David Wessel and Mark Thoma on The Summers Call for Fiscal Stimulus

Update: At the end of my post, I noted Sudeep Reddy’s argument that state and local fiscal policy will bail us out of this recession. If this claim struck you as odd, Menzie Chinn also found this to be odd as well.

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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.

CGE: Is There a Defense?

I’ve been asked to review an article using computable general equilibrium (CGE) methodology. I’m likely to decline, but before I do I want to ask the vast universe that follows this blog: is there any defense against the argument that CGE and its offspring (DSGE) are simply bad economics?



There are two arguments actually:

1. CGE is an attempt to implement empirically a model that has been blown away theoretically. For 30 years we have known in precise terms why representative agent GE models are hogwash. We also know that the conditions for unique solutions are impossibly restrictive. Finally, while we have models that can translate modern, post-utility understanding of economic behavior into functional form, to do this throughout an economy, in every nook and sector, would be a gargantuan, and probably pointless, project. To put it bluntly, CGE modelers take as their starting point refuted theory.

2. CGE is false empiricism. It claims to generate results based on real-world data, but testing is nil, and I mean nil. Is there any literature out there I have missed in which past models are examined retrospectively against actual economic outcomes? If not, where is the falsifiability?

I will wait to send my rejection email. Maybe one of you can convince me that it is worth a few hours of my time to promote “better” CGE work.

Further Thoughts on Populism, With Application to Criticisms of Edwards’ Fancy Digs

Inspired by Barkley, I have more to say about populism. In a nutshell, the word has multiple connotations, and political opinion-molders manipulate the ambiguities for their own purposes. Let’s disentangle and shed some light.



I think the Wikipedia entry is right in identifying “the people” in populist thought as counterposed to an elite that insults and oppresses them. But what do populists propose as the remedy?

Long ago, in an article for a journal with no web presence and therefore no linkability, I wrote that there are three ways that political movements can claim to be democratic. (1) They can claim that their leading members are “of the people”, that they can be trusted to represent the majority because, by birth and life circumstances, they are part of it. I called this agent-based publicness. (2) They can claim that their programs would benefit the interests of the majority. This is akin to the utilitarianism of mainstream economics, particularly if metrics, such as median income, are used to take distribution into account. I called this interest-based publicness. (3) They can promote programs or institutions that expand the direct role of the majority in deliberation and decision-making in the public sphere: transparency, participation, etc. I called this process-based publicness.

In my view, all three have a role to play, and all of them have blind spots that need to be recognized and offset. What interests me right now is not the question of what mix would be best in general or in the US in 2008, but how these different approaches are confused in our current political discourse.

First, all three can be expressions of populism if they are presented as solutions to the dispossession of the people by the elites.

And what do they look like today?

Agent-based populism: A candidate has a personal style, including a method of speaking, that shows he or she is “like us”. This could mean anything from avoiding complicated academic language to making references to pop music, to going to NASCAR races (OK, not in 2008 any more) or on hunting trips. It can also mean being multi-racial if “the people” are seen as multi-racial. It depends, obviously, on who “we” are. Mike Huckabee’s populism is, as far as I can tell, almost entirely of this sort. South of where I normally sit (in an office in the US), one of the chief populist claims for Hugo Chavez and Evo Morales is that they really understand the poor, nonwhite majority because this is their heritage too.

Interest-based populism: Every reader of this blog knows that America has reached new depths of economic inequality under Reagan-Bush-Clinton-Bush. An interest-based populist in this context should be someone like Edwards who campaigns on this reality and proposes policies on the grounds that they would reverse it. (Whether those policies are adequate to the job is another matter.) It is possible, however, for someone to argue that the true interests of the people are not economic but cultural, the preservation of their prejudices, taboos, etc. This opens the door to populists like George Wallace or, today, Lou Dobbs—to take an example from the media.

Process-based populism: I make a big deal of this possibility because I believe it has much more to offer than it is given credit for, but I have to admit that it is barely visible on the current political landscape. A candidate could take up this mantle by championing democratic social movements, unions and greater direct public participation in government. Civil liberties largely fall within this framework as well, as they provide the foundation for popular activism against the state. There is much discussion of how to expand the capacity and role of civil society elsewhere—in Latin America and the EU especially—but hardly any in the US. Kucinich gives us a small taste of this, when we can find him, and Obama (very) obliquely hints at it.

So this brings us to the use of “populism” as a pejorative, and specifically as it pertains to Edwards. Those who say he is a false populist because he enjoys an upscale lifestyle are relying on populism #1: he is not truly of the people. But he could live in bourgeois luxury of the most extreme sort and still deliver on populism #2. Think FDR.

A second critique of populism goes directly at #2, I believe. It is argued that the immediate interests of the downtrodden are in conflict with sound economic policy. The poor want handouts, but this would bludgeon the budget, wipe out incentives for investment, etc. By appealing too openly to the multitudes, someone like Edwards is seen as being at risk of becoming beholden to their short-sighted demands. Here the underlying presumption is that the poor have little understanding of their long-term interests and are prone to being bought off. Indeed, there is a cynical form of populism, much practiced in Latin America, in which a few highly publicized giveaways are used to win support, while fundamental policies continue to favor the rich.

My judgment, for now, is that Edwards is not guilty of this second sin.

What we mostly lack, I think, is the third dimension, empowerment. Is it accidental that it is historically linked to socialism?

The Payoff From Being Too Big to Fail?

The Wall Street Journal had an interesting piece suggesting that banks pay a premium for takeovers that bring their size up $100 billion. Maybe if the writeoffs get a bit bigger, Too Big To Fail status may pay off.

Two Federal Reserve economists, "Elijah Brewer III and Julapa Jagtiani, combed through 13 years of banking merger data to establish whether banks were willing to pay extra premiums to attain TBTF [Too Big To Fail] status, which they concluded was around $100 billion in assets."

"... the researchers found that premiums shot up when a bank did a deal that vaulted it over the $100 billion asset threshold. Overall, the nine banks that did such deals paid an additional $14 billion to $16.5 billion to get to that gold-plated TBTF status."

""It's more than Too Big To Fail. It includes all the benefits of being so big and powerful. These may not just be benefits from being bailed out, but being able to talk to the White House and Congress," Ms. Jagtiani said in an interview. "There is a lot of subsidy provided to really large banks," she added, noting that the study was the opinion of the authors and not the Federal Reserve. "It seems like we may be encouraging misallocation of resources." She did caution that "at the Federal Reserve, we don't have a list of Too Big To Fail banks"."

Cimilluca, Dana. 2007. "Can Banks Grow Too Big To Fail? Research Finds Lenders Would Pay More to Cross $100 Billion Threshold." (12 December): p. C 2.

http://online.wsj.com/article/SB119743338212123099.html

Who is a "Populist"?

In recent election cycles the term "populist" has been applied to such varied figures as John Edwards, Mike Huckabee, Patrick Buchanan, and Ross Perot, arguably sharing a sort of economic nationalism for the poor. Originating in anti-aristocratic agrarian movements in Europe, especially the Russian Narodniki of the late 1800s, the movement in the US attempted to encompass the urban working class as well, as symbolized by the rural Scarecrow marching along with the urban Tin Woodman on the Yellow Brick Road to defeat the Wicked Witch of the East, with populist heroine Dorothy and the Cowardly Lion stand-in for fundamentalist and anti-imperialist populist William Jennings Bryan, he of the "Cross of Gold" speech, in Baum's populist fantasy novel. The movement would be partly absorbed by the later Progressive and New Deal movements.

The movement has always had a deep divide, with race the central issue. So, on the one hand we have the progressive wing, symbolized by the remnant Democratic-Farmer-Labor Party of Minnesota and the presidential candidacy in 1948 of FDR's former Ag Secretary, Henry Wallace for the Progressive Party. On the other, in the Deep South, we got "Pitchfork" Ben Tillman in South Carolina, whose follower, Strom Thurmond, would run as the "Dixiecrat" in the 1948 presidential campaign. Today, this divide most clearly shows up in the struggle over immigration.

Summers: Increase Aggregate Demand Now

When Angrybear introduced me as a ProGrowthLiberal, he speculated that I tended to agree with Lawrence Summers on macroeconomic policy. So one might wonder if I agree with his latest:

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.

Green Gas Emissions, Risks and Uncertainty: When Kenneth Arrow Speaks – Just Listen

Kenneth Arrow explains the general issue thusly:

Two factors differentiate global climate change from other environmental problems. First, whereas most environmental insults – for example, water pollution, acid rain, or sulfur dioxide emissions – are mitigated promptly or in fairly short order when the source is cleaned up, emissions of CO2 and other trace gases remain in the atmosphere for centuries. So reducing emissions today is very valuable to humanity in the distant future. Second, the externality is truly global in scale, because greenhouse gases travel around the world in a few days. As a result, the nation-state and its subsidiaries, the typical loci for internalizing externalities, are limited in their remedial capacity. (However, since the United States contributes about 25% of the world’s CO2 emissions, its own policy could make a large difference.)

While Arrow notes that the critics of the Stern Report cite the role of uncertainty as their rational for taking no action, he fires back with his own analysis of the roles of uncertainty and risk.

There is greater disagreement about how much to discount the future simply because it is the future, even if future generations are no better off than us. Whereas the Stern Review follows a tradition among British economists and many philosophers against discounting for pure futurity, most economists take pure time preference as obvious. However, the case for intervention to keep CO2 levels within bounds (say, aiming to stabilize them at about 550 ppm) is sufficiently strong to be insensitive to this dispute. Consider some numbers from the Stern Review concerning the future benefits of preventing greenhouse gas concentrations from exceeding 550 ppm, as well as the costs of accomplishing this. The benefits are the avoided damages, including both market damages and non-market damages that account for health and ecological impacts. Following a “business as usual” policy, by 2200, the losses in GNP have an expected value of 13.8%, but with a degree of uncertainty that makes the expected loss equivalent to a certain loss of about 20%. Since the base rate of economic growth (before calculating the climate change effect) was taken to be 1.3% per year, a loss of 20% in the year 2200 amounts to reducing the annual growth rate to 1.2%. In other words, the benefit of mitigating greenhouse gas emissions can be represented as the increase in the annual growth rate from today to 2200 from 1.2% to 1.3%. As for the cost of stabilization, estimates in the Stern Review range from 3.4% of GNP to -3.9% (since saving energy reduces energy costs, the latter estimate is not as startling as it appears). Let’s assume that costs to prevent additional accumulation of CO2 (and equivalents) come to 1% of GNP every year forever, and, in accordance with a fair amount of empirical evidence, that the component of the discount rate attributable to the declining marginal utility of consumption is equal to twice the rate of growth of consumption. A straightforward calculation shows that mitigation is better than business as usual – that is, the present value of the benefits exceeds the present value of the costs – for any social rate of time preference less than 8.5%. No estimate of the pure rate of time preference, even by those who believe in relatively strong discounting of the future, has ever approached 8.5%.

History Note: Chico Plane Hijacked to Arkansas

My home, Chico, California, is not often seen as the center of the world, but we do have some distinctions. For example, the first airline hijacking on US soil occurred here. It may also be the only time that anyone ever hijacked a plane to Arkansas.

http://blogs.ocweekly.com/navelgazing/main/another-california-first-hijac/

Blood for Oil in Iraq Achieved! Now We Can Come Home!

Great news! As of this past week or so, for the first time oil production in Iraq has exceeded what it was under Saddam Hussein before the US invaded, a whopping 2.3 million
barrels per day!! For a country with the world's second largest oil reserves, this is a great achievement!!! Clearly, our goal there has been achieved, so now our troops can come home!!!

Radio Interview Today

I was interviewed today on KPFK Los Angles on Ian Masters' Background Briefing for the last 20 minutes of his show. I did not get to discuss the Confiscation of American Prosperity very much because the publisher neglected to send him a copy.

http://64.27.15.184/parchive/mp3/kpfk_071216_110100bbriefing.mp3

Transfer Pricing Enforcement in China- the IRS Should Be Paying Attention!

On my long list of statements from tax officials that strike me as incredibly short sighted comes this:

The China's State Administration of Taxation, emboldened by the Internal Revenue Service's result in the GlaxoSmithKline case, is directing its auditors in appropriate marketing intangibles cases to apply the residual profit split method to recompute royalty income.

The IRS was indeed very successful in arguing that some of the profits that British based Glaxo made on US sales of Zantac were attributable to the marketing efforts of Glaxo’s US subsidiary. But mind you that the tax planners for US based pharmaceutical companies with foreign marketing subsidiaries took notice of the IRS theory to successfully argue that some of the profits from US created drugs belonged offshore under arm’s length pricing. So if the Chinese are about to argue that distribution subsidiaries deserve a large share of the profits – wouldn’t this hold for US entities distributing products manufactured in China. Last year – the US exported only $55 billion of goods and services to China, while China sold almost $288 billion in goods in services to the US. Unless there existed no intangible profits from Chinese exports to the US and there were substantial intangible profits when US manufacturers sold goods to the Chinese, something tells me that China's State Administration of Taxation could come up with the short end of this stick.

It would seem that the Indian tax authorities successfully made a similar argument in a tax dispute with Rolls Royce. If this argument is turned on US based companies selling into India, let’s keep in mind that the India exports twice as much to the US as we export to them. With the US as a net importer of goods, any argument that the local distributor deserves a large slice of the profits is something the IRS should look forward to making in a bilateral way!

how does Mankiw's right differ from liberals and the left?

Wednesday, December 12, 2007 [by Greg "I worked for Dubya" Mankiw]

How do the right and left differ?

The conclusion of today's ec 10 lecture:

In today's lecture, I have discussed a number of reasons that right-leaning and left-leaning economists differ in their policy views, even though they share an intellectual framework for analysis. Here is a summary. [I replaced his asterisks with "GM," while my comments are labelled "JD."]

JD: first of all, I should note that Mankiw is only talking about one dimension of the political spectrum. I'd define left vs. right in terms of class, with the left siding with the poor and working classes and the right siding with Mankiw's employers. This left vs. right mostly coincides with democracy vs. dictatorship. There's also a centralized vs. decentralized spectrum, which is what Mankiw mostly describes. Finally, there's the tradition vs. modernism spectrum.

GM: The right sees large deadweight losses associated with taxation and, therefore, is worried about the growth of government as a share in the economy. The left sees smaller elasticities of supply and demand and, therefore, is less worried about the distortionary effect of taxes.

JD: Mankiw implicitly assumes that taxes "distort" markets, i.e., that the markets were "perfect" ahead of time. He assumes, for example, that no deadweight loss arises from the business sector. But even in the simplest neoclassical theory, it can do so: monopolies and monopsonies impose deadweight losses.

GM: The right sees externalities as an occasional market failure that calls for government intervention, but sees this as relatively rare exception to the general rule that markets lead to efficient allocations. The left sees externalities as more pervasive.

JD: This might be right, i.e. that the difference is empirically-based. But it should be mentioned that the right also likes to use methodological fiat to rule out the role of an important class of externalities, the pecuniary ones. They'd like to ignore such events as towns being destroyed economically when the major employer shuts down its operations, along with the Keynesian multiplier effect and the like.

GM: The right sees competition as a pervasive feature of the economy and market power as typically limited both in magnitude and duration. The left sees large corporations with substantial degrees of monopoly power that need to be checked by active antitrust policy.

JD: This defines the "left" as antitrust liberals. It ignores those of us who want to replace the capitalist monopoly on political power (unless we make a big noise) with real democracy, both in politics and in the economy.

GM: The right sees people as largely rational, doing the best the can given the constraints they face. The left sees people making systematic errors and believe that it is the government role’s to protect people from their own mistakes.

JD: The right's notion of "rationality" is close to tautological: rationality involves people doing what they want to do. Individual preferences are taken for granted and unexplained. A heroin addict is "rational" according to the right-wing economists. Further, "rationality" is totally an individual thing that can be expressed only in markets. This forgets the role of social values, which typically cannot be expressed through markets (no matter how rational they are) but can be expressed via democracy.

GM: The right sees government as a terribly inefficient mechanism for allocating resources, subject to special-interest politics at best and rampant corruption at worst. The left sees government as the main institution that can counterbalance the effects of the all-too-powerful marketplace.

JD: Again, this "left" is the liberals. It ignores the left which wants to end the artificial distinction between the state (government) and the "market" and to subordinate both of these to democracy.

GM: There is one last issue that divides the right and the left -- perhaps the most important one. That concerns the issue of income distribution. Is the market-based distribution of income fair or unfair, and if unfair, what should the government do about it? That is such a big topic that I will devote the entire next lecture to it.

JD: Is it a "market-based distribution of income"? Not according to the standard economics which Mankiw professes to profess. Standard neoclassical economics starts with the distribution of _assets_. Then the market results reflect that distribution (along with differences in preferences).

At this point, we should bring in non-standard economics: those with the most assets benefit most from the market. This allows them to accumulate more assets, so that they benefit even more from the market.

This kind of snowballing inequality of asset-ownership (and power) can be seen happening during the last 27 or so years of US economic history. This is now being admitted by mainstream economists. See the interview with Frank Levy in the current issue of CHALLENGE.

Jim Devine / "The conventional view serves to protect us from the painful job of thinking." -- John Kenneth Galbraith

Now that's a free ride!

It's that time of year again, time to make the donuts....er, grade final exams. I had a question on the Principles exam asking whether a tunafish entrepreneur - Charley "The Tuna" Sharkspear by name - who knew that consumers value safe dolphins more than the added cost of fishing in a dolphin-safe fashion could make money providing the dolphin-safe tuna. The idea I wanted them to get was that the safety of the dolphins, if accomplished, is a public good. From one student I learn that:

"People will continue to buy a cheaper tuna and still 'free-ride' on the dolphins that Charley is saving."

That sounds like fun. Back to work!

CNN Caught Mimicking Faux News with Iran Nuclear Weapons "Speculative Documentary"

CNN was to air today a "speculative documentary" entitled "We Were Warned - Iran Goes Nuclear" with actors playing real officials and hyperventilating on the now discredited non-data about Iran's nonexistent nuclear weapons program. The program has been postponed for now, given the recent NIE report. This shows how CNN has been under pressure to imitate the war hysteria of Faux News. An old friend of mine, who is quite progressive, was involved in helping make this, and had been bamboozled by briefings from unnamed national security officials. Details on this story are available from Bill Gallagher at http://www.niagarafallsreporter.com/gallagher344.html, and if this is not right, you can find it by linking through today's posting by Juan Cole.

Credit Crunch and Sudden Stop: Can We Avoid a Perfect Financial Storm?

Credit markets are all a-jitter again. No one knows how many assets will be nonperforming, which ones they will be, how much total value is at stake. We also know that there has a been a sudden stop, a complete cessation of net long-term private capital inflows to the US; nearly all of the financing burden of the US current account deficit has to be shouldered by central banks and sovereign wealth funds. These two events are related.



It is US debt, mortgage items but perhaps not only, whose quality is in doubt. This is why there is little appetite for such goodies among private investors. But if enough liquidity is pumped in to dissuade investors from wholesale dumping, and if the CB’s continue to do what it takes to keep the dollar afloat, we may continue to muddle through.

The risk is that the two dangers will interact. The Fed and its partners can support asset values by buying into these markets, as they have indicated they will. But if for any reason this effort falls short, it is possible that default risk and currency risk could spiral upward in tandem. Fear of default could push private capital flows into the red; this would ramp up the pressure on the dollar, increasing currency risk, and so on. It is not beyond the realm of the possible that this nasty synergy could erupt within the time frame of a few hours or even minutes. It would be sudden and unexpected: one morning you could go online to scan the headlines and find out we were already in the thick of it.

I’m not saying that a crisis is inevitable, but I’m not saying it can’t happen either.