A high level of government spending doesn’t necessarily produce heavy government debt. Nor does low spending guarantee low debt. Debt levels are a function of government expenditures and revenues and economic growth.
Archive for the 'Economic policy' Category
To spend is to owe?
April 18, 2011Can we get to below-4% unemployment? Do we need to?
January 26, 2011Robert Pollin has a piece in Boston Review arguing for a return to full employment in the United States. The following is my comment, cross-posted from the Boston Review forum.
I share Robert Pollin’s view that the U.S. should strive for full employment — by which I mean, following his lead, an unemployment rate below 4%.
Can we do it? Pollin points to two historical precedents as grounds for optimism. The first is Sweden from 1960 to 1989. Sweden succeeded in keeping unemployment below 4% throughout those three decades by coupling employment-oriented monetary and fiscal policy with wage restraint. But Sweden’s central bank at that time was subordinate to the government. Ours, the Federal Reserve, is independent. Since the late 1970s, independent central banks such as the Fed almost always have prioritized low inflation, rendering low unemployment difficult to achieve. If the Fed isn’t on board, even a workable plan for full employment supported by the American public and our elected officials probably won’t be enough.
What about Pollin’s second precedent, the United States in the late 1990s? During those years the Fed, under Alan Greenspan, did keep interest rates low enough for the unemployment rate to drop below 4%. But Greenspan held rates low despite opposition from other Fed board members, who were concerned about potential inflationary consequences — particularly given the internet-driven stock market bubble. Greenspan took this stance in part because his belief in the self-correcting nature of markets led him to worry less than others about the bubble. In light of the painful consequences of the 2000s real estate bubble, I doubt we’ll see the Fed take that approach again for some time.
Do we need below-4% unemployment? Here a cross-national perspective might shed some light. The following charts show indicators of Pollin’s desired outcomes — a healthy economy, decent pay, low poverty, good working conditions, absence of discrimination — in twenty rich democratic nations. Each outcome is plotted against the number of years from 1979 to 2007 in which each country had sub-4% unemployment.
These charts tell us that while full employment may contribute to good outcomes, it isn’t a necessary condition. In each case, some countries have done well despite seldom or never reaching sub–4% unemployment during the measurement period. In some instances this is a function of strong unions or “production regimes” (think German manufacturing) that are unlikely to be relevant in the American context. In others, though, successful outcomes have owed much to government action.
This is good news because Americans have more influence on the policy choices of the government than on those of the Fed. Whether or not we get back to full employment, we can reach important economic and social goals.
Yet I fear this conclusion is too optimistic. I’m confident that the United States could achieve satisfactory economic growth, a reasonably high employment rate, decent wages, poverty reduction, good working conditions, and less discrimination without full employment. I’m less certain that we can manage sustained wage growth for those in the bottom half of the distribution.
The post–World War II experiences of the rich democracies suggest three routes to rising working- and middle-class wages. One is an environment in which firms face only moderate competition in product markets and limited pressure from shareholders, allowing them to pass on a significant share of growth to their employees. This characterized the period from the late 1940s through the mid 1970s, but it’s now long gone. The second is strong unions. I see little hope of that in America’s future. The third is full employment.
Is there any alternative? One possibility might be to use the Earned Income Tax Credit to subsidize wages. We could extend it higher in the income distribution (currently it phases out at about $45,000), reduce its connection to children (currently it’s minuscule for households with no kids), and index it to average wages (it’s now indexed to inflation). I would prefer the full employment path that Pollin envisions, in which wage growth comes from firms rather than taxpayers. But we ought to have a backup plan.
Political traps for Keynesians
August 16, 2010In early 2009 Congress and the president passed an $800 billion economic stimulus (tax cut and government spending) package. A number of analysts argued at the time that given the context — very severe downturn, interest rates already near zero, steep drop in home and stock asset values — the package was too small. Though the stimulus has helped (CBO, Blinder and Zandi), the pessimists appear to have been right: the economic recovery is languishing.
It looks very unlikely that there will be a second stimulus. This isn’t surprising. An initial stimulus that is insufficiently large risks creating (at least) three kinds of political trap:
1. Debt worry. From a post I wrote in January 2009:
Our experience in the 1930s and Japan’s in the 1990s … teach that if early stimulus efforts are too modest, they create a political trap: concern about the government debt produced by the earlier stimulus packages grows, which heightens opposition to further stimulus.
2. Perception that insufficient = ineffective. Here’s Paul Krugman in March of 2009:
Sooner or later the administration will realize that more must be done. But when it comes back for more money, will Congress go along?
Here’s the picture that scares me: It’s September 2009, the unemployment rate has passed 9 percent, and despite the early round of stimulus spending it’s still headed up. Mr. Obama finally concedes that a bigger stimulus is needed.
But he can’t get his new plan through Congress because approval for his economic policies has plummeted, partly because his policies are seen to have failed…. And as a result, the recession rages on, unchecked.
3. The party-in-power’s need for an optimistic message in election season. Mark Thoma:
The administration joined in pushing the “we are poised for recovery” line because it seemed like good politics and good economics to try to create a sense of optimism. When the economy did start to recover, they could build upon this story of how the stimulus package saved the day.
But what if the economy, and employment in particular, didn’t start to recover before the election, what then? The administration suddenly finds itself in a predicament. There’s not enough time before the election to actually implement a new stimulus program and expect to see results, so they are stuck with the economy they have, an economy they promised would be boosted by the stimulus programs (…).
So the administration has little choice but to argue that the stimulus programs that it put into place have set the stage for the economy to recover, and, in fact, that recovery is already underway.
Allocating talent productively
May 25, 2009A retiring hedge fund manager, interviewed by the New York Times‘ Joe Nocera, reflects that his business
was part of this huge trend toward the celebration of wealth. Hedge fund managers overearned. It just became too easy. There has been a massive misallocation of human resources. I have so many smart guys here who were making seven figures. And I think it is a fair question to ask: what would they have been doing in 1948 — going into the foreign service? If Obama does anything, the best thing he could do is change a generation’s values.
The point is right on. A significant portion (though not all) of the activity that’s yielded huge incomes in finance over the past several decades has been, in effect, little more than high-stakes gambling — betting on which way asset valuations will move, devising new instruments and techniques for doing so and for collecting fees on the transactions, and convincing investors to pony up more and more money to fund such bets. Even setting aside the danger this can pose to the real economy, it would be good if less of our collective intelligence and effort were dedicated to these sorts of pursuits.
Yet while changing values is a worthwhile aim, I doubt it’ll do the trick. What’s needed is to shift the incentives, via regulation and/or taxes.
Tax cuts: a solution for every problem
January 30, 2009Mark Thoma discusses the remarkable economic cure-all.
A triumph of illogic
January 28, 2009From a full-page ad in the New York Times signed by more than 200 economists, including three Nobel laureates:
More government spending by Hoover and Roosevelt did not pull the United States economy out of the Great Depression in the 1930s. More government spending did not solve Japan’s “lost decade” in the 1990s. As such, it is a triumph of hope over experience to believe that more government spending will help the U.S. today.
If I observe that exercise didn’t by itself solve the weight problems of persons A and B, should I infer that it won’t help C?
Why the Conversion to Keynes?
January 18, 2009Gary Becker poses an interesting question:
There appears to have been a huge conversion of economists toward Keynesian deficit spenders, but the evidence that produced such a “conversion” is not apparent (although maybe most economists were closet Keynesians all along). This is a serious recession, but Romer and Bernstein project a peak unemployment rate without the stimulus of about 9%. The 1981-82 recession had a peak unemployment rate of about 10.5%, but there was no apparent major “conversion” of economists at that time. What is so different about the present recession compared to that one, and to other recessions since then, that would greatly raise the estimated stimulating effects of government spending on various types of goods and services?
There are others better equipped than me to answer this question. But here’s my take:
1. Monetary policy isn’t enough this time.
Most Keynesians would still prefer monetary policy to be the first and main tool for stimulating demand in a recession. And no wonder; it did the trick in the recessions of the early 1980s, 1990s, and 2000s.
The 1981-82 downturn that Becker highlights differed from the ensuing ones, including the current one, in a key respect: the inflation rate in 1981 was 10%. The Fed Chair (Paul Volcker) and a growing number of economists viewed that as the central challenge initially, to be tackled via high interest rates. High unemployment was seen as a sacrifice necessary to wring inflation out of the system. Once that was achieved, monetary easing worked to end the recession.
But the Fed has now gone about as far as it can in lowering interest rates. As one of the apparent “converts,” Martin Feldstein, put it back in October, “With the Fed’s benchmark interest rate down to 1 percent, there is no scope for an easier monetary policy to stop the downward spiral in aggregate demand. ” The rate has been reduced further since then, and is now lower than at any point in the three prior recessions.
Also, Japan’s experience in the 1990s offers an empirical instance of drastic reductions in interest rates failing to revive demand effectively.
2. Getting credit flowing again — that is, restoring the normal functioning of the financial system — is critical. But doing so has proved difficult, and it probably won’t suffice in any case.
Despite various efforts by the Treasury Department and the Fed to encourage lending, including infusions of cash to banks, credit remains tight. Scarred by their mistakes of recent years, lenders appear to be very cautious about extending credit. Moreover, the problem isn’t just lack of access to credit; it’s also inadequate demand. This takes us back to fiscal stimulus.
3. Because of the steep drop in household assets due to the collapse of stock and housing prices, the shortfall in demand is likely a good bit larger this time than in other recent recessions. As Joseph Stiglitz puts it, “Americans confronted with debt, shrinking retirement accounts, houses worth less than mortgages, and a tough credit environment will save more of their money than in the past.”
4. None of this, however, answers Becker’s specific question: Why is there enhanced belief that fiscal stimulus will be effective? As best I can tell, most who favor a Keynesian response in fact are uncertain about its impact. The justification is closer to “this is very likely a wise strategy” than to “this will work.”
On the first page of their memo estimating the impact of various stimulus packages, Christina Romer and Jared Bernstein caution that
It should be understood that all of the estimates presented in this memo are subject to significant margins of error. There is the obvious uncertainty that comes from modeling a hypothetical package rather than the final legislation passed by the Congress. But there is the more fundamental uncertainty that comes with any estimate of the effects of a program. Our estimates of economic relationships and rules of thumb are derived from historical experience and so will not apply exactly to any given episode. Furthermore, the uncertainty is surely higher than normal now because the current recession is unusual both in its fundamental causes and its severity.
Mark Thoma is a bit more blunt:
We have very little U.S. historical data for time periods when the economy is in a depression, so … I don’t think we know much at all from the econometric evidence about the success of fiscal policy in deep downturns. We’ll know more in the future because we’ll be able to look back at this one, but for now policymakers are flying pretty blind. What we can examine is the experience of the Great Depression, and when you do, the case for fiscal policy is strong.
Did it work in Japan? Here’s Paul Krugman in the new edition of The Return of Depression Economics:
Some readers may object that providing a fiscal stimulus through public works spending is what Japan did in the 1990s — and it is. Even in Japan, however, public spending probably prevented a weak economy from plunging into an actual depression. There are, moreover, reasons to believe that stimulus through public spending would work better in the United States, if done promptly, than it did in Japan. For one thing, we aren’t yet stuck in the trap of deflationary expectations that Japan fell into after years of insufficiently forceful policies. And Japan waited far too long to recapitalize its banking system, a mistake we hopefully won’t repeat.
This touches on a final point: Why do many who advocate fiscal stimulus favor one that is immediate and large? Our experience in the 1930s and Japan’s in the 1990s suggest that moderate and sporadic stimulus efforts are unlikely to be sufficient in the case of a deep downturn. The Depression and Japan’s “lost decade” also teach that if early stimulus efforts are too modest, they create a political trap: concern about the government debt produced by the earlier stimulus packages grows, which heightens opposition to further stimulus.
A Keynesian Free Lunch?
January 14, 2009In the newly-revised edition of his book The Return of Depression Economics, Paul Krugman writes that
The quintessential economic sentence is supposed to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch … because there are unemployed resources that could be put to work.
Is there a Keynesian free lunch with respect to government revenues? The idea is that heavy government expenditures and/or large temporary tax cuts will increase demand and thereby invigorate the economy. This will produce larger tax revenues several years down the road than would otherwise have been the case, helping to offset the deficits incurred now.
This seems plausible. But it sounds suspiciously similar to the claim made by “supply-side economics” advocates: a reduction in tax rates will increase investment and hence growth and thus government revenues, offsetting the short-run loss in revenues due to the tax cut. If you don’t buy the supply-side free lunch claim, and relatively few serious analysts do these days, why should you believe its Keynesian counterpart?
One distinction lies in the hypothesized magnitude of the effect. The Keynesian version I’ve seen suggests that a large government deficit will be partially recouped by the resultant spur to economic growth, whereas the supply-side claim tended to be that the revenue loss from a tax cut would be fully or more-than-fully offset.
Another difference lies in attention to context. If the current tax rate is high enough that it really does impede investment, the supply-side free lunch exists: reducing the tax rate will yield little or no loss in government revenues. Put another way, the so-called “Laffer curve” is a reasonable depiction of reality. But its proper application requires asking where the current tax rate lies on the curve — whether, in other words, the current tax rate actually is impeding investment. Few supply-siders bothered to take this question seriously, and the notion became a blanket rationale for continued tax cuts. The experience of the past several decades has not been kind to the claim (see here and here).
As best I can tell, few contemporary believers in a Keynesian free lunch view it as context-independent. The hypothesis is that in conditions of a significant shortfall in demand and limited potential for further help from monetary policy, such as our present situation, an increase in the current government deficit is likely to stimulate enough growth to partly offset the cost.
