s the employment elasticity that counts, not the distribution of jobs.
2slugs, resorting to ad homs. So, how would you better target the stimulus to create jobs? Lessee, one hand we have state and local governments, and on the other we have new small businesses and small businesses where even you admit 80% of the job creation resides.
If you truly believe that job distribution does not matter to target job creation in stimulating the economy then you would also believe that the stimulus was too small. Oops, you and others here do believe that. To me that indicates a callousness toward the pain and suffering created by economic down turns.
Not too small, just misdirected for rapid economic stimulation.
As an outsider, it seems to me that American’s aren’t willing to admit that their economy has essentially turned Japanese, that is the only things driving it at present are fiscal stimulus and exports as the private sector rapidly deleverages. Just like Japan in the last 1990s, I fear the public will not accept this is the case until they have undergone a second recession after the government has cut spending, but has failed to bring down the deficit. Good on you for making the arguments, but the comments here and the political mood in your country tells me you’re facing a very tough task to convince people you’re right. Good luck.