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My EconoSpeak colleague Brenda Rosser seems to more pessimistic than even Lawrence Summers as she argues that a $75 billion fiscal stimulus may not be enough. David Wessel also seems to think a fall in aggregate demand is likely:
That the economy needs help isn't at issue. The issue is whether to mix fiscal stimulus with monetary policy - whether the government should do something more than offer a little help to some struggling homeowners.
The policy mix to boost aggregate demand is indeed the hot topic of the day.
David starts with the usual reasons why we rely on a fast, nimble, and perhaps independent Central Bank and its monetary policy tools rather a sluggish and political Congress and its fiscal policy tools for aggregate demand management. David then makes a few arguments why monetary policy alone may not do the trick. One of these arguments strikes me as very odd:
The Fed can't cut rates because it fears a dollar crash. At the Fed, the gradual decline in the dollar is viewed as a tonic for the economy; it'll help boost exports, though it does exacerbate the central bank's inflation anxiety. But cutting rates too much too fast could trigger a market-rattling, confidence-shaking plunge in the dollar.
To David’s credit, he picks up on the fact that easy money will tend to raise net exports. But given our massive current account deficit, isn’t dollar devaluation on its own not only desirable but necessary?
Mark Thoma seems to have a preference for using changes in government spending over tax policy if we need to turn to fiscal policy for stabilization purposes:
If we are going to use tax cuts as a fiscal policy tool to stabilize the economy, we have to be willing to move the tax rate in both directions, up as well as down. We are quite willing, currently, to move the tax rate down but when people like Martin Feldstein call for a temporary tax cut to stimulate the economy, if such a policy were to be enacted does anyone doubt the difficulty of raising taxes again later even with automatic expiration provisions?
Then there is the view that all will be AOK:
Predicting the economy's path is especially difficult at turning points, and the economy is sending mixed signals. But here are some reasons why the economy might avoid the ditch
Sudeep Reedy offers up five reasons why a recession may be averted. One comes from a usual White House silliness that job growth is still terrific, while another comes from the dubious claim that the slump in residential investment is over. A third – and more plausible - argument is that net export demand will pick up some of the slack. The last two come from the belief that easier monetary policy and increases in government spending are already in the works. Real government purchases for 2007QIII, however, were only 2.7% higher than they were for 2006QIII so Reedy’s claim focused on the increase in state and local spending. Why not also focus on the even larger percentage increase in defense spending while one is at this game? Reedy failed to note the important fact that real nondefense Federal purchases haven declined over the past year. It would seem the new found GOP fiscal discipline campaign is working against using fiscal policy as a stabilization tool.
While tax cuts may be the popular stimulus method now, it was not so when JM Keynes devised fiscal stimulus. He preferred public works, as you may recall, and still the valid economic texts point out that public works, spending, is more efficient since it creates jobs directly rather than trusting people taking their tax cut to the store and then creating jobs.
ReplyDeleteThe question is now, what are we expecting tax cuts to do? A new housing surge? More consumer discretionaries? Is that really going to happen? If it does, will it really create a significant economic surge? Would we not be better off spending directly on the infrastructure, energy and green technologies we need to survive.
It seems to me, in the downturn, people will use tax cuts to stay in their homes longer or will attempt to save more against what is looking like a more and more shaky future. Neither of these will generate a significant stimulus.
I think aggregate demand stimulus via fiscal policy may be the wrong response to the very real threat of a recession. We are experiencing a sort of bubble sclerosis, and the trauma of the post-bubble Japanese economy should be a warning to us.
ReplyDeleteThe starting point, IMO, is recognition of the basic macro reality: we have an aggregate demand drain of 5% or so attributable to the trade deficit. This is offset by the inflows on the capital account that permit us to borrow in ways that restore the lost demand. But over time these flows have to generate asset price bubbles depending on what purchases they make. "Fiscal stimulus" under this circumstance becomes a way to recycle inflows to threatened asset markets by way of (thus far) less risky public debt.
But asset price inflation generates demand only by expansion -- simply supporting an existing price structure (preventing a deflation) doesn't do the job. This is why bubbles run out of steam. (I wonder about this pair of metaphors.) Hence the reference to Japan, whose bubbles were not, of course, attributable to the financing of trade deficits.
My suggestion is that we need to take drastic remedial action to wean ourselves from capital inflows. That 5% drag stemming from trade is an opportunity to generate a lot of employment. The problem is that we have let it go so long and have not taken even the first steps to implement an adequate response. We should have set up Plaza-type discussions years ago. If negotiated xrate adjustments are not feasible we should move fairly quickly toward marketable import permits, the only unilateral way to get the same relief.
Having vented, I can now backpeddle and admit that temporary fiscal measures to forestall debt deflation may be necessary -- but they should be seen as a transitional mechanism, not the primary solution.
Thanks for the mention colleague PGL.
ReplyDeleteI hadn't considered by response to Lawrence Summer's suggestion as pessimistic. I was trying to focus on what I saw as the actual problems being faced and how a mere injection of money could not possibly address what is in essence a 'systemic' or 'paradigmatic' problem.
I feel that this is the end of a particular industrial era. Something much more promising might/could be in the air.
Here's what I see: The modern industrial economy is suffering its death throws. It is now full of huge fiscal holes. For instance, if governments start injecting billions of dollars into markets in the usual ways then that money will drain right out of the economy shortly thereafter.
The money is travelling (not in a circular mode) but straight to those who already have plenty of it. For example, if a general tax cut results in people spending more in the shops then most of it will go into the consumption of goods made in China or India by large multinational corporations. It's not like the money will stay in the country of origin nor even circulate where it is spent.
The productivity of large multinational manufacturing firms who make those goods is now so great that very little labour is employed in the production of these goods. And what wage incomes do exist in the production process is pushed down by the smaller and smaller marginal productivity of labour and the corresponding lower return to the worker. So income generated from the retail sales of these goods doesn't even translate into decent levels of wages, whichever nation they are paid into.
National goverments around the globe are acting to ensure the continued one-directional flow of monetary wealth in the trading system. Making things far worse than they need to be.
That's because governments are now almost entirely composed of the representatives of vested interests of the financial, energy, electronics, weapons, mainstream media and communications industries. They want to maintain their privileged position.
They've tried to boost the inevitable failing markets with continuing credit expansion. Saturation debt levels have now been reached. Default ensues.
A similar breakdown is occuring on the level of the earth's biosphere. Saturation point for pollution and degradation and resource depletion.
The modern industrial economy has nowhere to go.
Ordinary citizens need to reengage in the production of goods and services locally. The mode of production must be environmentally and socially sustainable.
I don't think it is wise to wait for Government to realise how necessary and unavoidable this change is. (Plant food crops now!)
Brenda - it was Michael Phillips of the WSJ that suggested Summers was more pessimistic than most. I'm not so sure, however. I bet if one polled academic economists who teach macroeconomics, there would be a lot more pessimism among them than those business economists that the WSJ usually talks to.
ReplyDeletePeter seems to be suggesting we need some sort of full blown expenditure switching policy. While I think that's correct, I bet any particular proposal to boost net exports would find economists hotly debating the specifics.
It is an old truism of the textbooks, largely forgotten by many, but true nevertheless, that one gets a bigger stimulus bang for the buck from spending on real goods and services fiscal policy than from tax changes. So, gimme de 'ol public works programs!
ReplyDeleteBarkley
Barkley,
ReplyDeleteIf we accept that fiscal multiplier(s) from "de 'ol public works programs" are higher than those from tax cuts and that rate of inflation is rising, what changes, if any, would you expect to see in FRB policies should such programs be enacted?
Aside from that, with his state and local prescription, is Reddy considering consequences to local bond issuance should one or more of the big monoline insurers be downgraded.
pgl, It doesn't seem to be a good thing IMHO for any nation to become dependent on exports, no matter what their composition.
ReplyDeleteWhen Summers advocates tax cuts, by the way, is he also promoting a diminishment of the government's ability for public policy? Arent' the two things inseparable?
Barkley,
wouldn't most 'public works programs' raise government indebtedness and therefore affect the value of the national currency?
'Public works' would still need to deal with leakages from the national economy that arise because of debt, concentration of industry, inequality of income, freedom in the setting of unholy remuneration levels for management, etc.
And then the banks (and other financial institutions) have become centres of alarming levels of inflation. Corporations have become predators and liberal democracy has sold-out to the highest bidder.
In 1999 John Ralston Saul said: "Europe and the United States have agreed to coordinate against illegal cartels and against the dominant positions of the multi-national corporations, ..And on the 30th October [1999] ..the most important event of your lives took place..it was a statement from the Group of Seven in which they basically said .."we commit to develop and implement international principles and codes of best practice on fiscal policy, financial and monetary policy, corporate governance and accounting and to work to ensure private sector institutions comply with the new standards of disclosure..."
[John Ralston Saul, 'Democracy and Globalisation', 1999]
What happened??
Tax cuts financed by federal spending cuts would be patently contractionary, since it would be substituting private spending for public spending.
ReplyDeleteThe difference might be thought of as hiring somebody vs. giving small bonuses to a lot of people. In the first case, the somebody has a job, he spends across the board. In the second case a lot more people have a lot less money each and they spend more on discretionaries.
Leakages from public works IMHO is not a substantial problem, certainly much smaller than tax cuts. Plus, with public works, you have the public work when you're done. If it were mass transit or green energy or another substitute for imported oil, you would have an additional economic benefit.
Another sane, easy way to provide stimulus would be simply to bail out the states and local governments as their own property tax bases crumble. Since they don't have the luxury of deficit spending, they are going to cut, cut immediate services, and cut middle class jobs. Such a bail-out would be a counter-cyclical, temporary (until the states' tax revenues resume their current levels) measure. No great administrative problem.
Temporary tax cuts are problematic. Do they work in the first place? Can they really be trusted to be temporary?
Alan
ReplyDeleteI guess that the specific design of any public works program would important. Things like avoiding construction projects that rely heavily on imports.
But I can just see powerful corporate interests objecting to incursions on their turf. Whatever the economic enterprise they will probably demand a major cut in it.
A national industrial policy sounds good.
The battle against corporate dominance and rule will have to be fought no matter which path to recovery is taken.
Brenda,
ReplyDeleteSubstantially agree.
Perhaps the concern about imported inputs might be addressed by a domestic content stipulation.
Public works themselves would be carried out by private companies, contracted to the government, for the most part. It would not be an expansion of government in that sense. Public works are public also in the sense that they produce public goods, roads and rail and suchlike, which are very underappreciated for their contribution to the general economic well-being.
The major problem with public works is the same problem with cutting interest rates. There is a long lead time to implementation. Summers was right insofar as "timely, targeted and temporary."
A convenient remedy for this problem lies with the state and local governments who have projects underway that could be accelerated or on the shelf that could be implemented quickly.
Or as I said before, you could simply bail out the states and localities from their declining property tax revenue problems. After all, they are already providing public works. If they are forced to reduce operations, that will have a contractionary effect that will likely offset any sort of expansion from any federal stimulus. Such a bailout would be the definition of stability.
A
"..Public works themselves would be carried out by private companies.."
ReplyDeleteAlan, by 'public' I meant direct employment by government. Local government, more appropriately.
By 'local' I meant in our local municipalities. Not state for federal.
I'd like to see a 'public-private' type of enterprise. Defined as the diffusion of ownership of land and engagement in enterprise as being as widespread as is possible. Not concentrated into large businesses as it is now.
It appears that we are talking about different things.
It must be different in Australia. In the US there is no road, sewer, water main, rail line, public housing, or other such public works project that is actually constructed by employees of the government. They are all done under contract by private construction companies. A great source of corruption at times. There may be some wholly owned public utilities that do this sort of thing.
ReplyDeleteWhat you are talking about seems to be a government employment program such as we might use for trails or environmental work or to help teenagers in the summer.
While these are not out of the question, as I said, there are already municipalities employing people who will be fired soon if tax revenues decline who could simply and easily be retained by subsidies from the feds to those state and local jurisdictions.
So, yes, we are talking about different things.