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?"

Thursday, January 15, 2009

Is diversity desirable?

The greatest predictor of desertion in the Union army was socioeconomic and demographic diversity.
That's the subtitle of a recent book review of Heroes and Cowards: the social face of war in the Wall Street Journal. A husband and wife team of economists wrote the book and the review itself makes for compelling reading.
What do the numbers say?

The main finding of "Heroes and Cowards" is that companies composed of volunteers of similar age and occupation who were born in the same areas were the least likely to suffer desertion... Factors like age, marital status, pro-Lincoln support back home and whether the army was on a winning streak also made a measurable difference, but the most important predictor of desertion was socioeconomic and demographic diversity.
A good quote used by the reviewer: Ardant du Picq, a 19th- century French colonel and military theorist. "Four brave men who do not know each other will not dare to attack a lion. Four less brave, but knowing each other well, sure of their reliability and consequently of mutual aid, will attack resolutely."

It should be noted though that most deserters in the Union Army did not do so under fire. Considering battles in the Civil War (and other wars) stimulates conflicting thoughts regarding a coherent understanding of rational behavior. Is it cowardice to resist marching across a mile of open field into the teeth of Union Artillery (see Pickett's charge) while some young officer calls out "steady boys" after a shell takes out a couple of your buddies?

Also mortality in POW camps was a function of social cohesion. The interpretation is that POW's were more likely to render aide and support to those who were like them, people with whom they could identify. A sound interpretation, consistent with research that shows that support for social welfare programs increases with the degree of homogeneity in a society - we tend to identify more easily with those who are like us.

Would those who support a stronger social safety net be willing to trade off for less diversity (see Japan and Germany)?
Is it possible to overcome the negatives associated with superficial diversity, race and ethnic differences? The American experience is cause for optimism and hope.