Monday, December 1, 2008

Cost and Benefits from a Fiscal Stimulus: Baker, Krugman, and Even the FED Chairman Tend to Agree

Dean Baker says Greg Mankiw gets something slightly amiss in Greg’s praise of Keynesian economics:

Greg Mankiw must know better than he indicates in his analysis of debt in today's NYT. He complains that efforts to use large-scale stimulus to boost the economy may put excessive burdens on our children.

Dean’s accounting is a must read and makes sense if one accepts the fixed interest rate version of the Keynesian multiplier. Paul Krugman has a similar take and explains:

Right now there’s intense debate about how aggressive the United States government should be in its attempts to turn the economy around. Many economists, myself included, are calling for a very large fiscal expansion to keep the economy from going into free fall. Others, however, worry about the burden that large budget deficits will place on future generations. But the deficit worriers have it all wrong. Under current conditions, there’s no trade-off between what’s good in the short run and what’s good for the long run; strong fiscal expansion would actually enhance the economy’s long-run prospects. The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing “crowds out” private investment — that the government, by issuing lots of debt, drives up interest rates

Paul seems to think we are in a liquidity trap where monetary policy is powerless and fiscal policy’s potency is not offset by this crowding-out effect. Ben Bernarke appears to be saying similar things:

Federal Reserve Chairman Ben Bernanke said Monday that further interest-rate cuts are "certainly feasible," but he warned there are limits to how much such action would revive an economy likely to stay weak well into next year. The Fed's key interest rate now stands at 1 percent, a level seen only once before in the last half-century … "Although further reductions ... are certainly feasible, at this point the scope for using conventional interest rate policies to support the economy is obviously limited," Bernanke said in the speech. The Fed can lower its key rate only so far — to zero — and it's getting ever closer to that threshold. Bernanke said there are other ways that the Fed might bolster economic activity. The Fed, for instance, could buy longer-term Treasury or agency securities on the open market in substantial quantities, he said. This might lower rates on these securities, "thus helping to spur aggregate demand," Bernanke said. Given the limits to how low the Fed can go in reducing interest rates, the central bank over the past year has resorted to a flurry of other radical — and often unprecedented actions — with the hope of busting through credit jams and getting financial markets operating more normally.

This Federal Reserve deserves a lot of credit for doing what it can to alleviate the recession – but clearly it needs help from the fiscal side as well. Even Greg Mankiw agrees with this Keynesian premise. Let’s hope Congress goes along with the President-elect on this one.


Myrtle Blackwood said...

"...Many economists, myself included, are calling for a very large fiscal expansion to keep the economy from going into free fall.

Keeping in mind that the economy is a subset of the real world and most of the real world is the natural environment.

It is no longer appropriate - in this time of massive and very dangerous environmental destruction - to talk about unqualified economic expansion.

Anonymous said...

"The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing “crowds out” private investment — that the government, by issuing lots of debt, drives up interest rates..."

For whatever reason, private-sector interest rates are heading to the moon already - see the A2/P2 spread.

Anonymous said...

"It is no longer appropriate - in this time of massive and very dangerous environmental destruction - to talk about unqualified economic expansion."

Well said! Bravo!

Eleanor said...

Brenda --

Can't we put some -- or much -- of the money into conservation and clean energy? Bring back the CCC. Fund mass transit. Rebuild cities, so they are compact and dense.

Being from Minnesota, I also like the idea of repairing bridges.

But you are, of course, right that we are reaching the limits of growth as it has been traditionally practiced by capitalism. Creative destruction. Isn't that the term? How about -- as an alternative -- the creative restoration of nature and human societies?

ProGrowthLiberal said...

"For whatever reason, private-sector interest rates are heading to the moon already - see the A2/P2 spread."

Credit risk premiums are up but not risk-free interest rates.

donna said...

Read Storm Cunningham's "The Restoration Economy" for a good look at what we need to do environmentally, in terms of infrastructure, etc...

Myrtle Blackwood said...

Eleanor and Donna,
There are many who say that the limits to the contemporary capitalism paradigm have already been long passed. After all, climate change has happened. It can't be undone and according to many scientists in the field we are approaching yet another, more dangerous tipping point; where climate change can spin out of control and make many parts of the (now habital) earth unviable for human existence.

I can't see how the modern industrial economy can avoid a distrous ecological outcome. Can you?

Because we're not just dealing with 'climate change' but also sea acidification, overfishing of the oceans, corporate clearfelling/destruction of the world's biodiverse forests, epidemics of every disease known to man (and new ones emerging), depletion of ground water, widescale pollution. The latter can't be fixed overnight just by withdrawing the sources of contamination. There are tonnes and tonnes of nuclear waste dumped off the coast of Virginia that will remain leaching into the sea water for thousands of years, for example.

I think that the modern consumers needs to become a producer instead. communities will need to engage in local trading economies using local products produced in a sustainable fashion. Money needs to drawn away from purchasing plasma TV screens to investing in water tanks and fencing etc.

The modern corporations IS objecting to any government initiative that threatens their consumer base. they have significant pollitical power because they have successfully promulgated the 'ideology of consumption' onto populations.

This propaganda needs to be countered.

It has been said that children who play unsupervised in the wild before the age of 11 develop strong environmental ethics. I'll send my grandchildren out to play.

Anonymous said...

"Credit risk premiums are up but not risk-free interest rates."

And so - ? Surely you agree that, if the government were borrowing less, then the private-sector rates would be lower. That is, let the government interest rate be rg and the private-sector rate be rp. rp is currently much bigger than rg. But the government rate is near 0, so the government borrowing less will not have much impact on rg (it can't go much lower), but more money available for private-sector borrowing could have a much greater impact on rg (it would decrease more). Now, if you define (rp - rg) as the "risk premium", as I think you're doing, this would mean that the level of government borrowing, in conditions where the government rate is already near 0, impacts the risk premium (as I think you have defined it). And so more government borrowing means a higher risk premium, and less government borrowing means a lower risk premium.

That is, in the case of risk-free rates near 0, there's a fine line between increased risk premia and crowding out.

TheTrucker said...

The Fed is creating money at a very fast clip and that will supposedly make the value of money somewhat less. The supposed "fear of inflation" is what drives up the private sector rates. The 8 trillion bucks the Fed will be creating over the next 6 months will not cause horrendous inflation because the money is being injected at the top of the economy (given to the rich people who already have so much money they don't know what to do with it). Giving money to the rich increases wealth disparity and that is all it does. This is actually deflationary and a good way to create a depression.

What Keynesians seem to misunderstand is that money is not what it was in 1935. You'd think that the Fed creation of $8T would alert the, so called, "economists" to the fact that money has no cost. But they continue in the brain dead tunnel that says that the money is borrowed and must be repaid (gold standard) by the people. In the real world that $8T has been created through "the bank loan process" and it is a loan from the Fed to the rich people. The interest and dividends from that loan had better damned well be paid to the Treasury. Yes! The "financial Sector" will owe the US government $8T plus interest. And all of that interest, dividends, and other debt service other than the original money (as the loan is repaid the money is disappeared) should flow to the US Treasury. If the "financial sector" does not repay the loan then the Fed will own the "financial sector". It is like repossessing the car in the event the loan is not repaid. In some cases the Fed is simply buying the failed companies. That should be really cheap because they are bankrupt.

But what about that $700B for which the taxpayers are on the hook? That, boys and girls, should be a different matter. That money should be used in the bottom of the economy for stimulus (and it won't be). That money also will be given to the rich people and the common people will now owe them that actual value. The money is a maker. The labor and toil to own up to it comes later. And that is what is meant by passing the problem to our kids. The problem that justified the $700B does not really exist as witnessed by the $8T.

And what is missing in all this discussion is the tax side of the equation. It is missing because it is/was politically impossible. Obama said he was going to raise taxes on the wealthy and now he back pedals.

In all of this the taxation side of the flow is ignored and spurned. Money created and blown into the bottom of the economy through stimulus must be reclaimed through taxation or you will devalue the currency significantly. It is a question of degree. How much devaluation is desirable?

Let us consider taxing bads. Why are we not putting a $1 a gallon tax on gasolines and refunding that money to the people as a citizen's dividend. The Alaskans get a citizen's dividend for using up MY oil? (The "north slope" is the US commons and we bought the entire state from Russia. But I digress).

Why are we not shifting taxes from corporate incomes taxes to import duties. The corporations will pass the tax savings to the consumers (competition). Consumers who will pay more for the goods due to the tariff will be breaking even. Yet the attractiveness of producing the goods here as opposed to offshore will be increased. And the corporations will like it because the taxes are less. -- Jobs Jobs Jobs

Peter Dorman talked about a carbon tax to fund a citizen's dividend. He expressed it as some sort of carbon credit to allow certain amount of carbon to be puked into MY atmosphere. That is the right way to do it but it takes to long. It is too complicated. The pols will play footsie for years before it comes to fruition. The gasoline tax and rebate deal is pretty simple and it may be politically possible in this current environment. It is a stimulus package that is self funding. The same can be said for the tax SHIFT from corporate income taxes to import duties. And if that shift isn't politically possible then shift the tax from FICA to import duties (give an FICA tax cut while taxing imports).

Last but nor least is the tax on the rich that was promised by Obama and this tax should be levied. A tax on economic rent will have no adverse effect on the real economy.

The government must do more with fiscal policies.

Anonymous said...

Thanks, Donna for the kind recommendation regarding my 2002 book, The Restoration Economy. At the risk of indulging in flagrant self-promotion, might I mention that my latest book, reWealth (McGraw-Hill, 2008) contains advice that more specifically addresses economic and environmental renewal? The first book was about all the various types of projects and industries that are renewing our natural, built, and socioeconomic environments. The new one reveals proven ways of integrating all of these "re" activities to create revitalization.