Jeffrey Sachs’s new SciAm column titled “The Economic Need for Stable Policies, Not a Stimulus” forcefully reinforces the lesson I drew from my interviews with Prescott and Phelps. Sachs highlights:
The U.S. political-economic system gives evidence of a phenomenon known as “instrument instability.” Policy makers at the Federal Reserve and the White House are attempting to use highly imperfect monetary and fiscal policies to stabilize the national economy. The result, however, has been ever-more desperate swings in economic policies in the attempt to prevent recessions that cannot be fully eliminated.
President Barack Obama’s economic team is now calling for an unprecedented stimulus of large budget deficits and zero interest rates to counteract the recession. These policies may work in the short term but they threaten to produce still greater crises within a few years. Our recovery will be faster if short-term policies are put within a medium-term framework in which the budget credibly comes back to balance and interest rates come back to moderate sustainable levels.
Looking back to the late 1990s, there is little doubt that unduly large swings in macroeconomic policies have been a major contributor to our current crisis. …
[...]
We need to avoid reckless short-term swings in policy. Massive deficits and zero interest rates might temporarily perk up spending but at the risk of a collapsing currency, loss of confidence in the government and growing anxieties about the government’s ability to pay its debts. That outcome could frustrate rather than speed the recovery of private consumption and investment.
[...]
Most important, we should stop panicking. One of the reasons we got into this mess was the Fed’s exaggerated fear in 2002 and 2003 that the U.S. was following Japan into a decade of stagnation caused by deflation (falling prices). To avoid a deflation the Fed created a bubble. Now the bubble has burst, and we’ve ended up with the deflation we feared!
By the way, here’s my earlier post on “Managing Expectations Better.”
Prescott told me that he considers economic theory that treats the economy like a machine attached to policy levers that can be pulled to achieve the intended outcomes to be pseudoscience. He actually compared stimulus-mongering Keynesians to chemists before Dalton. (I gathered that Dalton is Robert Lucas.) Commenter Odograph gave me a bit of grief for quoting Prescott saying “Stimulus is not part of the language of economics,” when of course, as Mankiw’s poll shows, 90% of economists believe you can get a growth boost by fiscally goosing the economy when resources are underutilized. I don’t know whether Prescott agrees or not (maybe not if he really thinks you can’t surprise an economy twice). But Prescott’s general point is pretty much the same as Sachs’s here: discretionary macroeconomic policy is very likely to be self-defeating and we’d do better to concentrate on setting in place a sound structure of stable rules. When I asked what he would have advised, Prescott said he wished Obama had used his considerable political capital to form some kind of task force to very deliberatively restructure the tax system, the entitlement system, the financial system, etc., instead of pushing for a stimulus. But when the President instead uses his political capital telling people to panic, you just get more of the kind of mess Sachs describes. The government under both Bush and Obama has been giving us ridiculous fool-in-the-shower macro policy, and it really needs to stop.
[HT: Tyler]
What we have is our first Affirmative Action president. This is not a time for on-the-job training (hat-tip: Hillary). Obama had an opportunity to do some smart restructuring, but instead he chose to go with the ultra-liberal Pelosi and Reid and deliver goodies to all sorts of Democrat causes. I do wish he would release his standardized test scores.
If Bush spent $3 trillion (estimated cost of this porker) in his first few weeks in office on junk like this, the press and Democrats would be screaming bloody murder. There has been about 10% the outcry since it's the messiah Obama. Well, he blew his political capital on this and he has really pissed off a chunk of this country. Santelli's rant and tea-party is just the beginning.
“…unprecedented stimulus of large budget deficits and zero interest rates “
How is that in any way different than the 8 years lil' Bush was in charge?
Interest rates were low, but not zero, and maybe Bush's deficits weren't big enough for Sachs to count as “large.” Obama's are certainly massive.
The current fed funds target rate of 0 – .25% was set on December 16, 2008.
It is part of the gift Bush left Obama and America.
And like in Atlas Shrugged, the answer to government stupidity is: more government stupidity!
I was never a fan of Bush, but I always worried about his rabid (and usually less-sane) critics. I wondered if they understood that we could end up with someone a lot worse. It's probably too early to tell, but Obama is doing his best to surpass Bush and it's happening in a hurry.
In some ways it seems Obama is suffering from psychological difficulty — a need to prove he can master the economy and willfully turn it all around. I know that underneath is the more banal influence of the congress, but his speeches and his urgency reveal a man desparate to prove individual success, whether it's to prove he, himself, can do it, or to prove an ideology centered on government action. He would be better off with a more humble approach, utilizing the capitalist power of the country and allowing the system to work, then claiming his share of the praise for political purposes. I'm afraid the combination of his need to will the country to recovery and the Democrat's cynical use of this to implement their laundry list of liberal goodies to please their power base is a combination that'll be his downfall. Peter Senge's book, The Fifth Discipline, would be a good guide for Obama regarding the power of correctly designed systems.
“grief off”
Isn't this why we should buy (or pretend to buy) Obama's stimulus, and then step up to buy (or pretend to buy) his deficit reduction plan? He seems to be stating the goal many of us endorse: counter-cyclical government spending.
I really think that Obama skeptics should step up to endorse the deficit plan and then move the ball further down the field if that is their goal.
“grief on”
Some, not you Will, might be slow to do that because they are more interested in being contrary than getting what they really, ultimately, want.
Shorter: Obama is trying to build a narrative. If it is not a terrible narrative, supporting it is better than not. At this point.
Great post. It's the same point that Higgs makes about the 1930s.
I am no fan of Bush or of the modern Republican Party. Nor did I vote in the last election (I am a resident and not a citizen). But I can't help wondering how many libertarians (and/or those on the non-social conservative right) are now regretting their vote for Obama.
I find it hard to believe that McCain/Palin would have been worse than this.
“Prescott said he wished Obama had used his considerable political capital to form some kind of task force to very deliberatively restructure the tax system, the entitlement system, the financial system, etc., instead of pushing for a stimulus.”
I too wish Obama had restructured our entire economy three weeks into his new job. I guess we'll have to settle for the stimulus for now.
I think your analysis is spot on, although it could seriously do with a mention of Robert Higgs' phenomenon of Regime Uncertainty, which he convincingly argues exacerbated the Great Depression, here: http://www.independent.org/pdf/tir/tir_01_4_hig…
Unfortunately, it looks as though the US is following the same route all over again. It's going to be a long 10 years.
It seems to me that once you get past the basics (police, roads, schools, etc.) the only thing that really matters to your standard of living is increasing productivity. Everything else is just fiddling at the margins. I find it impossible to understand why we spend most of our time debating the irrelevant or counterproductive (e.g., income inequality or fiscal stimulus) and almost no time discussing what really matters: INVENTING NEW THINGS.
Prescott told me that he considers economic theory that treats the economy like a machine attached to policy levers that can be pulled to achieve the intended outcomes to be pseudoscience.
When I asked what he would have advised, Prescott said he wished Obama had used his considerable political capital to form some kind of task force to very deliberatively restructure the tax system, the entitlement system, the financial system, etc., instead of pushing for a stimulus.
Do these two Prescotts know about each other?
Thanks for doing this bit of reporting on Prescott's view. Any chance you could get him on Bloggingheads for an extended discussion.?
The economy is more like a biological organism than a machine. In either case though, you do better with general maintenance than waiting to fix problems when they occur.
+1 on getting prescott on bloggingheads
Isn't the stimulus passed and gone?
If it is passed, and perhaps you and I would be happy with re-legislation that shaved it back a bit, I still think the best path forward is to assert confidence.
This is about the narrative and the animal spirits.
Maybe I'm getting a little Realpolitik here, or perhaps even Machiavellian, but I think we're all better off if you pretend to like the stimulus, and the debt reduction plan, and then work to go further.
There is momentum involved, and conservatives or libertarians who dig in their heels for a train that left yesterday … not so effective.
“…we’d do better to concetrate on setting in place a sound structure of stable rules.”
The word is spelled “concentrate”.
I'm Bubba.
Where is the difficulty in doing both?
Yes. We need medium to long term restructuring of many areas of US capitalism. Perhaps not “restructuring” so much as “reconstruction”. The end of cheap oil, and the onrushing threat of global climate change mean energy policy, and the way we shelter ourselves, will be rebuilt. Information technology changes mean that banking regulations from the 1930s and manufacturing policy from the 1950s are a long ways from useful today. Our WWII vintage health care system is in the process of collapse. Helluva mess, Bushie. All of these institutions will be reshaped. The only question is how.
But in the short term, we got issues! The argument being made isn't that short term stimulus is going to solve all our problems; although there are areas of synergy. The argument is that the alternative to appropriately sized counter-cyclical fiscal policy and some pretty radical re-plumbing in the financial system is pretty damn bleak. Lots of real people actually suffering a lot, as opposed to relatively few people suffering barely at all.
I'm Paul G. Brown.
I'm Spartacus.
Indeed.
Propagandist fear mongering mularky…
I don't trust you Paul G. Brown.
“The argument is that the alternative to appropriately sized counter-cyclical fiscal policy and some pretty radical re-plumbing in the financial system is pretty damn bleak.”
Is that the argument, Paul? A few might say that the massive influx of liquidity has begun to do the trick (yeah, chicago! boo, everyone else!) and we should consider getting ready to stop future “stimulative” expenditures.
Inflation is a somewhat regressive taxation, no?
To a degree, this is why I'm curious as all fuck about liberalterianismestablishment-tarianism. This word, it just rolls off the tongue.
In my balls, I feel like I'm all for it. Because, well, in the son of the enlightenment sense, I”m a liberal. In the other sense – I just barely made it through econometrics for dummies – I'm a libertarian.
But, Inflation is a regressive tax. Sin taxes are regressive taxes. (Etc., Etc., Etc.,) Square these circles and I'm on board. Shit, personally? I'm conflicted.
One day I will be able to reply to a previous comment rather than create a new one. Apparently that day is very far off.
I'm sorry I had to see who Will Wilkison was and now I know. A laissez faire Repubican dolt. Let's see, the economy sucks real bad and needs something to be done, so let's tackle rewriting all of the regulation, tax policy, etc, to fix the economic woes – that get's people back to work, creates job, extends unemployment benefits….are you for real? It would take congress years to finally fix all of the regulatory and tax problems. By then, even more jobs would be loss, people's unemployment would be run dry, and we'd be in a long-term recession. Spending money is the fastest, most effective way to stimulate the economy.
i wonder if you were singing this tune when it came to the Bush tax cuts. Stable medium term policy indeed.
Jeffy Sachs? Oh dear, that's the same guy who ruined both the Russian and Bolivian economies right?
Imminent repeal an excellent illustration of time inconsistency problems!
At least you don't think it was Milton Friedman! I'm pretty sure these economies were pre-ruined. But yes, his privatization plans were ill-conceived basically because they didn't take Hayek seriously enough.
Anyway, are you able to follow and evaluate an argument or do you just have a good guys/bad guys switch that determines what utterances you thoughtlessly accept and reject?
Actually, its more of a filter than a switch.
Sachs' thesis that policy shifts produce bubbles, which in turn cause larger economic pain down the road is interesting, but his argument is mostly grounded in: 1) conflating monetary policy with spending poilcy and 2) a bunch of assertions that aren't backed by any real evidence (to be fair, it is a short piece). Given #2, all I'm really left with is Jeffrey Sach's good name that what he's asserting is reliable. His role in taking “pre-ruined” economies and re-ruining them in all sorts of new and interesting ways, and his generally dreadful book “The End of Poverty” (sorry, not enough time today to get into why this re-packaging of failed 1950s development ideas is so bad – oh wait I guess that's enough) all I'm really left with is his name and my so-called “switch”. He's not a bad man, just not someone who, after producing a piece like this, should be taken seriously.
“conflating monetary policy with spending poilcy”
That's kind of funny. Some people call “spending policy” fiscal policy. “Spending policy”, how very, very apt for the times.
Actually, its more of a filter than a switch.
Sachs' thesis that policy shifts produce bubbles, which in turn cause larger economic pain down the road is interesting, but his argument is mostly grounded in: 1) conflating monetary policy with spending poilcy and 2) a bunch of assertions that aren't backed by any real evidence (to be fair, it is a short piece). Given #2, all I'm really left with is Jeffrey Sach's good name that what he's asserting is reliable. His role in taking “pre-ruined” economies and re-ruining them in all sorts of new and interesting ways, and his generally dreadful book “The End of Poverty” (sorry, not enough time today to get into why this re-packaging of failed 1950s development ideas is so bad – oh wait I guess that's enough) all I'm really left with is his name and my so-called “switch”. He's not a bad man, just not someone who, after producing a piece like this, should be taken seriously.
“conflating monetary policy with spending poilcy”
That's kind of funny. Some people call “spending policy” fiscal policy. “Spending policy”, how very, very apt for the times.