Category Archives: Recession

Let's Not Follow the Japanese Example, Okay?

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Masaru Tamamoto’s NYT op-ed is brutal:

There can be no justification for all those mostly unused airports. Or for roads that lead nowhere. Or for the finance minister who appeared to be drunk at the Group of 7 meeting this month in Rome. Our problem is so deep that it sometimes seems that no political party can tame the bureaucracy and put in place a coherent national agenda.

But what most people don’t recognize is that our crisis is not political, but psychological. After our aggression — and subsequent defeat — in World War II, safety and predictability became society’s goals. Bureaucrats rose to control the details of everyday life. We became a nation with lifetime employment, a corporate system based on stable cross-holdings of shares, and a large middle-class population in which people are equal and alike.

Conservative pundits here like to speak of this equality and sameness as being cornerstones of “Japanese” tradition. Nonsense. Throughout much of its history, Japan has had social stratification and great inequality of wealth and privilege. The “egalitarian” Japan was a creature of the 1970s, with its progressive taxation, redistribution of wealth, subsidies and the dampening of competition through regulation. This all seemed to work just fine until our asset-price bubble popped in the 1990s. Today, the hemmed-in Japanese seem satisfied with the knowledge that everyone around them is equally unhappy.

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Japan desperately needs change, and this will require risk. Risk-taking is not common among the bureaucratically controlled. You won’t find many signs on Japanese beaches saying, “Swim at your own risk. No lifeguard on duty.” If that sign were to appear, many Japanese would likely ask the authorities to tell them if it is safe to swim. This same risk aversion translates into protectionism and insularity.

My greatest worry is that as we have become wealthier, we have also become more risk-averse, and that, basically, the U.S. will end up like this.

Redistribution, Fairness, and Stability

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Here’s my commentary on this morning’s Marketplace. 

It’s really terribly hard saying anything in 300 words. If I’d had more space I would draw out how there is no way to succeed in promoting a unifying “we’re all in it together” mood when massive government intervention has massive redistributive consequences that track basically NO ONE’s sense of fairness or desert. That’s sure to be divisive. When Obama said in the campaign he meant to “spread the wealth around,” I’m sure most people took that to mean downward redistribution meant to rectify either the unfairness of rising inequality, the unfairness of the fact that some people are struggling for no fault of their own, or both. But bailouts of all sorts–to banks, to car companies, to underwater homeowners–spreads the wealth around in an entirely different way. “Investment” in the “green economy” spreads the wealth around. Increasing the size of the military spreads the wealth around. And so on. None of this accords with any coherent notion of fairness. And the scale of Obama’s initiatives do badly unsettle the structure around which people build expectations, and that’s an independent source of unfairness. We desperately need better framework rules for both private and public finance. It would be silly to oppose serious structural reform. But what we’re getting is the kind of half-panicked, half-opportunistic myopic intervention that breeds future half-panicked, half-opportunistic intervention. That is the opposite of what we need.

The Color of Government Money

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I’m reprinting this in full from Chris Good at the Atlantic. Someone please tell me how this is supposed to work, even in theory. And someone please tell me how speeding up the process of picking winners doesn’t simply make well-prepared regulatory capture specialists like T. Boone Pickens (whose PR blitz seems to have worked to get him into the DoE inner circle) richer simply because they’ve got the resources to hoover up contracts. 

Chu Works to Get the Green Cash Flowing

After environmentalists and mainstream politicians alike succeeded in dedicating a good chunk of President Obama’s stimulus package to green energy, Obama’s new energy secretary has been working on ways to make that happen more efficiently. Last week, Energy Secretary Steven Chu (who holds a Nobel Prize in physics) announced a slew of reforms to how the department doles out money, and a department official says more are on the way. The goal: streamlining the process so stimulus dollars can get spent sooner.

Many have posed the economic crisis as an opportunity for green revolution, and at a roundtable discussion on energy yesterday at the Newseum, the economy/energy/environment nexus was on the tip of many tongues.

“We have a plan going forward where we can reduce what could have been years down to months, and we feel very strongly that this thing will work,” Chu said of DoE spending as luminaries such as Bill Cinton, Al Gore, T. Boone Pickens, Senate Majority Leader Harry Reid, and House Speaker Nancy Pelosi listened.

Chu’s reforms include rolling appraisals of applications for loans and funding, using outside contractors to underwrite loans, more staff and resources to process applications, and simplifying application paperwork. Chu has appointed Matt Rogers, a former senior partner at consulting giant McKinsey & Company, who also worked on energy procurement reform as part of Obama’s transition team, to implement these reforms and oversee the stimulus money.

The stimulus placed $38.7 billion in the department’s hands, with heavy emphases on alternative energy, efficiency, and infrastructure modernization. DoE says it will start offering loan guarantees under stimulus provisions early this summer, and that 70 percent of the stimulus cash will be spent by the end of next year.

To hear politicians and activists talk about the timing of stimulus cash flow, “now” seems to be the only acceptable answer. A significant part of Chu’s job, so far, has been changing the way the department operates in order to make that happen.

Sachs on the Self-Defeating Stimulus

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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.

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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 Do Recent Nobel Prize-winning Macroeconomists Say about the Prospects of the Stimulus?

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I decided to ask!

I talked to Edward Prescott and Edmund Phelps the day Obama signed the stimulus into law and wrote about it in my latest column for The Week.

I’m persuaded that the general logic of Prescott and Kydland’s work on time inconsistency applies to the present situation (and I don’t think you need to accept the strict rational expectations framework to see how it applies), but I was especially taken by Phelps’ concerns about the potentially damaging effects of the stimulus on entrepreneurship and innovation. Please check it out.

Talking to these giants of macro has convinced me that we need to be talking about is how to get the institutions right and keep them stable. What the government is now doing amounts to a pretty radical restructuring of our scheme of economic institutions, but with shockingly little deliberation about or regard for the optimality or stability of the overall incentive structure. This mess was precipitated by what turned out to be a disastrously unstable alignment of incentives. That fact would seem to prescribe taking a lot of care in thinking through how various large interventions might ramify through the system before jumping in. But our government’s behavior increasingly looks a bit like a zealous small-town narcotics squad, excited by its slick new SWAT gear, that’s just kicked down the door to a meth house and has started shooting at anything that moves.

Austerity Chic

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Here’s Ed Glaeser:

Yet there are many Americans who spent the last eight years living within their means, and have plenty of resources left. For those Americans, the ones with cash in their bank accounts, this is the time to spend.

Cracking open the Champagne does not exactly feel in tune with today’s spirit of national austerity, but recessions get worse when prosperous people do not spend. In fact, if you can afford it, then this is exactly the moment to redo your kitchen or buy a car. Not only will you be able to get a good deal, but your spending will help revive the economy. The economist John Maynard Keynes convincingly argued 70 years ago that thrift was no virtue during a recession.

Despite the strength of the economic logic urging spending during a downturn, powerful psychological forces push in the opposite direction. America is hurting; thousands are losing their jobs. In today’s political climate, public displays of prosperity are the kind of thing that gets you lambasted by a Senate subcommittee.

I made a similar argument on Marketplace just before Christmas. Here’s what I said:

Most of us won’t lose our jobs, won’t face a pay cut. Yet we tighten anyway. Dollar-stretching tips circulate even among the most comfortable. But if your paycheck’s intact and you’re still cutting back, you may be part of the problem.

When home values surge, we tend to feel richer and spend a bit more, even if we don’t plan to sell the house. Economists call this “the wealth effect,” and it’s got a recessionary flip side. So when our 401(k)s dive as the economy hits a rough patch, we feel a bit of a pinch and rein in consumption — even when our incomes and the long-term value of our investments hasn’t changed a bit. In short, we don’t always look to our personal financial fundamentals when choosing whether to splurge or scrimp.

But just as “irrational exuberance” can keep a speculative bubble afloat, equally irrational anxiety, and the ethos of austerity it produces, can trap us in the doldrums. So maybe you went a bit crazy during the boom, and now’s the time to return to financial sanity. Good! But if you were living comfortably and responsibly within your means last year, you probably don’t need to cut back now. 

You know what? This argument DRIVES PEOPLE CRAZY. Check out Glaeser’s comments, and mine, which tend to confirm that there is in fact a Keynes-ish sort of pack psychology about appropriate consumption behavior. It’s funny that people get upset by a recommendation to do things that are both individually prudent (it’s just good financial stewardship to buy things when prices are low) and that have larger than ususual positive spillover effects. I doubt people really think it’s better to leave yourself and everyone else worse off. My diagnosis is that most people either don’t get the idea of periodic downturns and recoveries and so tend to suspect  with each serious recession that this time everything may go to shit permanently (which is true, it might, but what are the odds?) and to infer that prudence demands hoarding. My biggest worry about things going to shit is that government profligacy may leave us with a worthless dollar. But then why not spend all your dollars now on durable stuff!  I recently put a lot of my savings into a diamond ring, which I’m now thinking turned out to be fairly savvy move in several different ways.

Whatever Disagreements I May Have With Jonah…

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I must say he nails this one:

I understand that from the 30,000 feet level most policymakers view these things from, having homes worth less than their mortgages is a real problem. People can abandon their mortgages, which breeds contagion etc, etc. But I really don’t understand why it’s such an unbearable crisis for responsible homeowners themselves. Maybe it is in some cases, but it seems to me that having your home worth, say, $500K when your mortgage is for $600K is certainly undersirable but not necessarily disastrous. If you bought during a housing boom, you shouldn’t be stunned and crestfallen if the value of your home temporarily sinks for a while —  that is unless you’re a house-flipper, in which case my sympathies are significantly reduced anyway. Most people buy their homes and expect to hold on to them for a while. I don’t sell my stocks every time they go down. A dip in the value of your home now, isn’t a dip for all time. So, long as you can pay your mortgage, I don’t really see why you would walk away.  And, even if you are the kind of person who abandons his obligations, I have to presume that walking away from your mortgage has real costs to your credit rating (and, hopefully, your self-esteem). Indeed, if abandoning your mortgage doesn’t nuke your credit score, what good are credit scores in the first place?

It would be nice if more (any?) Republicans in Congress agreed with this.

Robert Mundell on Stimulus

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I just stumbled on this, and don’t think I’ve seen it anywhere else, so I offer for your consideration economics Nobel Laureate Robert Mundell on the stimulus in a January 9th Turkish TV interview :

Ipek Cem: There is talk of a stimulus package in the US. We also know that the average US citizen is highly leveraged as a consumer. And when we talk about stimulus we are also talking about consumer pending. How to make the two of them, you know work hand in hand?

Robert Mundell: Well there’s a lot of questions about “What a stimulus package really is?” And I don’t think the major has been taken called a stimulus package are going to be much of a stimulus. To a certain extent, monetary policy, an easy monetary policy, is stimulating for us. But that’s not the pack what we mean by a “stimulus package” because “Federal Reserve” can always do that. What they mean by that is government spending. But government spending doesn’t have that bigger effect. If you have a big increasing government spending, without monetary expansion, they have to finance that deficit by bringing bonds. So while the spending adds to demand, the selling of the bonds, takes away the demand. So if there’s a multiplier in one process, there is a negative multiplier with the other process. And the other fact is that the exchange rate is flexible. So if you sell more bonds with a stimulus pending interest rates rise a little bit. And the capital comes in, the current account deficit increases. The trade deficit increases. So a good part of that stimulus package goes to the rest of the world.

Ipek Cem: So what kind of policy measures would you be advocating at a time like this?

Robert Mundell: Well I think that the difficulty of all the banks, they need to recapitalize the bank, which everybody says it’s necessary. And is also true with corporation you need to recapitalize the corporations like “General Motors”, “Ford” and “Chrysler”. The glories, what used to be glories of American capitalism in the 20th century. American manufacturing. They need to be recapitalized, too. And instead of the government taking its stimulus package, the bailout package, recapitalizing, buying stocking these banks, it is much more important to look at what’s happenning right now, what the goverment is doing today to economy. What the government does to the corporation today is take thirty five percent of the profits of the corporation. And without putting anything in. So with the 35 percent of corporate tax, they take all that, draining the corporation from that, without putting anything in. And so what the best thing to do for stimulus is to reduce or eliminate the corporation tax. It is a double taxation anyway, because the capital pays the tax to the corporation and the profits are taxed at the corporate level after 35 % is taken out. And then there are also tax in the individual level. So eliminate it. By the way the revenue isn’t going to be very much because the corporate tax used to earn 5 % of GDP in revenue. It’s gone down about 1,5 % of GDP. So it doesn’t add too much. And in a recession period there won’t be any profits and tax, so the revenue will be very little. So you don’t loose too much, but you would, if you stimulate economy all the other taxes will increase. And the revenue then from the tax cuts of corporations will increase the tax of every other corporation. Just recently, Germany has cut it it corporation tax from 25 % to 15 %. That’s a very good move and that’s what the United States should do. I think, I was going to say from 35 % to 20 %, but it would be even better if they do it to 15 %.

Recap: Bond-financed spending doesn’t much help. Recapitalize banks and eliminate radically reduce the corporate income tax.

Chait Empiricism Watch

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I like how Jonathan Chait wrote a whole book accusing right-wingers of braindead supply-sider free-lunchism and now induldges in left-winger braindead demand-side free-lunchism with all the zeal of bizarro Jack Kemp on meth. 

I mean, check it out!

The point of stimulus spending … is simply to spend money–on something useful if possible, wasteful if necessary. Keynes proposed burying money in mineshafts, so that workers would be hired to dig it out. (Imagine what the GOP could do with material like that.) World War II was an effective stimulus that, economically speaking, consisted of 100 percent waste. If war hadn’t broken out, we could have enjoyed the same economic benefit by building all those tanks and planes and dumping them into the ocean. 

Oh my. Since Chait’s a pure empiricist with no agenda but truth, I’m sure he’ll be receptive to the facts revealed in Robert Higgs’ Depression War and Cold War. Here’s Price Fishback’s summary.

[UPDATE: Also see Tyler Cowen.]

Managing Expectations Better

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Expectations matter. A lot. Stable institutions in a context of trust are necessary for liberal prosperity. In this sense, the work of government is to manage expectations–to maintain a stable strategic framework within which plans can be formed and cooperative action successfully coordinated over the long term. That is why, for instance, I think quickly restoring a legal and administrative framework for functioning financial markets ought to be among the government’s chief priorities.

Yet I’m extremely suspicious of what strike me as intellectually contentious, ad hoc interventions into the economy aimed at expectation management. Countercyclical economic mood-control initiatives seem to me inconsistent with the maintenance of a general framework of stable rules — that is, they don’t take the importance of expectations seriously enough — while also smacking of illiberal state propaganda. It’s hard to draw a principled distinction between framework and ad hoc rules, but I think it’s intuitive enough. Steady, predictable expansion of the money supply seems like the good kind of expectation management, while fool-in-the-shower money supply management seems like the bad kind. Likewise, automatic stabilizers, such as the predictable increases in welfare and unemployment transfers during recessions, strike me as greatly preferable to freestyle panic-mode stimulus legislation.

I understand that on some theories, a spell of poor economic performance cannot be expected to end without government assistance, and the failure to open the monetary spigot and induce spending through tax cuts and government spending is to invite disaster. OK. Suppose we’re all convinced by those theories. (I’m not, but suppose.) Wouldn’t we be naive to ignore the opportunistic nature of democratic politics and to therefore fail to grasp how Keynesian theory plus economic decline will tend to invite a pork bonanza rather than timely, targeted, and temporary stimulus policy? Doesn’t taking both politics and the seriousness of recessions seriously suggest rigging policy in advance to include more automatic stabilizers? Why not have it as standing policy to halve payroll taxes, or increase TANF payments a certain percentage, or what have you, whenever the NBER gets around to calling a recession? If you insist on infrastructure, why not plan out, far in advance, some well-considered but non-urgent infrastructure projects that can be switched on immediately upon the onset of a downturn?

Wouldn’t this be better expectation management? People about to hit recession would know in advance what’s going to happen, instead of being made to wait on the outcome of the unpredictable, volatile and often self-undermining political wrangling of opportunistic panic.

The objections I anticipate to auto-stimulus are (1) it can’t work without the element of surprise and (2) that each recession is an unrepeatable precious snowflake that requires special initiatives targeted to its unique circumstances. About (1), why think the political process will reliably deliver the right surprise? About (2) the TARP stuff does seem like that. But so far, I don’t see anything in Obama’s bill that seems unique to the times. It’s just a train wreck of haphazardly considered tax cuts and spending.

Krugman on the Bully Pulpit

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Paul Zrimsek in the comments below offers us this gem:  

Last but perhaps not least among causes of the consumer funk is the administration’s own determined pessimism. Mr. Bush has a bully pulpit, and he is using it to preach economic alarm. This adds powerfully to the chorus of doomsaying. And when it comes to short-term economics, believing can sometimes make it so.

–Paul Krugman, 2/21/01

Oh snap!

The Incoherence of Neo-Keynesian Doomsaying

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In response to my post below, friend and former colleague Ryan Avent writes:

This is just too cute. The paradox of countercyclical macroeconomic politics is only a paradox if you believe that the current recession is the result of equal parts Democratic fear-mongering and facts on the ground. But can any sane person actually believe this? Does anyone really think that Barack Obama’s acknowledgement of economic reality and the op-ed warnings of lefty economists are the things producing this downturn, or perpetuating it, or deepening it?

I don’t think Ryan understands the cute argument. The cause of the recession is irrelevant. I never even intimated that Democratic fear-mongering caused it. (I think normal periodic breakdown of efficient-ish economic coordination + American houselust + democracy + fancypants finance + executive myopia + regulatory failure caused it.) So does anyone think that pants-wetting op-eds by Presidents and Nobel Prize-winning economists can perpetuate or deepen a downturn? Yes! For example, people like the President or Nobel Prize-winning economist Paul Krugman who believe that countercyclical macroeconomic policy works largely by manipulating consumer and investor psychology. If you don’t think Obama and Krugman’s confidence-destroying disaster forecasts hurt, then you probably shouldn’t accept confidence-restoration theories of stimulus, either. Or maybe Ryan knows of some research that shows that badly-targeted tax cuts and infrastructure spending effectively boost confidence and buoy markets while doomsaying from the most powerful man on Earth means squat. That would be interesting to see.

The Passionate Politics of Paul Krugman's Apolitical Economics

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Like the president, Krugman seems firmly caught in the paradox of countercyclical macroeconomic politics. The intermediate-level textbook theory says that at times like these we need a certain kind of policy to steady the economy’s nerves and lubricate consumption and investment. The economics says we need confidence. But political reality says we need panic. So we try to induce panic so that we can later induce confidence. This seems an extremely awkward and implausible approach, but that doesn’t keep anyone from trying it. 

The deeper problem, I think, is that the textbook theory doesn’t have any politics in it. In macroeconomics textbooks, government is a benevolent central planner beyond politics. It is assumed, for simplicity’s sake, that governments can act in perfect compliance with theory. It is also assumed that theory is settled before coming to a policy problem, that motivated disagreement over theory is not an essential element of democratic policymaking. But of course, there is politics, which trashes hope of either consensus on or compliance with theory. And that’s how we ended up with the legislative monstrosity actually under consideration in Congress. As Harvard’s Robert Barro puts it:

This is probably the worst bill that has been put forward since the 1930s. I don’t know what to say. I mean it’s wasting a tremendous amount of money. It has some simplistic theory that I don’t think will work, so I don’t think the expenditure stuff is going to have the intended effect. I don’t think it will expand the economy. And the tax cutting isn’t really geared toward incentives. It’s not really geared to lowering tax rates; it’s more along the lines of throwing money at people. On both sides I think it’s garbage. So in terms of balance between the two it doesn’t really matter that much.

The economists can duke it out over the possibility of successful fiscal stimulus. But is there any reason based in up-to-date economic theory to believe that this trillion dollar deficit-spending bill is not, as Barro says, garbage?

Krugman is plumping for it anyway. Hard. So what can one say about Krugman? That he is a creature of extraordinary double consciousness. Perhaps more than any economist of his caliber, Krugman understands that policy is largely determined by the outcome of the public opinion shoutfest. Yet this recognition seems to have no effect on Krugman’s ideas. Rather than bring inside his models disagreement over economic theory and the lack of political incentive to faithfully apply them, which would lead him to radically revise his prescriptions, Krugman leaves his textbook theory untouched and simply tries to win the shoutfest. Krugman’s often unbearable stridency seems to reflect an attempt to overcome the problems of democratic disagreement and incentive compatibility through sheer force of will–as if the deep reality of politics is no match for the rhetorical gifts and gold-plated reputation of Paul Freaking Krugman. It is as if his own imagined ability to singehandedly overwhelm the opposition is part of Krugman’s implicit model of how a politics-free macoeconomic theory can be made politically relevant in a time of perceived crisis, which is to say, a time of rank political opportunism.  

One can see this attitude reflected in Krugman’s advice to Obama, who he says “made a big mistake” by failing to mercilessly bully his opponents into submission: 

It’s time for Mr. Obama to go on the offensive. Above all, he must not shy away from pointing out that those who stand in the way of his plan, in the name of a discredited economic philosophy, are putting the nation’s future at risk.

As Krugman sees it, the big problem here is Obama, who lacks Krugman’s intransigent will to mercilessly crush any who would dare keep cartoon Keynesianism from coming to life.

Keep in mind this is legislation that Krugman admits would do little more than “improve our odds.”