Debating economic policy

Last July / August it should have become abundantly obvious to all that there is no political center left in American politics. Given the 11th hour and 59th minute capitulation on the debt ceiling, which should have been done nine minths earlier, who can predict future stability? Filtering out the noise, debt-to-GDP is not relevant. What is relevant is debt divided by tax revenue. In my extimation Warren Buffet's "quadruple-A" is a toxic "XXX". Government would like to see the economy grow at a 4 to 5 percent annual rate in order to finance vote-buying "entitlements". However, global growth appears to be constrained by inability to produce petroleum at more than a 1.2% annual rate. In consequence we must have a rotational super-regional geographic recession in order to balance demand with limited supply. While global money supply says "Go!" energy says "Stop!" which gives rise to volatility and potentially wide swings in market price. Petroleum is not regulated by price because exporting countries subsidize domestic consumption while importing countries merely inflate.

Suppose lenders tire of negative US Treasury rates? There's a potential for a sharp run-up in interest rates -- a potential crisis of confidence when our government emulated Enron and buyers vacate the window where T-bonds are sold. Once demand disappears and pushed annual interest expense above tax revenue, there's no way out but hyper-inflation. My absolutely wild goess would be that 1 X tax receipts is the amount that could be repaid over multiple years but 15 x income tax receipts is well past the limit. The difference will be inflated away.

US inflation turned $0.04 1913 into $1.00 2012 for a total of 96% debasement. Bernanke is fine with 2% inflation, or 84% debasement in 100 years. Big improvement.

If money doesn't retain its value the public turns to inflation hedges, preferably tax-leveraged and subsidized, which begets vote-buying schemes. That's how we arrived where we are today. We can recycle, repeat or we can fix the problem with truly sound money, but only after the next great financial debacle.

The current political class is not shy to shell out Trillions of dollars or Euros to "save the economy", but never, ever are they capable of paying back debts in good years.
I think Bill Clinton was the only exception to this rule in Europe and the US. Even the supposedly "strong" German government is inching closer to a 100% debt to GDP ratio and certainly not a single Euro or DMark of debt was paid back during the good years of the last two decads. The politicians celebrated when the "Neuverschuldung" ("new debt taken" would go down. So they celebrated when they increased the debt load "just" by 20 billions instead of 60 billions. Never, ever did they celebrate paying back even 100 millions. Because there was not a single event of paying back.
If this does not change, we are on the direct path of Sovereign Bankrupty OF GERMANY !

All the discussion is whether the stimulus is desirable or not. Why is it no discussion taking place whether the stimulus placement was misdirected?
The trillions given to financial institutions could have lead to the industrial recovery of US, if this money was used to subsidize industrial projects. These projects would have had a multiplier effect on the economy which was what was the original concept.
The employment situation would have eased.
The subsidies could have been for basic industries requiring large investments. What little was there was offered to exotic industries like solar panels which folded.
No such multiplier effect was obtained when the trillions reached the financial institutions.

KEYNESIAN DEFICIT SPENDING VS. EXPANSIONARY AUSTERITY

This is heavy weight economic language but absent of relevance.

Now, it's come down to Keynesian Deficit Spending vs. Expansionary Austerity.

I much preferred sound economic principles like Supply and Demand.

That seemed to work pretty good.

This is a very well written article though I wonder about the message.

The stimulus seems to have helped the auto industry.

In today's Super Bowl almost every advertisement seemed to be an auto ad. Seems the stimulus helped these corporations.

Yet, not so sure about teachers, firefighters, etc. Yes, they initially got a reprieve but now try finding a job as a teacher - very hard to find.

And what about all the college graduates who will never be able to pay off their student loans. The Colleges got paid with government student loans and the students are broke and hounded by collection agencies - their lives shattered in debt.

Seems to me stimulus contradicts the basic principles of supply and demand, and chooses winners, and losers.

I think the 2012 election should be about real issues.

Issues like how can we stop the decline of the USA?

How can we create good paying jobs for Americans?

How can the elderly invest in bank savings and get better than a .30% interest on their money?

How can we end FED interest rate manipulation and dollar devaluation, and along with it possibly the real 8% inflation rate? (Oh, I guess it's 2% when you don't count basic necessities like food, gas, etc.)

How about the folks over 45 who can no longer get employed because corporate America prefers the young and tender, to work them to the bone?

All the important issues of the 2012 election are never even discussed anymore by the politicians or media.

What about the middle class, so derailed.

What about an equitable tax structure? The rich can borrow at near zero interest, invest, make fabulous returns and pay only a 15% capital gains tax.

The average working man or woman earning a salary is paying 35% in taxes, medicare and social security.

Are these not some worthy issues that should be resolved in the 2012 elections?

What about the Wars?

Did we kill Osama Bin Laden or did he kill America, the Western World with the high cost of War? Did we win in Iraq? Are we now promoting or supporting attacks and War on Iran? Have we learned anything?

Seems to me, there are so many important issues for the 2012 election than Sir Maynard Keynes.

Why is it none of the important issues ever get discussed openly with the American masses.

I guess our leaders think the masses are too stressed out to raise these issues or maybe too stupid to understand them. I think not. Americans are catching on!

I sure hope these and other important issues become talking points for the 2012 elections, don't you?

Warmest,

Richard Michael Abraham
Founder
The REDI Foundation
http://www.redii.org

Sorry, but I can't resist a chance to link to Scott Sumner's excellent (as usual) response to this article:

http://www.themoneyillusion.com/?p=12976

"In fairness, smart Keynesians like Krugman knew their plan had flaws, but just imagine what Keynesians would say if we’d had a monetarist president for the last 3 years, and the same path of unemployment. Do you think they’d make nuanced arguments separating out “good monetarists” and “bad monetarists?”"

None of today's candidates is anywhere near being a monetarist. All of them favor the Fed sitting tight. That's why the economy would not be the key election issue for me - at least not in the sense of, how do we "fix" the economy - cause none of these candidates will. We have to judge them on other merits of their economic policies.

"We are certainly further along than the periphery of Europe, but I don’t see what that shows. We are less far along than northern European members of the eurozone like German, Austria and Netherlands. But the US has its own currency, so we really ought to be compared to other developed countries with their own currency. How about Japan, Australia, Canada, Britain, Sweden, Poland, etc? Japan’s a special case that looks really good with unemployment and really bad in terms of growth. We aren’t doing as well as Canada, Australia, Poland and Sweden. We are doing better than Britain, but then Britain is one of the few countries that actually did even more fiscal stimulus than the US. Indeed more than just about anyone. So I don’t see how Britain’s poor performance strengthens the Keynesian case."

That shoots down M.S' main argument most effectively.

"If even the Keynesians can’t seem to get their story straight on Japan; how am I supposed to judge how effective the policy has been? All I know is that their national debt as a percentage of GDP has soared much higher during recent decades, and all that stimulus produced precisely 0% nominal GDP growth in 19 years. And yet we’re being told that fiscal stimulus is “obviously” effective?"

Don't believe it when you're told that "the evidence is on Keynes' side". You have to distinguish between the seperate aspects of Keynesianism. Sure, nominal wages really are sticky downwards. Sure, aggregate demand (or NGDP, as Sumner insists on putting it)does matter. But fiscal stimulus being the tried and tested "cure" for recessions? Not in my history.

"It’s really annoying when Keynesian writers keep implying that only fools think fiscal stimulus is a bad idea. The entire concept of fiscal stimulus fell out of favor in the best universities for several decades. The only argument I’ve ever seen for reviving it is that monetary stimulus is ineffective at the zero bound. But many of the most dogmatic proponents of Keynesian economics, the ones who in early 2009 were telling their readers that there was nothing the Fed could do at the zero bound, are now loudly and relentlessly bashing the Fed for not doing more. That’s right, there’s only one good argument for fiscal stimulus, and even the proponents of fiscal stimulus don’t seem to believe it."

*Ahem* Snap.

Speaking about stimulus being not so efficient do not forget what markets feel when they face: political instability, social unrest (with possible riots included), sharp increase in crime and prison population... and long term costs associated with all these nice things. Do we want it or not since September 2008 America and the World had to deal with a return of "Depression Economics" as Mr.Krugman calls it. As I feel it we all must give him a credit for at least finding a proper name to the stuff we are discussing here.

So Ferguson disagrees with a more knowledgable 'liberal' commentator, makes a bunch of provocative comments, gets a load of publicity, then when it turns out his arguments are nonsense, claims that he's been misrepresented. His self-publicising tricks are getting tiresome.

There seems to be a lot of confusion about what Keynesians believe. They do believe that money spent on even worthless projects increases aggregate demand in depression-like economy, and that government spending to increase aggregate demand is valuable or even essential to returning the economy to state with a full employment equilibrium.

Keynesians do NOT believe however, as some allege, that money should be thrown away on worthless projects just to create greater aggregate demand.

Instead they argue that the added benefit of aggregate demand moves a whole lot of spending from the negative marginal value to the positive. They also argue that we should be quick and aggressive about seeking these spending opportunities, since the economy will only slowly if ever return itself to full employment equilibrium without additional stimulus.

Now ... is that so complicated?

All good stuff. Although the term "expansionary austerity" ought always to be preceded by "the myth of"

M.S. has conveniently left out the next part of Cochrane's post:

'Nor is it about debt financing of "infrastructure" or other genuine investments. If the project is valuable, do it. And recessions, with low interest rates and available workers, are good times to do it. That doesn't justify all "infrastructure" roads and rails to nowhere, of course. A good test: If China offers to deliver an infrastructure project at half price, but no "jobs" will be "created," do you still want it? If you say "yes, even more" than it's infrastructure. If you say "no, we need to create jobs" then it's stimulus.

The "stimulus" proposition is that additional spending -- whether needed or not -- raises output and general welfare. Pay people $1 to dig ditches and fill them up again, and the whole economy gains $1.5. Yes, endorsed by Krugman because it "feels like a job" (his back must not hurt like mine does) and by DeLong: "anything that boosts the government's deficit over the next two years passes the benefit-cost test--anything at all."

The "targeted," "infrastructure," and the whole worthy apparatus to monitor the wisdom of "stimulus" spending (see John Taylor) is, in the Keynesian model, beside the point, or at best a smokescreen to befuddle the ignorant masses. It would in fact be better if the money were stolen. Thieves have high marginal propensity to consume, and they can get that "spending" out fast in an economy with few "shovel-ready" projects.'

Cochrane goes on to point out that vocal Keynesians like Krugman and DeLong talk as if there were no such thing as the "broken window fallacy" whilst having the audacity to claim that they are disciples of a "general theory" of the economy, when indeed it would take a very "special theory" to explain why such a basic and universal law of economics sometimes ceases to hold, putting us in a "topsy-turvy world" (Krugman). He also emphasises that the New Keynesian models that they draw upon for intellectual justification have little to do with Keynes' original dogma - they simply take the basic insight of short-run monetary non-neutrality and demand-side recessions and attempt to justify it in a thoroughly modern and rigorous way, leaving us with something that can hardly be presented as populistically as a "Conscience of a Liberal" column.

"If you think that the German-led European solution to the euro-zone crisis is deeply confused, and a lot of Americans do, then you have to be troubled by the ways in which it resembles what austerity proponents would have liked America's response to the financial crisis to have been. Americans are starting to recognise that our recovery is further along than other advanced countries' in part because the way we handled the financial crisis wasn't really so awful."

I thought theirs was a different financial crisis, rooted ultimately in the fundamentally unstable nature of the current Eurozone arrangement itself. Calling the response to it thus far confused, as many indeed do, was supposed to be a comment on how none of the countries can be safe from the storm until the basic problems are addressed - Democracy in America has itself remarked on this.

"The 2012 elections are taking place at a moment when people have lost faith in expansionary austerity."

We'll see about that.

To argue the stimulus saved the unemployment rate 2% is a bit like arguing about the butterfly effect--theory, not proof.

Even if it did, however, to spend billions and only shave 2% off of unemployment is a wretched return on investment. No one can credibly argue that the billions spent on the stimulus would not have been more effectively put to use in the business community.

The author almost hits the mark in his mentioning of the inability of government to work on electric smart grid and its failure at venture capitalism. Government is not suited for quick, decisive, and risky projects.

Government is good at paving roads and setting up regulatory schemes which promote growth. If it would focus on reinvigorating its expertise in those areas rather than dissipating its energies elsewhere we would all be better off. This does NOT mean overregulation.

Question to Krugman and the other neo-chartalists:
If fiscal stimulus is such a success why is it that the unemployment rate is higher in fiscally stimulated USA than in the UK?
Why is it Krugman, when commenting on the UK, harps on about the 1930s. There wasn't a depression in the UK in the 30s - it was worse in the 20s.

I suspect Krugman is yet another superannuated witch doctor.

The stimulus in America might have been effective if it had been "Top Down" and generated to primarily small banks for mandatory distribution to "Small Business" for local not offshore consumption. Unfortunately more than half of the Stimuls went to Public employees and Unions while the rest went to big business or dissappeared with little effect.
Greece is an interesting comparison because they have more than 50% hired by Federal Government and increasing debt. America has hired more Federal Governemt employess at a historic pace and acquired historic debt. Hello greece

Stimulus I and II were not great examples of fiscal legislation, and they expanded or created "programs" not "projects". They were good to the extent that they saved some number of teacher/firefighters/police jobs, if the folklore is to be believed. All in all, those who read the bills could see stimulus for what it was - that's why we're done with it, as citizens. The thing that didn't happen was a failure to get construction/housing turned around. You can pour stimulus money down every rabbit hole, but when housing tanks and our political leaders can't summon the will to deal with it, it's just good money after bad.

Both stimulus and austerity (in the sense of so-called ‘expansionary austerity’) in the above sense aim at encouraging the aggregate demand to increase whether directly or eventually.

The biggest flaw lies in there. It is completely wrong to try to target the aggregate demand as long-run policy. The flaw comes from applying the loanable-funds theory to analyses of long-run determinants of interest rates, analysis that overlooks or makes light of speculation or the propensity to hoard.

According to the classical economics tradition, the aggregate demand is the aggregate-supply function, and thus every single level of employment, whether full employment or under employment, is considered to be at a neutral state of equilibrium. The tradition thus insists that an economy can get close to the only stable state of equilibrium, which is at the state of full employment, through encouraging competition towards the state of full competition. That thought completely overlooks how and why full competition is an unreal state, or a state that should not be materialised, in the real world.

One of the most important determinants that hinder the economy from encouraging competition is irreversibility of durable capital-goods such as capital equipment. Those durable capital-goods could not be eliminated further than a certain extent as part of the essential characteristics of the real world. That is why there are the notions of the marginal efficiency of capital and user cost. When the schedule of the marginal efficiency of capital has not shifted much, a lower marginal efficiency of capital requires a lower interest rate that would add upward pressures to the speculative-demand for money or, in other words, the propensity to hoard. This discourages the transactions-demand for money, which is considered to be an increasing function of NGDP when the income velocity of money is considered to have been unchanged. Unless the money supply increases in some sufficient manner to make the transactions-demand for money outrun the speculative-demand for money, the NGDP will stagnate by that much. Still, monetarists, such as Ben Bernanke, insist that the transactions-demand for money may increase in any way as long as the NGDP growth is targeted. But, monetarists are then overlooking how the increasingly encouraged speculative demand for money will result after the interest rate (i.e. complex of all the nominal interest rates in the present open market) has reached the lowest possible level in an attempt to meet a marginal efficiency of capital at a point that would prop up the aggregate investment. The situation is a true liquidity-trap in a closed economy and a pseudo liquidity-trap, which Paul Krugman calls a liquidity-trap, in an open economy. In an open economy, the pseudo liquidity-trap encourages speculative asset-lending abroad or speculative asset-purchasing relative to foreign assets, which will someday face insolvencies in the long run, because interest rates cannot count the insolvency risks in full. (Uncertainty lies in here). Still, the economy at home, and either employment or wages, will keep stagnating despite the low interest rate. That as a whole is what Japanisation really is. A long period of Japanisation is foreseen unless we shake off the classical economics tradition.

The central authorities (i.e. the government and central bank) should not benchmark NGDP or aggregate demand when it comes to long-run policy and so called fine-tuning. It should instead prioritise how to improve the schedule to the marginal efficiency of capital as long-run policy, because the notion of NGDP cannot be sufficiently precise with no common physical unit to measure all the goods and services or calculate the net increment of capital equipment within a period. And, there is no such convenient physical unit – in the real world. Attempts to improve the marginal efficiency of capital are what the US should really do – whether by the team Obama or that of a Republican president.

Still, the central authorities must make the most of stimulus and austerity, or aggregate-demand targeting, as short-run policy only to regain market-confidence at large market-fluctuations. They should be implemented with severity and compactness to provide a sufficient surprise to change the then market sentiments. Austerity for short-run policy may sound bizarre, but we may expect austerity with some determined severity, compactness and meticulosity (i.e. meticulosity as a policy that, unlike monetary stimulus typically, requires a certain length of agenda) to work efficiently if we compare the case of Poland (i.e. The Balcerowicz plan) with that of Russia during the early 1990s. The US economy needn’t implement this form of austerity at all, but Italy and Greece must as part of the first step to later move to the second step that is a long-run policy package to improve the marginal efficiency of capital.

"jump-start"

If I never hear this over used term again, it wont be soon enough. The financial markets are too big for their britches. The tail wags the dog. Too much of the eocnomy consists of money circulating in the casino market which has nothing to do with the economy that sustains people's lives and prosperity.

BTW isnt expansionary austerity only established to work under full employment, when gov borrowing competes with private borrowing?

Progress can't always be measured, for instance when it consists of policemen or teachers NOT losing their jobs, but it is still an important type of rescue. Perhaps the word "stimulus" is misleading for such actions that help to sustain the status quo, but the money serves a vital purpose nevertheless.

The passage you quote from Cochrane's blog looks strikingly similar to the introduction to his November-2010 paper entitled "Stimulus RIP".

This paper is linked from the post you refer to, and seems to argue against any recent change of mind.

This is a little off topic, but its possible if the banks and AIG had not been bailed out, home mortgages could have been picked up by smaller banks for pennies on the dollar. The smaller banks would have been more than happy to reduce the principles and still made a killing.

Home prices would have crashed to levels that people could afford, and the recovery in housing would be fully underway today. Instead, the government tries to keep housing prices propped up. Houses are not worth as much as the government induced bubble made them, so let them fall dimwits.

The socialist Obamic Health care is a gigantic black hole.