Former Treasury Secretary Lawrence Summers, once a fiscal hawk among Clinton Democrats, said the government should consider a $50 billion to $75 billion tax-cut and spending package to stave off a deep recession. Mr. Summers, now a Harvard University professor and investment-fund manager, also urged the Federal Reserve to take more aggressive action to ensure that its rate cuts actually reduce consumers' interest charges and stimulate spending.
I’ve been calling for a more expansionary monetary policy for while, but I have also been calling for long-term fiscal restraint. So do I agree with Larry’s recent call for fiscal stimulus?
When it finally became evident to most economists that we were in the midst of a business investment led recession back in 2001, this Rubinesque Bear suggested that we have a redux of the 1993 Clinton fiscal philosophy – a little short-term fiscal stimulus with a commitment that we would gradually move to long-term fiscal restraint. The hope was that a mix of short-term interest rates – which the Greenspan FED gave us in spades – combined with an acceleration of public and private consumption but the promise of higher national savings in the out years might help reverse the investment and general aggregate demand slump. What we got from the Bush White House was very little in short-term fiscal stimulus and a virtual guarantee that we would have long-term fiscal irresponsibility. It has always been my view that this upside fiscal policy was one reason why long-term interest rates took much longer to decline and why the business investment slump lasted so long. Sure, residential investment rose back then – but that only partially offset the dismal performance of business investment - as well as the export slump.
Today, business investment is stronger but residential investment has plummeted. If Dr. Summers is dusting off the 1993 Clinton fiscal philosophy, which was also what Robert Rubin had convinced a few moderate Republican and Democratic Senators to advocate back in late 2001, then I agree with him 100 percent. And maybe this time – the President might also work towards passing the recommended policy package rather than undermining at every turn like he did six years ago.
Hat tip to Mark Thoma.
7 comments:
..When it finally became evident to most economists that we were in the midst of a business investment led recession back in 2001, this Rubinesque Bear suggested that we have a redux of the 1993 Clinton fiscal philosophy – a little short-term fiscal stimulus with a commitment that we would gradually move to long-term fiscal restraint...
I'm not sure what you are referring to here, ProGrowthLiberal?? The 'restraint' under Clinton certainly didn't exist in the financial industry or in financial regulation.
Here's a little history I've gathered of the US financial system under Clinton for those who don't know:
1994 – US small investor money riding on publicly-traded securities climbs from 46% in 1987 to 61%. However “much of the smart money is really riding on computer-generated, hypersophisticated financial instruments that use the public’s massive bet on securities to create a parallel universe of side bets and speculative mutations so vast that the underlying $14 trillion involved is more than three times the total value of all stocks traded on the New York Stock Exchange and twice the size of US GDP”.
DERIVATIVES. Pre-tax profits of US brokers and investment banks climbed to an unprecedented $8.9 billion in 1993 due to record sales of every financial product – derivatives, new stock and bond issues, merger financing. .. “Wall Street’s big winners have been firms that are leaders in designing and selling derivatives.”
“…a group of investment funds run by David Askin of Askin Capital Management was forced to liquidate its portfolio -- reportedly worth about $500 million. The funds speculated on the price difference between two different sets of mortgage-backed securities. When interest rates rose quickly, the speculative scheme fell apart.
1994 – New legislation in the US. Congress gave the US Fed the authority (and directed the Fed) to clamp down on dangerous and predatory lending practices. This included otherwise unregulated entities such as sub-prime mortgage origninators. But the Fed stonewalled and declined to use the legislation until 2007.....
I don't think it's a coincidence that President George Bush rehired all of the Clinton money and financial people in his administration.
Laurence Summers: "the government should consider a $50 billion to $75 billion tax-cut and spending package to stave off a deep recession."
I can't imagine how a tax cut is going to stave off a recession when we face:
(i) business and personal lending is shut down due to a lack of trust, regulation, solvency, integrity and transparency.
(ii) Critical shortages exist along with very high (and rising) prices for key resources.
(iii) Expectations for an unceasing consumer lifestyle and business-as-usual can no longer be met.
(iv) climate change and other sever e forms of environmental degradation threaten life on the planet.
This is not just another recession.
brenda - a $75 billion fiscal stimulus might indeed be insufficient to avoid a recession even with easier monetary policy. But then the claim that Summers is being more pessimistic than most seems to not be the case as you certainly are more pessimistic than he is.
Aren't we already having a fiscal stimulus due to the Iraq War supplemental? $200 billion a year largely being directed at the Military-Industrial Complex should be giving the economy all the boost it would need, to suggest we need to throw another $50-$70 billion on top of that seems kind of perverse. Geez next we will have Bush-niks arguing that the cost of the war is just the price we have to pay to maintain the domestic economy. I have a hard time believing that the biggest problem this country faces is the result of us taxing too much and spending too little.
For that matter it is not clear we are doomed for recession anyway, November numbers did not seem to me to support Bernanke's conclusion that GDP in Q4 was going to flatline. For that matter I'll withhold my views on the housing numbers for 2005 lest people think I was a nutter. At a minimum Summers is asking for too much too soon here, particularly since I suspect little to nothing of that $50-70 billion would end up trickling down to me.
Bruce, no doubt fiscal policy has been/is on the stimulative side but, in trying to recall difficulties, I'm only coming up with limited effectiveness due to leakage, negative consequences for internal and international account balances and potentially greater currency volatility. Likely there are more, (inability to effectively target; greater sectoral disproportionalities; exacerbated social inequalities...), and in our present situation, Sommers' suggestion seems more one of desperation.
The recession question is, IMO, already decided. Some will argue that employment growth has been/remains sufficient but this seems contradicted by BLS Business Employment Dynamics. Or, as Ritholz put it: 'The bottom line: New job creation has been mediocre, and wildly overstated... since changes made to measuring jobs in 2001.'
Some may argue that 'housing sector investment is only 5 perecent of GDP' [therefore we should not be concerned no matter that monetizing the inflation of that particular asset added trillions of dollars to aggregate demand, no matter that sectors are never so tightly bordered...]
Some may believe that the Chicago Fed's National Activity Index (CFNAI) three month moving average being negative for 15 consecutive months means nothing, no matter that this index reaches back into the mid-1960s and has exhibited good accuracy.
Some may accept that 3Q07 GDP really was not effected by a more than questionable deflator, heck, some might even believe that the financial system is in good shape and that the DJIA is the best indicator of all.
Most though know better.
With all due respect to EconoSpeak, the problem I have with this post is that it rests on 2 questionable assumptions: (1) that deficits increase interest rates (2) that increases in the interest rate have a signifigantly negative effect on investment.
In regards to the first point, I recommend James Galbraith's essay, "Breaking Out the Deficit Trap", who critiques a paper by two (liberal) deficit hawks, William Gale & Peter Ozrag. In regards to the second point, I recommend Stephen Fazzari's 1993 paper for the Levy Institute, which finds "that interest rates and the cost of capital play a small and uncertain role in the determination of investment when compared with the strength of firms’ financial condition and the growth of their sales."
Just to give an excerpt of Galbraith's critique of deficit hawks:
"That being so, one should ask: What if the short-term interest rate entered directly into the determination of the long-term interest rate? (It is clear from any casual examination of the data that the two series are strongly related, though not perfectly so.) Such a reformulation of the basics of interest rate determination would have two effects on the GO
argument. Theoretically, it would knock away any reason to believe in a connection running from deficits through the rate of national saving, the capital stock, and the marginal productivity of capital to the long-term interest rate. It would instead assert (again, with Keynes) that the principal force over long-term interest rates is the current and expected future path of short-term interest rates, variables entirely determined by interaction of Federal Reserve policy and the psychology of financial markets (inter alia,
liquidity preference). In that case, future deficits could affect long-term interest rates only for one reason: the belief, however irrational it may be, of financial market participants that they will have such an effect. In medicine,
this would be called a psychosomatic disorder."
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