Wednesday, March 18, 2009

Why buy long-term Treasuries?

1. The U.S. Treasury issues bills/bonds when it needs to borrow money.

2. Buying a bond is lending money. Banks, insurance companies, and other financial intermediaries buy bonds with reserves. They also make other types of loans. (Banks only keep a fraction of all reserves (deposits) on hand to meet the liquidity demands of their depositors. They loan out most reserves in order to earn a profit on the interest rate spread - pay one rate of interest to depositors and charge another, higher, rate to borrowers).

3. Bond prices and interest rates move in opposite directions. Why?
Because buying a bond is lending money. An increase in the demand for bonds will, like an increase in the demand for apples, put upward pressure on the price of bonds and send interest rates lower. Or, look at it this way. Someone buys a $100 bond and the interest rate is 10% so that at the end of one year the bond can be redeemed for $100 plus $10 in interest. Then, right after buying the bond, interest rates fall to 3%. Now the holder of that bond can sell the $100 bond for something more than $100... because current interest rates are only 3%.

4. Treasury Bond/Bill maturities vary. One month, three month, 6 month, one year...

5. Monetary stimulus: The Fed, the central bank, typically buys and sells short-term bonds when conducting monetary policy. When the Fed buys bills (short term bonds) it creates the money to do so. Roughly, it credits the bondholder (bank) by increasing the reserves that the bank has at the regional Fed (member banks have accounts at the Fed. The Fed is the bankers' bank, the lender of last resort). The bank, the seller of the bond, now has cash, excess reserves that it is free to lend to a borrower in the private sector. When the Fed demands bonds it sends the price of bonds higher and interest rates lower. It is increasing liquidity, creating money.

6. Liquidity trap: When interest rates are very low as they are now (short term rates are as low as they can go), then it might be that conventional monetary policy does not stimulate increased lending and borrowing. If the Fed buys short-term bonds that pay less than 1% per year then the bank has merely substituted one low yield asset, a Treasury Bill, for another - cash reserves. Lenders, in a time of uncertainty and credit risk, are reluctant to lend - liquidity is trapped. Banks might choose to hold excess reserves instead of making more loans. Monetary stimulus doesn't stimulate.

7. Fed has more bullets: The Fed can also buy agency debt - bonds issued by the likes of Fannie Mae and Freddie Mac (google TALF). Again the Fed can create money to buy bonds (lend to GSE's). The Fed can, and will, buy longer term Treasury bonds. Again, this sends the price of those bonds up and longer term interest rates down. This should increase liquidity that can then be used to loan to riskier borrowers (everyone is riskier than the U.S. government).

Notes:

Bernanke is a great scholar of the Great Depression. Milton Friedman's great contribution was his assertion that the Great Depression was primarily a monetary phenomenon. The Fed, according to Friedman, failed at the onset of the downturn to act as the lender of last resort. They allowed banks that were otherwise solvent to fail via bank runs. They should have added liquidity. The money supply contracted. Interest rates rose. The recession quickly deepened.

As the money supply fell prices fell - deflation. Big problem, two actually. With falling prices it becomes rational, for banks and people, to horde money. Banks don't lend; holding money has a positive return. People don't spend; better to wait for prices to fall further. Second problem - the real value of debt increases. Suppose you owe $10,000. As prices and wages fall the real value of your debt increases.

I think the Fed has a very healthy fear of deflation and buying long-term Treasuries - increasing the money supply substantially - is inflationary. Mortgage interest rates should fall. Re-finance activity should increase.

I refinanced about six weeks ago and went from 6.25% on a 30 year note to 4.75%. This will save me nearly $200 per month. Multiply this by many households and you're talking about a real stimulus. Falling housing prices are a real problem. People lose equity and consumption falls. If housing prices increase nominally, not in real terms (they increase at the rate of prices and wages generally) then that should help to stabilize the economy.

Active fiscal and monetary policy are short-term remedies. Long-run growth is not achieved via tinkering with the money supply and by engaging in massive deficit spending. Indeed there are costs associated - inflation and paying down the debt. Long run growth, for any country, is achieved via improvements in techology, improvements in human capital (health and education), stable prices (good monetary policy), fiscal discipline, respect for property rights, and through free and fair markets.

I think Bernanke will be seen as a great Fed chairman in years to come. We'll see. Obama? Depends on one's perspective. If GDP is growing and unemployment is down two years from now he'll cruise to re-election. Supporters will claim his fiscal stimulus worked while others will say that it didn't hinder recovery a great deal.

On Keynesian economics: According to a recent Amer. Economic Association survey of PhD economists, 90% believe that fiscal policy can be used to stimulate an economy in recession. 85% believe, as did Keynes, that the budget should be balanced over the course of the business cycle. That is to say that deficit spending should be employed at the onset of a downturn but the debt should be re-paid when growth returns. In other words, fiscal policy should be used to smooth the business cycle.

Friday, February 27, 2009

A humble attempt to provide some clarity on the question of taxes

Harvard economist Greg Mankiw posts data (2005 data) on the average federal tax rates (tax liability / income). It shows that the top quintile (20%) pays an average tax rate about 6 times what the bottom quintile pays, 25.5% versus 4.3% This is all federal taxes - income, payroll, and excise taxes. This is so because we have a progressive tax system - the higher your income the greater percentage of that income is paid in taxes. But, it is only the income tax that is progressive.

Some more data though adds clarity. That same year the highest quintile (20%) of households earned about 55.1% of all income. They paid about 68.7% of all federal taxes. The lowest quintile earned about 4% of all income and paid about 1% of all taxes. Still progressive. However, if you add state and local taxes - sales and property taxes and in some cases an income tax - it is less progressive. Sales and property taxes are not progressive and only some states have a progressive income tax. (A good graph can be found here but I can't find the source and am curious to see if it is accurate) Simple interpretation, while rich folks pay a higher percentage of their income than do less affluent people on income taxes, less affluent people tend to pay higher percentage than rich people on payroll and sales taxes.

It should be noted that there is progressivity on the spending side - poorer folks benefit disproportionally from the spending - at least as measured by direct transfers.

My comment: We'll waste all kinds of energy and emotion on debating and provoking with respect to "taxes on the rich" (how progressive our income tax code should be) when the more important argument should be had on tax simplification and role and size of government. Eliminating the more distortionary taxes - capital gains and the payroll tax - in a tradeoff for higher income taxes all around would help. I'd throw in a higher gas tax too to help offset the increase in income taxes. A simple and predictable flat tax on income beyond a certain level of income (the bottom quintile pays no income tax right now anyway) would increase efficiency and clarity.

Consider for a moment the distortionary nature of the mortgage interest deduction. It is a subsidy that goes to rich and middle income alike yet the idea is to encourage home ownership. Does anyone thing that higher income people would not own a home were it not for mortgage interest deductibility? It increased home prices; that's what subsidies do. It encouraged people to buy more house - get a bigger mortgage - than they otherwise would have. It encouraged people to borrowing against their house in order to consume - so much for eliminating the deductibility of consumer loans. It is bad energy policy; bigger homes use more energy.

Thursday, February 26, 2009

Race, partisanship, and self-interest

If Bobby Jindal's mom was pregnant before she came from India to the United States, does that make him an "anchor baby" in the GOP's eyes?

A local bloggger and Democratic activist (Braisted) asked that question yesterday. I challenged it by opining that the immigration debate did not break cleanly along partisan lines. The blogger insisted that his take was accurate. Another blogger and Dem activist challenged echoed the first...

The GOP can throw all of the brown faces out there it wants. That doesn’t change the fact that there’s a huge racist faction within the Republican Party. Until they acknowledge it and deal with it, it won’t be going away.

This is bizarre.

If the GOP has a large racist faction that they want to appease why would they "throw a brown face out?" Put another way, couldn't "throwing Jindal's brown face out" be interpreted as trying to attract more minorities? Is the elevation of Michael Steele a signal that the Republican party is not dealing with "a huge racist faction?"

And what of immigration and race considerations?

"Every hour sees the black man elbowed out of employment by some newly arrived emigrant."

That's Frederick Douglass. What about Booker T. Washington?

"The continual stream of well-trained European laborers flowing into the West," warned educator Booker T. Washington in an 1882 speech, "leaves Negroes no foothold."

Marcus Garvey in 1920 speaking in favor of tighter immigration...

"We will be out of jobs, and we will be starving."

My suspicion is that the districts who voted most heavily for Obama are also the districts most in favor of immigration restrictions. But the more important point is that it is often not about race but economic self-interest.

Wednesday, February 25, 2009

Required reading for liberals

Liberals are more optimistic about the capacity of individual reason and the government’s ability to execute transformational change. They have more faith in the power of social science, macroeconomic models and 10-point programs.

That's David Brooks in the New York Times offering a pretty darn good summary of the difference between liberals and conservatives in an age where making meaningful distinctions has become more difficult.

I disagree with his last point, that the success or failure of the Obama administration will solve the question of who has it right, liberals or conservatives. It will not be easy to make definitive judgments with respect to the success of the myriad initiatives. Besides, we'll not know how things would have turned out with an alternative approach.

Tuesday, February 24, 2009

The Good, the Bad, and the Ugly

Obama looked good. No surprise there. The contrast - Biden and Pelosi sitting behind him - helped.

Bad: On energy... when is a major political figure going to propose the single most important policy to improve national and economic security - a higher gas tax? A third rail? Not so. Offset it with a decrease in the payroll tax. Jindal gets points for promoting domestic energy production.

Good: On healthcare... Obama didn't use the term but what he described at one point sounded like Health Savings Accounts. Yes! Expand high deductible insurance combined with savings accounts which are tax free that can be tapped to pay for routine care.

Bad: No mention of transitioning away from employer based health care in the private sector. This stifles job creation and decreases dramatically the mobility of labor. How many people stay in jobs they otherwise hate because they depend on the health benefits?

Good (Great even): Obama plugged charter schools. Do progressives now have cover to support charter schools? Can mayors start pushing them more aggressively? Will the Tennessee legislature expand the option so that kids not from "failing" schools can go to a charter school? Jindal was even better here. He talked of enabling children to go to parochial schools.

Bad: Enough with the obsession with the goal that everyone should go to college. Cite all the statistics you want on income but correlation is not causation. You can be a very productive citizen without ever stepping foot onto a college campus. Subsidies for college have enabled colleges to increase tuition far above the rate of inflation for long enough.

Really Bad: Subsidizing early education is a joke. Where does it say that putting four year olds in classrooms is the only way to educate them? Talk about a power grab. This is government reaching toward the cradle. Is it now a radical idea to think that families are more capable and better suited to raise kids? Show me one shred of evidence that suggests that kids scribbling in classrooms has any long-term positive impact.

Good: Jindal acknowledged the reality that Republicans lost credibility on fiscal discipline.

Good: Two smart guys spoke, were positive, and laid out fundamental differences. Bobby Jindal, Mark Sanford, and Tim Pawlenty impress me as worthy candidates. Nothing against Sarah Palin; she has a great story and I can relate to her on many levels but she is not in the same league.

Who cares?

The nation not only needs the injection of money, it needs to see that somebody somewhere cares about what is happening.

That from yesterday's staff editorial in the Tennessean defending the federal fiscal stimulus. Hard to argue such a point - that it is important, necessary even, for people to understand that government cares - but the argument is worthwhile nonetheless. However, it is not so much a matter of whether to care or not but rather how that caring manifests itself. Let's assume that the primary purpose of the stimulus is to alleviate suffering rather than to "jumpstart" economic growth. Seems there is a powerful argument to be made that the massive spending is not focused enough on alleviating suffering, that it is unclear how spending designed to bring alternative energy to market or weatherize government buildings does little, in the short term, to alleviate suffering.

Also noteworthy is that some folks are doing well due to the downturn. Dollar General revenue is way up, shoe repair services are doing a brisk business, and seed companies are selling more seeds (I just placed my order). Apparently Breyer's is selling more ice cream. Used car salesmen are very busy.

Defending the fiscal stimulus package is one thing but shouldn't there be some mention of the trade off? Some mention that some sectors of the economy are counter-cyclical, that the market does work and we see plenty of evidence?

The notion that people who favor and promote free markets don't care has to be challenged. At times like this it is helpful to listen to a smart Jew and a dumb Irish-Catholic.

Friday, February 20, 2009

Are you biased?

You're invited to watch this short video. Watch it and count how many times the players in white shirts pass the ball. See if you can get the right answer. Do this before reading further. Don't cheat.

Now watch the video again.


Now watch the video again. This time don't bother counting anything just try to get the big picture. See anything now that you didn't notice before? Did you see the stimulus bill, I mean animal, passing through?

Thursday, February 19, 2009

The third economist

One local economist has a pretty good diagnosis but doesn't offer much in the way of a solution. Another economist offers a solution but I think it is the wrong one. The current downturn is difficult to diagnose and solve in a 500 word op-ed.

Dr. Grant from Lipscomb offers this...

There is a mistaken belief that falling home prices are the cause of the crisis in the financial industry. The real reason is the failure of many borrowers to live up to their loan agreements.

Ouch! That's true, but simplified. Increased foreclosures have driven home prices down. As soon as home prices stopped rising foreclosures increased. The initial foreclosures were primarily speculators - had little or no money down and counted on ever rising prices. As housing prices started to fall consumption decreased, the financial sector that held mortgages was rocked, and unemployment started to rise. The downturn has made it more difficult for others to pay their mortgage, people who were not speculating but maybe lost business or their job as the result of the downturn. It should be added that the distinction between a speculator and a responsible homeowner is unclear. All people who buy a home hope for appreciation and many tend to reach to buy as much home as possible, to leverage their money. The Lipscomb professor goes on to say...

Not understanding this, the Treasury Secretary wants to prop up home prices, and also wants to prevent foreclosures. To the extent that he succeeds, he will prevent the home market from adjusting to reality.

True again but simplified. It is understandable that policymakers are trying to prevent a further collapse of home prices. That will yield more foreclosures, less consumption etc. However, the housing market might still be over-priced. Generally we want rapid adjustment in markets. That's why I think we will see higher rates of inflation. With an increase in inflation we can have housing prices increase in nominal terms but continue to adjust in real terms.

Dr. Wahid from TSU wants to use all of the TARP money to buy up the toxic assets.

Thus, I suggest the government help financial institutions to clean up the toxic assets from their balance sheets with the entire $700 billion TARP fund. If the government does not do that, then to straighten out the bad balance sheets, it might take as long 10 years for the financial institutions to clean it on their own.

I prefer nationalizing the insolvent banks. Sounds bad to someone who prefers the free market but it shouldn't. It is like bankruptcy. When a firm is failing or struggling they can get bankruptcy protection. Bondholders, those who have loaned money to the firm are paid off at a steep discount. A judge often presides over the procedure. Often management is removed and the firm taken over by new owners. When it comes to banks the people who have loaned the bank money are not bondholders but depositors. Deposits are insured by the FDIC, the government. The government has an important role to play - come in, clean house, and sell it to investors in the private sector.

What's so bad about public schools?

ONE OF THE great barriers to a discussion of poverty and social policy in the 1980s is that so few people who talk about poverty have ever been poor.

That's the first sentence from Charles Murray's thought provoking essay What's so Bad about being Poor? I can't help but remember that sentence when I read of former senator Bill Frist's new initiative - State Collaborative on Reforming Education (SCORE). Who attended yesterday's announcement? Well, Bill Frist of course. He didn't attend public school. He attended the most exclusive (expensive) private school in the city. His offspring? Not sure but I bet they didn't attend the neighborhood public school. It is the same school that Mayor Karl Dean sent his children. Phil Bredesen sent his son to a swanky private school in Nashville, one just as exclusive. Former mayor Bill Purcell's kid went to a magnet school. The academic magnet schools look nothing, demographically speaking, like neighborhood public schools. This year only one in four students in the lottery got a slot at an academic magnet. Many of the teachers and administrators in Metro schools opt out of the public system just as our president did when he moved to Washington D.C. Is this reality not a barrier to any discussion of school reform? For such people school reform is an abstraction. There is no intensity to enact the most basic reform, to empower all parents to act as consumers of education. If people like Bill Frist, Karl Dean, Phil Bredesen, and all Metro teachers and administators had to send their kids to the neighborhood public school you'd get real reform.

Don't even begin to tell me about programs that have "worked" elsewhere in terms of graduation rates or test scores until you make clear that a fundamental goal of reform is to expand parental choice. Those who believe in the power of programs miss the point. It is the power of a system that is important. On the one hand you have a thriving market system that serves affluent consumers and on the other a public monopoly system that enjoys a captive market, those who can't afford the market system. That system serves various interests.

Update: After checking out the SCORE website I have to say that the thrust and direction of the Frist effort is very good. It is a step in the right direction.

Wednesday, February 18, 2009

The influence and confusion...

... when considering John Maynard Keynes.

Our ignorance of what causes economic ailments -- and how to treat them -- is profound. Downturns and financial crises are not regular occurrences, and because economies are always evolving, they tend to be idiosyncratic, singular events.

That's Amar Bhide writing yesterday in the Wall Street Journal. Our ignorance is profound? That from a distinguished professor of business at Columbia? An exaggeration maybe but I like the humility. As he points out there are still debates with respect to how we sunk so low during the Great Depression and what brought us out. And, downturns are somewhat idiosyncratic, each downturn is somewhat unique.

On what leads to a downturn I think there is general agreement that energy price spikes and financial crisis that come after a speculative bubble bursts precede downturns. In 2001 there was the dot.com bursting then the real shock of 9/11 which that thwarted real trade in goods and services, in 1991 the spike in oil prices when Iraq invaded Kuwait, the mid-seventies and 1981 - again high oil prices. We agree on some basics about monetary policy; the Fed's failure at the onset of the Great Depression to act as a lender of last resort, to let so many banks fail, was a disaster. The Fed policy under Paul Volcker that brought inflation under control in 1979 and the early 80's required an adjustment (downturn).

The debates tend to focus on magnitudes - how much of a role did monetary policy play versus FDR's New Deal policies? Then there is confusion with respect to what is a "conservative" response versus what is a "liberal" response to a downturn. GDP began to grow fairly rapidly when FDR took over until the recession within a depression that occurred in 1937. Though unemployment did not fall dramatically in the early years of the New Deal it is hard to say that FDR's policies had no impact. And what of John Maynard Keynes? He's been identified as an economic liberal though that's hard to square with what he actually wrote. He believed strongly in free markets and thought that the government ought to back out quickly after a downturn was over. His influence is undeniable not only because his analysis supported, broadly, what FDR was trying to accomplish but because he provided a framework for viewing the macro economy that persists today. His influence is reflected in the current fiscal response...

The economic theory behind the nearly $800 billion stimulus package may be cloaked in precise mathematics but is ultimately based on John Maynard Keynes's speculative conjecture about human nature. Keynes claimed that people cope with uncertainty by assuming the future will be like the present. This predisposition exacerbates economic downturns and should be countered by a sharp fiscal stimulus that reignites the "animal spirits" of consumers and investors.

Indeed Keynes' diagnosis led to a logical prescription, that the government must step in to halt then reverse the downward spiral. This doesn't mean that we should all embrace what are considered to be "Keynesian" policies today. As professor Bhide points out...

... there is no consensus about why huge public-spending projects and a zero-interest-rate policy failed to pull the Japanese out of a prolonged slump.

He goes on to argue against the particular fiscal approach being employed today particularly the anxiety peddling that was a large part of getting the stimulus package passed. Encouraging anxiety works against reversing "animal spirits." It is worth reading. The alternative, as Bhide points out, isn't to shrug our shoulders and wait for markets to adjust.

The alternative isn't, as the stimulus scaremongers suggest, to turn our backs to the downturn. We do have mechanisms in place to deal with economic distress. Public aid for the indigent has been modernized and expanded to provide a range of unemployment and income-maintenance schemes. Bankruptcy courts and laws give individuals another chance and facilitate the orderly reorganization or liquidation of troubled businesses. The FDIC has been dealing with bank failures for more than 70 years, and the Federal Reserve has been empowered to provide liquidity in the face of financial panics for even longer.

In short an opponent of the huge fiscal stimulus should not be characterized as someone who objects to the state having any role whatsoever. I think Harvard economist Greg Mankiw spoke for many by saying that fiscal policy can work to mitigate the symptoms (suffering) of the downturn but we shouldn't rely on fiscal policy to shock the economy out of a recession.

Monday, February 16, 2009

What if we could "out" the elites?

Suppose that we could "out" the top policy wonks and leaders of both parties. My guess is that we would see a Democratic elite that views poor people with more disgust than sympathy. And I suspect that we would see a Republican elite that finds religious fervor more disturbing than congenial.

That's economist Arnold Kling commenting on something from Ross Douthat. I'll buy that in general. Which is more objectionable? Is it more objectionable to exploit the poor or the fervently religious?

Friday, February 13, 2009

Is being critical of the stimulus synonomous with being conservative?

Is being critical of the stimulus synonomous with being conservative?

I'd have to answer no. This story that Drudge linked has economists speaking critically of the stimulus.

"I think (doing) nothing would have been better," said Ed Yardeni, an investment analyst who's usually an optimist, in an interview with McClatchy.

So far so good but then this...

He argued that the plan fails to provide the right incentives to spur spending.

So it is not the idea of fiscal stimulus that is the problem but the particulars that are the problem. Then this...

"It's unfocused. That is my problem. It is a lot of money for a lot of nickel-and- dime programs. I would have rather had a lot of money for (promoting purchase of) housing and autos . . . . Most of this plan is really, I think, aimed at stabilizing the situation and helping people get through the recession, rather than getting us out of the recession.

Is that - subsidies for home and auto purchases - conservative? Helping people get through the recession, presumably by helping them stay fed and reasonably healthy, is not conservative but helping them buy cars and houses is? Then there's this...

"All this is 25 years of government expansion jammed into one bill and sold as stimulus," said Brian Riedl, the director of budget analysis for the Heritage Foundation, a conservative policy research group.

That's plausible. That represents a legitimate conservative objection. What about this?

"While the stimulus bill is a necessary condition for economic stabilization and recovery, it is hardly sufficient," Galston wrote. "As the lesson of Japan in the 1990s shows, fiscal stimulus without financial rescue yields stagnation — at best."

That's William Galston who is at the center-left Brookings Institution. Now conservatives can tend to agree with that. In fact I'd say it is a major point that center-right economists have been making, that until the financial system is reformed and working efficiently a fiscal stimulus is not going to yield a recovery. Conservatives would tend to argue more strongly against the fiscal stimulus but agree that it is no silver bullet.

Then to demonstrate that forecasters don't know what the hell they're talking about, and neither does anyone else, half the time...

"Something is better than nothing, and bigger was better than smaller in terms of the stimulus needed," said Chris Varvares, president of prominent forecaster Macroeconomic Advisers in St. Louis. "The economy needs a fiscal jolt."

There is more agreement among economists then most people realize. Perhaps it is a matter that there is less agreement and understanding now with respect to what defines and constitutes conservatism/liberalism.

Thursday, February 12, 2009

Perhaps a way to increase support for English First in places like Green Hills

Egads!

The median price of a single family home rose from $30,600 in 1940 to nearly $120,000 in 2000 (in 2000 - inflation adjusted - dollars).

O.K. we worry more in a recession but we can still strive to be happy

Nurture your relationships, be charitable, and be grateful

Sonja Lyubomirsky, professor of psychology at the University of California–Riverside and author of The How of Happiness: A Scientific Approach to Getting the Life You Want, suggests cultivating a sense of appreciation through something like a gratitude journal, where you write down three to five things for which you are thankful.

Like it Centurion, like it, like it

This is worth proposing just to observe how support and resistence breaks along party and other demogrpahic lines. I like the idea, always have. On what basis does one object? (via Marginal Revolution)

“All you need to do is grant visas to two million Indians, Chinese and Koreans,” said Shekhar Gupta, editor of The Indian Express newspaper. “We will buy up all the subprime homes. We will work 18 hours a day to pay for them. We will immediately improve your savings rate — no Indian bank today has more than 2 percent nonperforming loans because not paying your mortgage is considered shameful here. And we will start new companies to create our own jobs and jobs for more Americans.”

Would an increase of doctors and other professionals change the demographic mix with respect to who would support English First type policies?

Wednesday, February 11, 2009

More steps...

Newt Gingrich is promoting 12 steps that would lead to recovery and prosperity. Positive Spillover took a look at four of those steps. Time for to look at a few more... but first a word from Milton Friedman via Harvard economist Greg Mankiw:

The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in light of what can be done, politics aside, and not to predict what is "politically feasible" and then to recommend it.

1. Control spending so we can move toward a balanced budget:

A balanced budget amendment is not the only way to achieve this. We could, and should, impose rules on spending. When tax revenue is strong there is tremendous pressure to spend, to introduce new programs and initiatives. These new programs and initiatives give rise to new interest groups who advocate for more spending. Then, when tax revenue falls or grows more slowly we're caught with a "shortfall." The process of proposing a budget should be changed and that will lead to a change in thinking and language. Currently a "shortfall" is reported even when revenues are growing. It is only a shortfall to the extent that revenues aren't increasing as rapidly as projections, projections that were used to come up with the current budget.

2. Abolish taxes on capital gains:

The objection here is, typically, based on an equity argument. Affluent people realize capital gains. Why should we cut taxes to benefit the affluent? True enough but there are other, better ways, to address equity. Making affluent people less affluent doesn't help those who are not affluent. Income and wealth inequality tend to decrease during recessions. Are they good for less affluent people? The best thing you can do for low-income people is to expand opportunity. Investment, which will increase if we stop taxing it, provides opportunity. Overall there should be less focus on income distribution and more on growth. It is not relative improvements that we should concern ourselves with but absolute improvements. Some numbers will help...

Suppose two households, one making $500 per week and the other making $1,000 per week. They both realize a 10% increase in income. Both are better off even as their incomes become more unequal - from a $500 difference to a $550 difference. Do you think the lower income household would trade this change for one in which incomes fell to $450 and $800 respectivley? In such a case the income inequality would be only $350.

3. Abolish the death tax:

A simple question... Why should a person who saved money to leave to his children be taxed at a higher rate than a guy who spent all his money on himself?

12 step elaboration

Yesterday I referred to 12 American solutions for jobs and prosperity. A reader has asked me to elaborate. Let's start with this; there has been recent attention given to the conflicting commentary provided by economists and President Obama joked (or was it scoffed) that everyone in Washington is an economist now. Well actually the level of disagreement among economists, has been a bit exaggerated. News coverage tends to try to provide a narrative and a story highlighting differences sells better than one that focuses on broad agreement. There do remain some significant disagreements, some unsettled questions, with respect to the efficacy of stimulatory fiscal policy - can deficit spending shock the economy back to full employment? It is not unsettled that fiscal policy also has the potential to de-stabilize the macro economy, to exascerbate the business cycle. Everyone recognizes that there are lags associated with fiscal policy - time, in this case a year, before we realize we're in a recession, time before fiscal stimulus is passed, time before it is implemented, and time before it has any impact. The economy might be recovering just as the impact of fiscal policy is felt which helps explain why the question, of the efficacy of fiscal policy, remains unsettled. It is comparable to going to the doctor after being ill for three or four days. If you start to feel better it remains unclear whether what the doctor prescribed had any impact at all or whether you were starting to recover even as you sat in the doctor's office. Paul Krugman, Nobel economist and perhaps the strongest fiscal stimulus enthusiast, highlighted his agreement with a Financial Times columnist...

Unfortunately, what is coming out of the US is desperately discouraging. Instead of an overwhelming fiscal stimulus, what is emerging is too small, too wasteful and too ill-focused.

That's another way of saying that fiscal stimulus might work in theory but a bunch of vote maximizing elected representatives are not theoretical. The foundational assumption of economics is that people are self-interested, and it is helpful to remember that elected officials are people.

It would also be helpful to remember what another Nobel economist said. Friedrich von Hayek in his 1974 Nobel address...

It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences - an attempt which in our field may lead to outright error...
...If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.

Translation: A person or group of persons is not competent, does not have the capacity, to "manage" the economy. The effort should be on establishing and maintaining the conditions that we know are conducive to the production and flow of goods and services.

So what of some of Newt Gingrichs' proposed solutions?

1. Reduce the payroll tax by 50%: That is no attempt to directly manage the economy but rather a move to improve the conditions that will tend to increase employment. And, it highlights an area where all economists agree - that payroll taxes distort the labor market, that it reduces the level of employment. There may be disagreement with respect to magnitude - how much will it change employment - but no disagreement that the result will be lower unemployment and higher levels of consumption.


I am converted to your proposal… for varying rates of contributions in good and bad times.
(June 16, 1942). Keynes, Collected Writings, vol. 27, p. 208.…[Y]ou are able to show fluctuations in income of an order of magnitude which is significant in the context… So far as employees are concerned, reductions in contributions are more likely to lead to increased expenditure as compared with saving than a reduction in income tax would, and are free from the objection to a reduction in income tax that the wealthier classes would benefit disproportionately. At the same time, the reduction to employers, operating as a mitigation of the costs of production, will come in particularly helpfully in bad times.


Not sure but I think John Maynard Keynes could be considered a Keynesian. So, the first solution is not controversial. There is a consensus among economists that lowering the payroll tax will stimulate the labor market.

2. More American Energy Now: We have imposed a constraint on ourselves by reducing our access to energy. With fewer resources our productive capacity is diminished. Any of my students in introductory economics understand that after the first week of class. But, there is a tradeoff you might argue; lower energy prices will contribute to climate change and getting the resources has a negative impact on the beauty of the land. If you take the positon that climate change is real then you should also understand that air and water quality improves with growth in per capita GDP. Poor countries tend to have dirtier air and water; when you are concerned with what you will eat next week or how you will pay the rent then whether or not a bit of sludge, or tons of sludge, leaks into the creek falls way down on your list of concerns. Americans, polls show, are not nearly as concerned with climate change as they were 18 months ago. As for diminishing the beauty of the land - soup lines don't look very good either. But, all energy is not the same. We should move to expand alternatives. That is part of the solution, but when we are becoming poorer our capacity to bring new forms of energy to market is diminished. The economics here is not controversial.

3. Protect Americans' rights to a secret ballot: Don't listen to me, listen to Larry Summers. He is a highly respected economist who works for President Obama...

Another cause of long-term unemployment is unionization.

Again, strong support among economists that unemployment is positively correlated with the level of unionization. This solution is not to suggest that efforts be made to thwart the right to form a union. Not at all, but we understand from behavioral ecoconomics that people are not nearly as likely to voice their true and sincere preference if they must do so publicly. Don't we want a situation where voting reflects the true preferences of the people voting?

4. Invest in energy and transportation infrastructure:

Public spending is not anathema to economists who favor limited government. This is about providing the public physical capital that is conducive to economic growth in a situation where conditions exist so that the market, on its own, will tend to yield an inadequate supply. This is not contraversial. It is not about "shocking" the economy back to full-employment directly.

Later today I'll address the other solutions that Newt Gingrich is promoting.



Tuesday, February 10, 2009

Just lost an opportunity to "re-brand"

Republicans were right, based on political considerations, not to vote for the stimulus package. It was predicatble (especially since Rahm Emmanuel called attention to it) that Democrats would use the fiscal stimulus to promote their policy preferences - a crisis should not be wasted. Neither should the Republicans though have wasted the opportunity. No, they wouldn't have gotten anything passed but that's not the point. In the popular imagination the choice is between borrowing an enormous sum of money to stimulate the economy and doing nothing or perhaps cutting taxes. There was that $15,000 tax credit for new homebuyers. Hard to get charged up about something that would have distorted the market for housing just after such distortions led to a bubble in housing that led to the current downturn.

Instead the Republicans should have used the downturn to offer a comprehensive alternative. Having lost nearly all their credibility over the past decade with respect to the promotion of sound fiscal management this was an opportunity to begin to re-establish their identity. In 1994 the Contract with America served to provide clarity just before the mid-term elections that saw huge Republican gains. Some characterize it as having served to nationalize the congressional election. You didn't need to be a policy wonk or political junkie to look and ascertain what the Republicans stood for. The Contract made it easy.

Now Newt is back with 12 American Solutions jobs and prosperity. Of course the mere mention of Newt Gingrich causes many to scoff but there is just no denying that he is a brilliant communicator. You try getting elected in late seventies Georgia with a professorial demeanor and a name like Newt. Then go on to emerge as the leader of a demoralized party and become House Speaker.

And, what of the substance of the 12 American Solutions?

a. Reduce the payroll tax by 50% - That reduces the cost of hiring and puts more money in consumers' hands. Even though most government revenue comes from the income tax, more Americans pay more in payroll taxes then they do in income taxes.

b. More American Energy now - This has a short term component - get more oil and gas from our reserves - and a long term component - investing in alternative energy. That has broad appeal. Energy price spikes - like the one we recently experienced - are de-stabilizing.

c. Protect the right of American workers to have a secret ballot - The presence of unions tend to increase unemployment. We need look no further than the American automakers to see how unions have tended to kill the proverbial goose that lays the golden eggs. Even those who identify with unions tend to admit that having a secret ballot is a fundamental right.

d. Invest in energy and transportation infrastructure - Enhancing our electrical grid and improving our ability to move people and goods increases productivity.

Suppose citizens were faced with these choices in the current downturn, an enormous amount of deficit spending that includes such things as funding for the arts, a $15,000 tax credit for new homebuyers, or a comprehensive effort that includes adjustments to the tax code to stimulate hiring, a move to increase domestic energy production, and infrastructure investments where there is broad agreement with respect to enhancing productivity.

Monday, February 9, 2009

Preferred fiscal policy

I would institute an immediate and permanent reduction in the payroll tax, financed by a gradual, permanent, and substantial increase in the gasoline tax... Call it the create-jobs, save-the-environment, reduce-traffic-congestion, budget-neutral tax shift.

That's Greg Mankiw discussing his preferred fiscal policy. Payroll taxes are just like cigarette taxes. If you want more of something subsidize it. If you want less of something tax it. Payroll roll taxes drive a wedge into the labor market, creating a difference between what firms pay for labor and what workers receive.

Here is John Maynard Keynes writing in 1942...

I am converted to your proposal…for varying rates of contributions in good and bad times.
(June 16, 1942). Keynes, Collected Writings, vol. 27, p. 208.…[Y]ou are able to show fluctuations in income of an order of magnitude which is significant in the context… So far as employees are concerned, reductions in contributions are more likely to lead to increased expenditure as compared with saving than a reductionin income tax would, and are free from the objection to a reduction in income tax that the wealthier classes would benefit disproportionately. At the same time, the reduction to employers, operating as a mitigation of the costs of production, will come in particularly helpfully in bad times.


Translation: a lower payroll tax will decrease their cost of labor and stimulate hiring.

James Hamilton on the fiscal stimulus...

I do not accept the proposition that there is a level of government spending-- however large a number you choose to suggest-- that will prevent the unemployment rate from rising above 8%. But I do believe that if the government borrows a sufficiently large amount, we will have to worry in a very concrete way about what will sustain the foreign demand for U.S. assets.

Well rising above 8% is not that big of a deal. We're almost there now. We should expect some stimulus, some positive shock to GDP... if I borrow a couple truckloads of money I can enhance my well-being in the short term. In the longer term we should expect the fiscal stimulus to lower the rate of growth as interest rates rise. Even the CBO has said that. Of course we can print money - the Fed can monetize the debt. That will lead to inflation. If you're a homeowner that's not all bad of course. Inflation, rising prices and wages, reduces the real value of debt.

Friday, February 6, 2009

More questions than answers

Well this caught my eye this morning...

... Although my favorite part was when he mentioned a study where women "politely" asked men for no strings attached sex and they counted how many agreed. (Less than you would think.)

I have to believe there is a difference between the short-run and long-run equilibrium. In other words there is a shock effect that you have to consider in the short run. Men, not even blogging studs, aren't accustomed to being politely asked for no-strings attached sex. In the short-run then it isn't surprising that many men didn't bite. Over time though I think you'd find a different outcome. If men became accustomed to being asked to have no-strings attached sex then I think far more would be accomadating. Another way of putting this is to say that if women were just like men there would be mass copulation in the streets.

Another thing that interests me about this study was how things were handled when a guy did agree to have no strings attached sex. I bet the woman then responded with a, "well this is all just part of a study, thanks for participating. Have a good day." Such a response then would merely confirm men's understanding of how the world works - women don't tend to ask politely to have sex.

Still another thing that interests me is what the outcome would be if women demanded some sex or begged for it. What if they manipulated... in a soft voice... "I just don't feel wanted anymore, I feel so alone, I just wish someone would hold me." What if they began by offering to buy a guy a drink?

Thursday, February 5, 2009

Don't get it

I don't quite get it now but maybe I'll learn something. I'm talking about the Republican contribution to the stimulus package:

The Senate voted Wednesday night to give a tax break of up to $15,000 to homebuyers in hopes of revitalizing the housing industry, a victory for Republicans eager to leave their mark on a mammoth economic stimulus bill at the heart of President Barack Obama's recovery plan.

Gosh why didn't we think of this before? Well we kind of did. Creative (no or low money down) financing caused the bubble in housing prices. The bubble popped and there is evidence the market is working as it should - housing prices have fallen and pending sales of existing homes increased in December. Aggressive monetary policy has lowered mortgage interest rates. Why should fiscal policy - tax credit to homebuyers - be used to further distort the housing market?

I am not impressed with programs that imply that the macro economy can be managed via surgically precise strikes. Beyond the doubts of efficacy they tend to be inequitable. Why should new homebuyers (homesellers) get subsidized? Nothing is being produced, rather there is merely an exchange of property. Why not subsidize the renter (landlord)? Why not subsidize more comfortable digs for the homeless?

I don't have a doubt that a $15,000 tax credit will stimulate activity in the housing market as long as it is extended. If taxpayers are forced to subsidize cattle production we'll all eat more hamburgers.

Wednesday, February 4, 2009

On the recession, stimulus, politics, and adjusting perspective

New car sales are way down. Not a surprise. Sales of durable goods, goods expected to last three or more years are particularly sensitive to consumer confidence. Lost equity in homes and lower retirement accounts have made people poorer and they feel poorer. Interestingly sales of Hyundi and Suburu increased. However, the numbers suggest new car sales for the year to be about 10 million, similar to last year and down about 7 million from two years ago.

Existing home sales, or rather pending sales, jumped. That's what happens eventually when prices fall and the cost of borrowing money - mortgage rates - falls. From Bloomberg, via the City Paper...

Purchases of previously owned homes, which account for about 90 percent of the market, climbed 6.5 percent in December from the prior month as foreclosures helped drive median prices down 15 percent from a year earlier.

I know the Business and Economic Research Center at UT is forecasting an unemployment rate of near 10% in Tennessee by this time next year. Two things: Unemployment is a lagging indicator. In the last two recessions the unemployment rate peaked roughly 18 months after the onset of recovery. Part of that phenomenon is that people get back into the labor market - start looking for work - when firms start to hire. That increases the measured rate of unemployment. Second, macro economic forecasting exists, according to some, to make astrologers look respectable.

On the stimulus: Yes, it can increase GDP and lower unemployment. That doesn't mean, or shouldn't be taken that it is successful. Anytime you have idle resources you can increase GDP via deficit spending. You can pay people, on an hourly basis, to cut their lawns with a pair of scissors. Unemployment isn't the primary problem but rather the drop in income, savings, and investment; poverty and the prospect of poverty are what hurt both at the household level and the macro level. Alice Rivlin, Congressional Budget Office chief under Clinton, said some good things recently that have been promoted by center-right economists.

On transfers to states (a way to enable states to run deficits via the federal government):

Aiding states will prevent them from taking actions to balance their budgets--cutting spending and raising taxes--that will make the recession worse.

On transfers to people (that are superior to having people employed building something stupid):

Another important element of the anti-recession package should be substantial transfers to lower and middle income people, because they need the money and will spend it quickly.

On the tax cut side:

On the tax side, my favorite vehicle would be a payroll tax holiday, because payroll tax is paid by all workers and is far more significant than the income tax for people in the lower half of the income distribution.

Payroll taxes distort labor markets. That is they suppress employment.

On infrastructure that will enhance productivity:

The anti-recession package should be distinguished from longer-run investments needed to enhance the future growth and productivity of the economy.

In other words, in a rush to pass a stimulus we will sacrifice efficiency, get caught doing too many silly projects in the districts of powerful members of Congress. Pass "anti-recession" spending quickly and take your time on the roads, bridges, and public transport.

The timing of all this can be great for Obama politically. Getting elected president when he did is like getting the head coaching job at Temple University. Win a couple of games and you look great. Remember Ronald Reagan took over during a nasty recession and period of high inflation. God willing and the creek don't rise (longer and deeper recession than expected), what do you think will be the answer when Obama asks during the next cycle, "Are you better off than you were four years ago?"

On GDP generally, we should stop being so obsessed. It is an imperfect measure of one's quality of life. The most worthwhile things in life do not involve market transactions and therefore are not captured in GDP statistics.

Tuesday, February 3, 2009

That doesn't inspire hope

Karl Lang who was principal at Hillwood High until last year was just named principal at McGavock. The state removed/demoted him last year. The state also inserted a new principal at McGavock last year. WSMV-TV is reporting that violence at McGavock prompted new school's director Jesse Register to turn to Karl Lang to tighten up that ship. Lang's reputation is that he was responsible for getting things squared away at Hillwood.

I don't have direct experience to say definitively that getting Karl Lang back to running a school is a move in the right direction, but my sense is that he is a capable leader, competent to maintain order. Without a sense of order nothing much positive is going to happen at a school. So it is not the re-emergence of Karl Lang that doesn't inspire confidence but rather the situation that gave us this sort of musical chairs at Metro high schools. The state was making decisions (it would be nice to know who precisely got rid of Lang at Hillwood). That, expanded state authority, happened of course because Metro schools failed to achieve adequate yearly progress. The problem is that authority to make decisions moved in the wrong direction. The state got more authority and parents got less. A large part of the struggle to correct such perverted processes is that so many in positions of influence do not, or have not, send their kids to public schools. They, including many public school teachers and administrators, maintain control over their own education consumption decisions by virtue of their relative affluence. They, like many, opt out of the public system. They tend to lack confidence that those with lower incomes are as competent to make such decisions for themselves. And, even if they believe that parents are the best suited to make such decisions they lack the intensity required to push dramatic reform; inferior school environments don't have a direct impact on them. Yes, of course the teachers' lobby stands in the way of expanding parental choice but that is just the proximate cause of reform failures. Leaders who don't have kids in the public schools have no stomach for a fight against an entrenched and powerful lobby.

Monday, February 2, 2009

Rep. Jim Cooper impresses

Studying models

Temple Gandin, who is on the autistic spectrum and has been a consultant for animal handling systems, has some interesting things to say in her book, Animals Make Us Human: Creating the Best Life for Animals, including this:

Animal research is getting more and more what I call "abstractified." Instead of people studying the real animals in their natural habitats, researchers use fancy statistical software to construct statistical models, and then they study the models.

Economist Tyler Cowen suggests that financial economists might be able to take away something positive from considering such an observation.

Who is this?

Having run unsuccessfully for the Senate in 1994, he returned to the House in 2002. A mordant Cassandra ("If members of Congress were paid on commission to cut spending, we'd see fabulous results"), he is no longer astonished by Congress's bipartisan avoidance of the predictable crisis coming to the big three entitlement programs — Social Security, Medicare and Medicaid.

Why it is Dem. U.S. Rep. Jim Cooper featured in the latest George Will column. The column makes for some discouraging reading but Cooper is impressed with Obama's leadership. It struck me as well that Obama has mentioned the importance entitlement (Social Security, Medicare, Medicaid) reform. Now mentioning is not addressing and the president is otherwise engaged but mentioning is a first step.

This really impressed me from Cooper who was one of a handful of Democrats to vote against the stimulus package. He favors cutting the Social Security tax from 12.4% to 8%. Payroll taxes, as Cooper points out, suppress job creation. That is stimulus that has a direct impact on employment.

How markets work

Katie Porterfield has a very good piece in today's City Paper on how those in the real estate business are responding to the housing downturn. The private sector responds relatively quickly to changes in economic conditions. The median price of a home sold in the middle Tennessee area fell, from about $188,000 to $164,000, in 2008. Realtors are adjusting strategy, positioning themselves for a recovery, and some are leaving the business.

War is not good

Washington Post (via the Tennessean): In the United States, a move to greatly expand Buy American provisions as part of the $819 billion fiscal stimulus package has generated shock waves overseas, with Canadian and European officials in particular rising up in protest.

For all the points of disagreement, economists agree that at the onset of the Great Depression there were three policies that made things worse - cutting the money supply which raised interest rates, tax increases, and the Smoot-Hawley bill that increased tariffs and launched a global trade war. We've learned. The Fed has lowered interest rates and has signaled that they will stay low. We're not talking about raising taxes. Can Obama resist the protectionist tendencies that emerged in the House?

Friday, January 30, 2009

Will the fiscal stimulus work?

To channel Bill Clinton, that depends on what the meaning of the word work is.

Megan McArdle has a good analysis of the stimulus debate that also illustrates that you don't need mathmatical equations or graphs to engage substantive economic analysis... no need to get sophisticated when addessing fundamentals, like what does it mean to say the stimulus will "work." In short, an increase in GDP does not necessarily mean that the fiscal policy worked. Suppose, she offers, that we pay people to mow their own lawns. Then GDP increases but there is no increase in output. Neither does paying people to maintain their lawns make us more productive though it might help to cushion the impact felt by those who were (will be) laid off. Point: don't build roads to nowhere and everywhere just to get people employed. It would be better to simply transfer money to people or, as a second best option, to subsidize training or expand food stamp programs. Such transfers would increase GDP as well, via consumption, but that is secondary. Primarily it would be the state addressing questions of equity, trying to ease the pain of adjustment.

Sounds radical these days but it is a worthy question; should the government actively manage the economy? Economists are dueling over the efficacy of a fiscal stimulus and the range of expert opinion is great. Essentially those who are dubious of the power and wisdom of active fiscal policy are humble when it comes to understanding precisely the cause and the solution. Or, they, and I include myself in this group, see the solution as being beyond the reach of government. Perhaps one way to look at it is to say that a fiscal stimulus is an attempt to treat the symptoms of the recession - an attempt to stimulate consumption via borrowing when it was exactly that which contributed to the downturn. It would be better to focus on the things that led to the bubble in housing prices, better to stabilize prices, to prevent a deflation. The role of government should be to provide security, public goods, and to facilitate the smooth functioning of markets.

There is ample evidence that the market is working even as GDP contracts. Housing prices have fallen and will likely continue to fall to a point that is more in line with supply and demand fundamentals. Labor markets will clear eventually. In the short term there will be some pain and government can do something about that even as knee-jerk conservatives howl about re-distribution. They'd do better to howl at the arrogance of liberals who think that the government can manage an extraordinarily complex economy.

Thursday, January 29, 2009

The alternative to a massive fiscal stimulus

The Fed still has ammunition:

The news coming from these reports the Fed doesn’t mention the word deflation in the statement, but did highlight the prospect for inflation to persist below rates that best foster economic growth and price stability in the long-term. That’s central bank code for a period of deflation! … I believe there are some members of the FOMC that want to move slowly on the plan to buy long-term Treasuries, since in doing so the Fed is basically “monetizing” the debt, trading government IOUs for Federal Reserve IOUs, that could ultimately be destabilizing for the dollar and U.S. inflation down the road. –Scott A. Anderson, Wells Fargo

Scott Anderson is commenting on the Fed's recent Open Market Committee meeting.

Fed speak is interesting - inflation to persist below rates that best foster economics growth - is, as Anderson points out is code for deflation. The primary responsibility of the Fed is to maintain the stability of the currency. In the extreme inflation and deflation, a lack of currency stability, is de-stabilizing in general. Simply put, in periods of high inflation no one wants to hold money. It loses value quickly. At some point the currency fails. It no longer serves as a medium of exchange. With deflation you get the opposite. People prefer to hold onto their money. The value of money increases as prices fall. Money and short term T-bills, with interest rates near zero percent, become perfect substitutes. This "flight to safety" or risk-aversion inhibits economic growth as consumption falls and private sector borrowers are starved... have to pay significantly higher interest rates.

In short deflation is a big problem. The housing market has gone (is going) through a rapid correction. Prices have fallen. Equity has been lost and the impact on consumption followed. Inflation reduces the value of debt while deflation increases your debt load. Consider someone with an income of $40,000 who purchases a $100,000 house with a 10% down payment. If prices and wages double in the next ten years then the value of the homeowners mortgage debt falls. He or she is not doing badly - a house worth $200,000 and an income of $80,000 - even if there has been no real appreciation of the house and no real increase in income because the real value of his debt has fallen. If prices and wages fall, again so there is no real change - a $20,000 income buys what $40,000 did ten years ago, the homeowner is poorer because the real value of his mortgage debt has increased. In short, deflation has a greater negative impact than inflation when it comes to consumption.

What the Fed is considering, buying long-term debt, is a way to facilitate active fiscal policy via money creation instead of through borrowing. It will lower long-term interest rates in the short run. The downside to such accommodation or "monetization" of the debt is, as Anderson points out, inflation down the road. The current deflation, and its associated problems, suggests that it might be a risk worth taking.

Roughly this is focus of the current macro economic debate. On one side there are those who favor the very large fiscal stimulus, a level of deficit spending double that which we saw in the eighties and those who favor greater reliance on aggressive monetary policy - the Fed's ability to lower long-term interest rates via money creation. Given the options I'd go with the more aggressive monetary policy.

You got paid didn't you?

...Speaker Williams bent over backwards, made him a subcommittee chairman. He's tried to meet him halfway, and he's still trying to dig in and keep this thing festering."
That's Nashville Democratic Rep. Mike Turner complaining about Brian Kelsey's decision to pursue an ethics complaint against Speaker Kent Williams. Translation: Kelsey's been paid off sufficiently to keep his mouth shut. Mike Turner it seems is from the Rod Blogojevich school of politics where you make explicit arrangements and understandings that others handle on an implicit level.

Wednesday, January 28, 2009

Alice Rivlin, Bill Clinton's budget director, testified before the House Budget Committee yesterday. (via Marginal Revolution)

"Such a long-term investment program should not be put together hastily and lumped in with the anti-recession package. The elements of the investment program must be carefully planned and will not create many jobs right away," said Rivlin, a fellow at the Brookings Institution. The risk, she said, is that "money will be wasted because the investment elements were not carefully crafted."

I agree, but then what is fiscal stimulus? What is the difference between "long-term investment" and the "anti-recession" part of the package? Such clarity would help. Long-term investment should be focused on public infrastructure, things that will make us more productive and that the market won't provide or tends to under-provide. Perhaps this includes expanded broadband, improved electrical grid, faster trains, and computerizing medical records. It is hard to tell. At some level people have to make decisions based on cost-benefit analysis. Rivlin seems to be saying that political considerations ought to be minimized - worthy goal, hard to achieve.

The anti-recession component can be considered transfers, an attempt to soften the blow of the downturn on those laid off as well as to maintain consumption spending. This includes transfers to state governments.

The efficacy of active fiscal policy - Keynesian economics - remains in dispute. On the bright side there is evidence that markets are working. Falling housing prices, and an uptick in sales, demonstrate that the housing market is beginning to clear. Monetary policy which has driven down interest rates is helping.

In response to classical economists who insisted, still insist, that the economy is self-correcting, that in the long-run a shocked economy will return to full employment on its own, Keynes said, "in the long-run we're all dead." OK, but even Keynes began to realize in the early 1940's that fiscal policy has significant lags as well, that active fiscal policy does not shock an economy back to full-employment instantaneously.

Tuesday, January 27, 2009

Gentleman, Scholar, and Economic Stimulators

Apparently some local youths were doing their best to help the automotive sector, or at least the automotive repair sector, when they were arrested by Williamson County authorities. They were destroying property you see. It is like the boy Frederic Bastiat wrote about in 1850 who broke a shopkeeper's windonw. The townspeople saw how it, the vandalism, provided meaningful employment to the window repairer who in turn bought bread. This enabled the baker to buy shoes. It wasn't vandalism at all people started to see but good for the economy. It created work for people. It was an act of stimulus.
The fallacy of course is that the observers did not account for the cost to the shopkeeper. The cops in Williamson County did not overlook the damage done to private property, not to mention the potential for personal injury. Perhaps they read Bastiat.
There is plenty not to like about economic downturns but important to keep basic principles in mind when thinking about stimulus.

Monday, January 26, 2009

Roads, bridges, and condoms

Discussions regarding the efficacy of a fiscal stimulus among macro economists have been interesting. One disagreement is whether a tax cut stimulus is more potent than a spending stimulus. The current proposal has both. Everyone recognizes the problem of lags associated with increased government spending. There is always a recognition lag - we've been in a recession since December 2007, however that was only determined this past quarter. The fiscal stimulus package will be voted on in February and the vast majority of projects won't start for months after that. Will we be emerging from the recession just when the fiscal stimulus kicks in? Does fiscal policy exacerbate the business cycle? Read John Maynard Keynes, the father of active fiscal policy, in 1942...


“Overall, only $26 billion out of $274 billion in infrastructure spending
would be delivered into the economy by the Sept. 30 end of the budget year, just
7 percent. Just one in seven dollars of a huge $18.5 billion investment in
energy efficiency and renewable energy programs would be spent within a year and
a half.”

“Organized public works, at home and abroad, may be the right
cure for a chronic tendency to a deficiency of effective demand. But they are
not capable of sufficiently rapid organisation (and above all cannot be reversed
or undone at a later date), to be the most serviceable instrument for the
prevention of the trade cycle.”

Another disagreement centers on the size of the multiplier. How much does a dollar of government spending increase GDP? Team Obama is using 1.8, a dollar of spending will boost GDP by $1.80. Others say that the multiplier is less than 1, a situation where a boost in government spending crowds out investment and consumption spending.

All recognize, but some downplay, that the government is not very good with respect to allocating resources efficiently - prioritizing projects based on return. Ideally projects should be addressed that make us more productive. Spending for the sake of spending isn't the idea, paying some to dig ditches while others to fill in the ditches. That's re-distribution and can't be expected to boost GDP long term. Put another way, all expect pork to be part of any new spending. A colleague joked recently that everything is becoming infrastructure. The question is how bad will it be. Well thanks to Speaker Pelosi we are beginning to see. She argued to George Stephanopoulos that spending on birth control would stimulate the economy.

Now one might argue that reducing the birth rate is good for economic growth (see especially Thomas Malthus), though those who make toys, diapers, baby food, and baby clothes might disagree. No, this is social policy, part of what Rahm Emmanuel was talking about when saying that a crisis should not be "wasted."

Friday, January 23, 2009

Robert F. Kennedy on our obsession with economic growth

Apparently no objection to religious coalition's role

It’s not every day that Nashville’s business leaders rub elbows with progressive activists.
That's Amy Griffith Graydon in the City Paper on a piece about the coalition that beat back English First or English Only or whatever you want to call it. There was a religious leaders coalition organized against the measure. The Catholic bishop of Nashville, David Choby, was featured in an anti mailer. Do so-called progressives object when religious leaders organize to speak on policy matters generally or only when they disagree?

Economists are at odds over the efficacy of the proposed fiscal stimulus. Recent Nobel Prize winner Paul Krugman believes strongly in the potential of a spending stimulus. Other prominent economists are dubious. Tyler Cowen, who is a skeptic, speaks to the disagreement, and asks the fiscal enthusiasts... where's the beef? It is as close as the George Mason University economist gets to a rebuke and he isn't out of line. Cowen sees what I see. The anti-stimulus group is using historical data while the pro-stimulus side attacks the competence of those in opposition.

Speaking of the recession, read this paragraph from a Time cover story...

...The slump is the longest, if not the deepest, since the Great Depression. Traumatized by layoffs that have cost more than 1.2 million jobs during the slump, U.S. consumers have fallen into their deepest funk in years. "Never in my adult life have I heard more deep- seated feelings of concern," says Howard Allen, retired chairman of Southern California Edison. "Many, many business leaders share this lack of confidence and recognize that we are in real economic trouble." Says University of Michigan economist Paul McCracken: "This is more than just a recession in the conventional sense. What has happened has put the fear of God into people."

Try this one...

...The deeper tremors emanate from the kind of change that occurs only once every few decades. America is going through a historic transition from the heedless borrow-and-spend society of the 1980s to one that stresses savings and investment.

Interesting thing is that the story is dated, about the 1991 recession. GMU economist Alex Tabborek sets it up beautifully.

Two points: There is abundant evidence that markets are working. Housing starts are way down and housing prices are falling. Good, the inventory is too large. Homes are becoming more affordable for those who want to own. What we are seeing is called a correction. Of course it is bad for those of us who have realized a loss of equity but it is not "bad" in some absolute or metaphysical sense.

GDP does not measure, can not capture, much of what makes life good. It only measures the market value of things. Things that happen outside of markets, conventionally understood, are important but not easily quanitifiable.

"Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile. And it tells us everything about America except why we are proud that we are Americans."

That's Robert F. Kennedy in an eloquent critique of our obsession with GDP.

Thursday, January 22, 2009

Questions for the nominee who didn't pay taxes

It is said that being boring is an occupational hazard for economists, but...

President Obama supports the estate tax. Why should a person who leaves his money to his children pay more in taxes than another person with the same lifetime income who spends all his money on himself?

That's a question Greg Mankiw would ask Treasury secretary nominee Tim Geithner. Here's another he'd like to see asked...

The American tax code is so complex that even Treasury secretary nominees can easily make mistakes on their returns. Furthermore, while income tax rates are 10 percent to 35 percent for individuals and 35 percent for corporations, because of the proliferation of deductions, credits, exclusions and loopholes, the revenue from income tax amounts to only 10 percent of gross domestic product. Should you give priority to simplifying the code and enforcing compliance before raising rates?

If economists got to ask questions such hearings would be a heck of a lot more interesting.



All in

See President Obama's bet and raise him one

Mike Warren over at Vandy Right responded very eloquently to my post (and Tennessean op-ed) on hiking the gas tax in the state and offsetting it with a cut in the food tax. Warren is a junior at Vanderbilt and his writing and thinking is impressive. Worth the read for those interested in transportation. His point that having drivers subsidize public transit users is wealth re-distribution is particularly interesting to me. Nearly everything government does has an impact on the allocation of resources, tends to re-distribute. However, not all such efforts are primarily about trying to achieve greater equity in society. If drivers benefit (they do) when more people take the bus then there is an efficiency argument in favor of such re-distribution. In short there is no great difference in having drivers pay, via the gas tax, for roads or to make those roads less congested.

President Obama was right and that is where the opportunity lies for those on the center-right

As a tactical matter it would be wise for those of us on the center-right to adjust the rhetoric on re-distribution... from whether to how. Most people for example don't object to our practice and tradition of subsidizing education. All should object to how it is done. It is a matter of who gets to decide how to spend money, the ostensible beneficiaries or a centralized bureaucracy. We should respect the views of libertarians and members of Ron Paul's revolution when it comes to their philosophical opposition to any re-distribution for the sake of improving equity, but attract them by pointing to changes that would improve how we currently try to achieve that. It is more efficient to have a person spend someone else's dollar in an attempt to improve his lot in life than have some agency decide how to spend that dollar trying to improve the life of someone they don't know.

Such an adjustment in rhetoric - away from re-distribution as a philosophical matter and toward treating it as a practical matter - would attract many on the center-left. President Obama struck a chord by insisting that most people are not as concerened with the size of government as with whether or not it works. Most would agree with the center-right position though in thinking that it works better when people are free to make their own decisions.

Wednesday, January 21, 2009

The gas tax should help fund public transit

One of my favorite economists has a piece today in the Tennessean calling for a higher gas tax.

A gradual and predictable increase in the price of gas that also serves to stabilize the price is the only thing, short of a dramatic, and painful, disruption in supply that will liberate us from an unhealthy addiction. A phasing in of the tax will enable consumers to pursue greater fuel efficiency and local governments to improve mass-transit options with a stable source of funding.

A 500 word op-ed doesn't allow much with respect to presenting the argument for dedicated funding for mass transit. What many, especially on the right, fail to grasp in considerations of mass transit funding is that there are positive externalities (spillovers) involved. It is folly to insist that mass transit "pay for itself." On the contrary, profit maximizing pricing would reduce efficiency when it comes to public transit; does it make sense for a bus headed downtown to be only half full? Drivers benefit when more people take the bus just as surely as they benefit from well-maintained roads. Increased use of public transit reduces congestion making roads more efficient for those who use them. The business community benefits when employees have a reliable means to get to work as well as an increased flow of customers. A dedicated source of funding would help us a avoid the scenario recently experienced in Nashville and around the nation - transit authorities had to hike fares and cut routes as gas prices spiked.

My sense is that many on the right link public transit intiatives with collectivism while never having experienced the benefits to a community that a good transit system yields. Consider what Washington D.C. or Chicago, NYC, Boston, Philadelphia would look like without their transit infrastructure. They'd look more like L.A.

Beyond efficiency, there is also an equity argument in play. Not everyone can afford to buy a car. Lack of mobility poses a serious constraint on labor market opportunities. Conservatives should embrace enhancements that help people get to work.

Tuesday, January 20, 2009

Would you prefer a $100 in goods or $100 cash?

I am impressed with the plethora of opinions and perspectives among economists regarding the efficacy of positive fiscal policy shocks. Paul Krugman, the brilliant Nobel prize winner writes...
What’s been disturbing, however, is the parade of first-rate economists making totally non-serious arguments against fiscal expansion.
Krugman is uncharacteristically partisan for an economist and I think it hurts his credibility. Harvard economist Greg Mankiw notes the obvious - first-rate economists don't tend to offer non-serious arguments. There are simply many economists who are fiscal policy skeptics. I sense that ten years out there will be little clarity since a large part of the Obama fiscal stimulus will consist of tax cuts (credits). How much credit (blame) will a spending stimulus get compared to the tax cut stimulus?

Speaking of who spends the money, I heard Ben Cunningham speak last night along with Rep. Susan Lynn and Justin Owen of the Tennessee Center for Policy Research. Ben really impressed me - always refreshing when passion is combined with intelligence. He returned time and again to that which can unite the various flavors of conservatives, the question of who is better equipped to make decisions about how your money should be spent. Reasonable conservatives are not opposed to all government spending. They realize that there are public goods and that markets fail under certain conditions (typically when a business fails it is evidence that the market is working as it should). Even those who are not opposed to re-distribution in principle - Crunchy Cons come to mind - object when government dictates how money will be spent. Ask any reasonable person whether they'd rather be given $100 worth of merchandise, and in-kind transfer, or $100 cash. Why do we assume that lower-income people are not reasonable, would not prefer the cash-transfer? Cunningham used education to illustrate his point. Chelsea Clinton attended an expensive, private school. The Obama kids - an expensive, private school in Chicago and now in D.C. Phil Bredesen's son - an expensive, private school. Nashville Mayor Karl Dean's children - expensive, private schools. Yet each of these elected officials are dead set against education reform that would expand choice to those who can't afford to opt out of the public system. Why can't parents, poor and middle income, opt for a cash transfer in the form of a voucher and make their own decision with respect to education? Conservative reformers tend to focus on the school child while those who stand in the way are concerned with school systems, not that their own children are part of any school system.

In the recent Nashville magnet lottery a qualified child had roughly a one in four chance of getting a slot at an academic magnet school. But, it is not merely about getting one's kid into a high-powered school. There are myriad approaches and philosophies regarding education. It is a place where the market can work well, can provide options suited to varying tastes.

Friday, January 16, 2009

What is an oath?

AP: President-elect Barack Obama wants to conclude his inaugural oath with the words "so help me God," but a group of atheists is asking a federal judge to stop him.

This is the kind of stuff ignored by most but interesting in a way. Why take an oath at all? Herbert Hoover (a Quaker) didn't take an oath but rather took an affirmation. Mennonites too avoid swearing oaths...

James 5:12, "Above all, my brothers, do not swear—not by heaven or by earth or by anything else. Let your "Yes" be yes, and your "No," no, or you will be condemned."

The Catholic tradition interprets that passage to mean that Christ was admonishing his followers to be honest in their dealings so that they could be trusted, so they wouldn't have to swear oaths for minor things. An oath, according to this understanding, is calling God in as a witness in serious matters, a promise to act for the good of the public when failure to do so would have dramatic consequences, or a promise to tell the truth even when it might have an impact on someone you like. An oath places you under the pain of serious sin if you don't do what you promise. The "so help me God" part is an acknowledgement that what you promise to do is likely to be difficult. You know you'll need help.
Cops, soldiers, and judges take oaths.

Obama of course should be able to say "so help me God" if that's what he wants to say, if that's what he believes, that there is a God and he can help.

The Tennessee angle is interesting in the wake of what Kent Williams did and what his caucus had him sign - a pledge, a promise but not an oath. Some have made fun of such pledges or interpret them in the political realm as a sort of fascist tactic. I think they misunderstand. A pledge implies that the one asking for it takes this issue very seriously. They emerge as the result of NOT being able to trust another's word... implicitly, we don't trust Kent Williams' word therefore we'll ask him to take a pledge. There is no need to ask a trustworthy person to take a pledge.

The reaction to Monica-gate was noteworthy. Some scoffed that it was about sex while others saw that it was about perjury, lying under oath, a serious matter that weakens the foundation of society.

It would be easier to sympathize with those who mock oaths and pledges if, at the same time, they acknowledged that what Clinton and Kent Williams did tend to harm the public good. And, Democrats have no monopoly on dishonesty. Remember "read my lips?"