Some people in the media are freaking out about the possibility of steadily and/or steeply falling prices, i.e., deflation. So I figured out what kind of deflation was currently being expected by those in financial markets.
I calculated the expected inflation rate implied by the difference between the rates on constant-maturity non-indexed 5-year government bonds and the inflation-indexed version of the same bonds. This number was steady at between 2 and 3 percent per year from 2003 to early July of 2008, which in general fits with the inflationary experience of the time. Then, there was a sudden fall. (What happened on July 2 or thereabouts?) As of November 20, it was –1.79%!! It's not just the media. The finance types are also freaking out.
Why is deflation a bad thing? Part of it is if people expect prices to fall, they delay purchases. Also, if prices are falling steadily, people don't want to borrow because the real value of their debts would rise. It's the opposite of the case of the inflationary 1970s, when people wanted to borrow a lot because the debts would lose value over time.
In looking at loans economists use the "real" interest rate, which is the nominal or money interest rate minus the expected inflation rate. Suppose I pay 4% interest on a loan. At the same time, inflation is barreling along at 2% per year and I expect it to do so in the future. That means the money I'm paying my loans back is losing 2 percent of its purchasing power each year. Thus, I subtract the inflation rate (2%) from the nominal rate (4%) to get the real rate, the interest rate in constant purchasing-power money (2%).
If the inflation rate that people expect goes from 2% per year to -2% and the interest rates appearing on loan agreements stays put at 4%, the real interest rate rises from 2% to 6%. And it's this rate that counts in determining decisions. The nominal rate can fall, of course, counteracting this. But it can't fall below 0. After that, increasing rates of deflation mean rising real rates.
Rising real rates make the recession worse by discouraging borrowing and spending. Recession then encourages further deflation. It can be a vicious circle.
It’s more than a matter of expectations. If people are locked into long-term loans with constant nominal interest rates and amortization rates on principal, and if nominal wages and salaries generally fall with prices, that means that debt service rises relative to wages due to deflation. If general enough, this phenomenon encourages bankruptcy.
Key to the last paragraph is the assumption that nominal wages and salaries fall with prices. A “true” deflation can be distinguished from a minor one by saying that in a true one, we see a wage/price spiral going downward. If wages and salaries don’t fall as quickly as prices, on the other hand, a mild deflation causes profit squeezes. Both are unpleasant in a capitalist economy.
--
Jim Devine
Monday, November 24, 2008
Tyler Cowen on Investment During the 1930’s
Tyler Cowen has been busy opining on macroeconomic policy during the 1930’s including a November 23rd NYTimes oped critiqued by Econoclast but let us turn attention to Tyler’s critique of what Brad DeLong had to contribute. While I am grateful that Tyler pointed out my graph of net investment, I’m puzzled by this:
Only in 1941 did net investment exceed its 1929 level. Here's a chart which seems consistent with these claims and which shows the difference between the net and the gross series for investment. The waves are very similar but at different absolute levels. Can any readers explain what is going on In this time period, using this data, is net or gross investment a better indicator of recovery and economic conditions? Is the pro-New Deal claim that making net investment "less negative" (but still negative) counts as a success or rather that the gross investment series is what matters?
Whether one uses gross investment as Brad did – or net investment as I did (given the George Will tirade) – the measured increase in investment demand was roughly the same. So Tyler’s first question seems silly from a Keynesian perspective, while the answer to his second question is YES.
One might be wondering why I choose to graph exports (EX) minus imports (IM) as a share of GDP (all series in real terms) for the more recent years in a post about net investment during the 1930’s, but this is by way of an analogy. We have had negative net exports (NX) for quite a long time but we are not shy about saying how an increase in export demand had been fueling economic recovery until recently. So I do not see anything odd about Brad showing us gross investment without including the depreciation chart.
Now if Tyler wants to lament that the capital stock fell during the 1930’s, he has a point but a very different point. Incidentally, the net financial wealth of the U.S. has also been eroding during this prolonged period of current account deficits.
Globalised banking 1944 - 1983
The following flow chart describing developments in the global banking and finance industry between 1944 and 1983 has been mostly compiled from information provided in Michael Moffitt's 1983 book 'The World's Money - International banking from Bretton Woods to the brink of insolvency'[1]. The common theme is clear; that the form of globalisation that has taken place over those decades has been largely determined by (mostly) western transnational corporations and with one overriding goal - worldwide profit maximisation.
Bretton woods (1944). -->The birth of the Eurodollar (1949) --> accelerating concentration of industry and banking --> American, Japanese and European corporations extend their global reach. --> the spectacular rise of the intracorporate (nonmarket) economy of the global oligopolies --> increasing intervention of government into the “private sector”--> A common tilt in investment and speculative decisions. US pressures European countries to restore convertibility of their currencies under the provisions of Bretton Woods (1958) --> Marked speculation in currencies begins with the re-emergence of hot money --> Development of the Euromarket (mid 1960s) --> a new generation of young bankers with the desire to go global. --> desire to build a global bank free of government regulation. US government prohibited interest on chequing accounts --> corporations and wealthy individuals transferred money out of these accounts and into financial products that earned interest (eg Treasury securities) --> banks forced to find new ways to attract corporate savings to stop the drain of funds --> negotiable certificates of deposits invented (CDs) by Walter Wriston of Citibank. --> banks bid competitively for corporate funds. --> the Euromarket undermines domestic monetary policy (1966). The 1973 oil shock [usury?] --> Petrodollar recycling 1973 --> bankers court the Saudis for deposits and conglomerate international banks try to drum up loan business from the 3rd world --> syndicated loans -->Growth of 3rd World debt --> Debt extended with eye to natural resources --> Interbank market--> Vast new opportunities to wheeler deal on a global scale --> Governments lose influence over events -->A regime of floating exchange rates is midwifed by massive speculation against the US dollar (1975)--> Despite the IMF the banks soon take over the business of lending to governments --> No way of recognizing a loss on a sovereign loan [Usury] -->European, Japanese and Arab banks take US share of global finance --> East-West Trade increased dramatically. Meaner terms are implemented on 3rd World loans [Usury]--> further debasement of credit standards in loans to 3rd World --> new forms of big business emerge in advisory role on loan reschedules to the 3rd World --> US Government bail out banks that made irresponsible loans to the 3rd World --> House of cards --> Global debt crisis now permanent. Usury in the form of extraordinarily high interest rates is institutionalized to preserve dollar hegemony (Volker, Oct 1979 ) --> IMF is now a supranational agency intervening in domestic politics --> Zero coupon bonds created by banks to avoid Government tax on interest. -->Economic and social disaster in poor countries (1983) --->
“…In the short run, the challenge of the global corporation concerns stability; in the long run, development. There has never been a time since the Great Depression when there has been more economic uncertainty around the world [1974]. But the corporate prospect of a world without borders offers something more distressing than uncertainty. It is a vision without ultimate hope for a majority of mankind. Our criterion for determining whether a social force is progressive is whether it is likely to benefit the bottom 60 percent of the population. Present and projected strategies of global corporations offer little hope for the problems of mass starvation, mass unemployment, and gross inequality. Indeed, the global corporation aggravates all these problems, because the social system it is helping to create violates three fundamental human needs: social balance, ecological balance, and psychological balance. These imbalances have always been present in our modern social system; concentration of economic power, antisocial uses of that power, and alienation have been tendencies of advanced capitalism. But the process of globalisation, interacting with and reinforcing the process of accelerating concentration, has brought us to a new stage…” [1]
[1]‘The World’s Money – International banking from Bretton Woods to the brink of insolvency’ by Michael Moffitt. Touchstone Book, Simon and Schuster New York. 1983. ISBN: 0-671-50596-3 Pbk.
[2]‘Global Reach – The power of the multinational corporations’ by Richard J Barnet & Ronald E Muller. Simon and Schuster1974. SBN 671-22104-3 Paperback. Page 364
Bretton woods (1944). -->The birth of the Eurodollar (1949) --> accelerating concentration of industry and banking --> American, Japanese and European corporations extend their global reach. --> the spectacular rise of the intracorporate (nonmarket) economy of the global oligopolies --> increasing intervention of government into the “private sector”--> A common tilt in investment and speculative decisions. US pressures European countries to restore convertibility of their currencies under the provisions of Bretton Woods (1958) --> Marked speculation in currencies begins with the re-emergence of hot money --> Development of the Euromarket (mid 1960s) --> a new generation of young bankers with the desire to go global. --> desire to build a global bank free of government regulation. US government prohibited interest on chequing accounts --> corporations and wealthy individuals transferred money out of these accounts and into financial products that earned interest (eg Treasury securities) --> banks forced to find new ways to attract corporate savings to stop the drain of funds --> negotiable certificates of deposits invented (CDs) by Walter Wriston of Citibank. --> banks bid competitively for corporate funds. --> the Euromarket undermines domestic monetary policy (1966). The 1973 oil shock [usury?] --> Petrodollar recycling 1973 --> bankers court the Saudis for deposits and conglomerate international banks try to drum up loan business from the 3rd world --> syndicated loans -->Growth of 3rd World debt --> Debt extended with eye to natural resources --> Interbank market--> Vast new opportunities to wheeler deal on a global scale --> Governments lose influence over events -->A regime of floating exchange rates is midwifed by massive speculation against the US dollar (1975)--> Despite the IMF the banks soon take over the business of lending to governments --> No way of recognizing a loss on a sovereign loan [Usury] -->European, Japanese and Arab banks take US share of global finance --> East-West Trade increased dramatically. Meaner terms are implemented on 3rd World loans [Usury]--> further debasement of credit standards in loans to 3rd World --> new forms of big business emerge in advisory role on loan reschedules to the 3rd World --> US Government bail out banks that made irresponsible loans to the 3rd World --> House of cards --> Global debt crisis now permanent. Usury in the form of extraordinarily high interest rates is institutionalized to preserve dollar hegemony (Volker, Oct 1979 ) --> IMF is now a supranational agency intervening in domestic politics --> Zero coupon bonds created by banks to avoid Government tax on interest. -->Economic and social disaster in poor countries (1983) --->
“…In the short run, the challenge of the global corporation concerns stability; in the long run, development. There has never been a time since the Great Depression when there has been more economic uncertainty around the world [1974]. But the corporate prospect of a world without borders offers something more distressing than uncertainty. It is a vision without ultimate hope for a majority of mankind. Our criterion for determining whether a social force is progressive is whether it is likely to benefit the bottom 60 percent of the population. Present and projected strategies of global corporations offer little hope for the problems of mass starvation, mass unemployment, and gross inequality. Indeed, the global corporation aggravates all these problems, because the social system it is helping to create violates three fundamental human needs: social balance, ecological balance, and psychological balance. These imbalances have always been present in our modern social system; concentration of economic power, antisocial uses of that power, and alienation have been tendencies of advanced capitalism. But the process of globalisation, interacting with and reinforcing the process of accelerating concentration, has brought us to a new stage…” [1]
[1]‘The World’s Money – International banking from Bretton Woods to the brink of insolvency’ by Michael Moffitt. Touchstone Book, Simon and Schuster New York. 1983. ISBN: 0-671-50596-3 Pbk.
[2]‘Global Reach – The power of the multinational corporations’ by Richard J Barnet & Ronald E Muller. Simon and Schuster1974. SBN 671-22104-3 Paperback. Page 364
Significant Stimulus ASAP
Jack Tapper reports some good news:
The story continues by noting that some Democratic officials argue that $500 billion might be too pricey and would invite a GOP filibuster. What – recessions are costless? My only complaint is that we can’t have this stimulus before Obama takes office. Then again - Gail Collins has an excellent idea:
Democratic sources tell ABC News that President-elect Obama's transition team is working with lawmakers on Capitol Hill so that on Obama's first day in office, Jan. 20, 2009, an economic stimulus package has passed both houses of Congress and is awaiting his signature … On Monday morning in Chicago, Obama will introduce key members of his economic team -- Geithner and soon-to-be National Economic Council director Larry Summers -- and will reiterate what he said in his Saturday weekly radio address: that he will push for a massive stimulus package proposal, one much larger than the $175 billion he proposed as a candidate, perhaps as high as $500 billion.
The story continues by noting that some Democratic officials argue that $500 billion might be too pricey and would invite a GOP filibuster. What – recessions are costless? My only complaint is that we can’t have this stimulus before Obama takes office. Then again - Gail Collins has an excellent idea:
Thanksgiving is next week, and President Bush could make it a really special holiday by resigning ... Putting Barack Obama in charge immediately isn’t impossible. Dick Cheney, obviously, would have to quit as well as Bush. In fact, just to be on the safe side, the vice president ought to turn in his resignation first. (We’re desperate, but not crazy.) Then House Speaker Nancy Pelosi would become president until Jan. 20. Obviously, she’d defer to her party’s incoming chief executive, and Barack Obama could begin governing. As a bonus, the Pelosi presidency would put a woman in the White House this year after all.
A Greenspan Moment for Summers
So Larry Summers will return to government in a key role on Obama’s economic team. It is said that he has a new outlook, less enamored of markets, more concerned with the fate of the bottom 90%. Fine. I’m all for a second chance, or a fifth or twelfth for that matter. I just want to see a Greenspan moment, with Larry facing the cameras and saying “I was wrong. Not just about a few small things or for a short time. I was wrong about the main thing, the idea that markets can be relied on to regulate the economy in the public interest, and I remained wrong throughout my earlier career in government. I cannot undo all the mistakes I made, but by acknowledging them I hope I can convince you I have learned from that experience, and that I will approach the crucial decisions before us with an open, humble and non-doctrinaire mind.”
I feel petty, oh so petty.
I feel petty, oh so petty.
On the Genealogy of Moralism
Once upon a time, the left (or most of it) thought they had history all figured out: they could interpret day-to-day politics in light of the tectonic shifts in social formations, and they had an endpoint to aim at, a model of an alternative, noncapitalist economic system. For some, this became an excuse for amoralism, the notion that the glorious revolutionary ends justified actions that would be morally repugnant by any other yardstick. The intellectual reflections of this amoralism, the writings on this topic by Trotsky, Merleau-Ponty, Fanon and the rest, are now seen as little more than an embarrassment.
Today the problem is more likely to be the reverse. Lacking a convincing view of history or the potential transformation of the existing order—in other words, lacking the basis for a systematic strategy—activists on the left are at risk of embracing an extreme moralism. If we don’t know how to change society, at least we can separate ourselves ethically: we can be the good people in an evil world.
So much political debate today has the unspoken premise, “How can I protect myself from being guilty?” Not in my name, they say, although the horrors are no less when some other name is invoked. Actually, wanting to not be guilty is a fine emotion, but it should be a springboard to effective, strategic action, not a politics of personal virtue.
Today the problem is more likely to be the reverse. Lacking a convincing view of history or the potential transformation of the existing order—in other words, lacking the basis for a systematic strategy—activists on the left are at risk of embracing an extreme moralism. If we don’t know how to change society, at least we can separate ourselves ethically: we can be the good people in an evil world.
So much political debate today has the unspoken premise, “How can I protect myself from being guilty?” Not in my name, they say, although the horrors are no less when some other name is invoked. Actually, wanting to not be guilty is a fine emotion, but it should be a springboard to effective, strategic action, not a politics of personal virtue.
Don’t Nationalize the Banks
In the latest issue of The Nation, Bill Greider expresses what has become the mantra of the left at this moment of high fiscal drama: nationalize the banks. Rather than just injecting passive capital, we are told to take a decisive position in common (voting) stock, so we can change the management, put our foot down on compensation, and generally change the whole modus operandi. It sounds very radical, harking back to the days when socialists saw nationalization of the commanding heights of the economy as the first step toward nationalization of the minor peaks, foothills and ultimately just about anything above sea level.
But it’s a bad idea. If you want the banks, you can have them. After the hammering they’ve taken in the market the last few months, their combined capitalization is a tiny fraction of the Fed’s new, gunky portfolio. And there’s a reason: they’ve got a solvency gap of trillions of dollars. Buy a bank and its liabilities are now yours. If you happen to be the US government, your full faith and credit is on the line for every penny.
There is nothing radical, not to mention equitable or practical, about underwriting the vast quantities of dubious financial instruments that metastasized during the past decade. You want a publicly owned and managed bank to lend against the tide and finance reconstruction? Start a new one.
But it’s a bad idea. If you want the banks, you can have them. After the hammering they’ve taken in the market the last few months, their combined capitalization is a tiny fraction of the Fed’s new, gunky portfolio. And there’s a reason: they’ve got a solvency gap of trillions of dollars. Buy a bank and its liabilities are now yours. If you happen to be the US government, your full faith and credit is on the line for every penny.
There is nothing radical, not to mention equitable or practical, about underwriting the vast quantities of dubious financial instruments that metastasized during the past decade. You want a publicly owned and managed bank to lend against the tide and finance reconstruction? Start a new one.
2.5. Million Jobs I
Today, I'm posting the first installment of a four-part serialization of an article from the 1962 AFL-CIO newsletter, The American Federationist. See also Unions, Unemployment and Shorter Hours.
From: AFL-CIO American Federationist | November 1962, pp. 19-21.
ECONOMIC TRENDS & Outlook
CREATING JOBS THROUGH SHORTER HOURS
From: AFL-CIO American Federationist | November 1962, pp. 19-21.
ECONOMIC TRENDS & Outlook
CREATING JOBS THROUGH SHORTER HOURS
Most opposition to the idea of attacking unemployment by shortening the workweek without loss of pay is based on the view that other policies are more efficient or otherwise more desirable ways of meeting the unemployment problem.
The case for shorter hours does not rest on the notion it is the best way. It is based rather on the view, supported by ample evidence in the past decade of mounting unemployment, that: (1) other economic measures to achieve full employment are not being applied and perhaps cannot be applied; and (2) even if other economic policies are successful in stimulating greater growth in the period ahead, the rate of advance in technology and other labor-displacing changes is gathering such momentum that, unless part of the gains in efficiency are distributed in reductions in hours, it is virtually inevitable that it will show up in persistent and increased unemployment.
Organized labor has not made shorter hours its first choice in the campaign against unemployment. Its first choice has been to apply its most vigorous efforts, all through the last decade, for a range of other public and private actions to stimulate a more rapid rate of economic growth. Shortening of hours has been discussed periodically but a major drive has been held off as a "last resort."
Unemployment has been mounting steadily and is threatening to increase further because of automation and other technological innovations and because of the increased rate of labor force expansion due in the mid-1960s as postwar babies enter the job market. The economic programs relied on thus far to expand economic growth and job opportunities have been inadequate. Additional programs discussed as preferable to shorter hours -- most notably tax reduction, reform of the tax structure, marked expansion in public investment and an eased monetary policy -- are not being put into effect. To oppose hours reduction on the ground that other approaches are sounder and then to fail to apply them is not an acceptable course of action.
Sunday, November 23, 2008
The 18-Hour Workweek
by the Sandwichman
What if, sixty years ago, we had collectively decided to take 1/2 of all future productivity gains as more and better goods and services and 1/2 as reduced hours of work? We would now be working full-time jobs of three days a week, six hours a day -- the 18-hour workweek. And we would have reached that point around 10 years ago.
Of course, my calculation assumes that everything else would have remained the same, which is unlikely. The reduction of working time would have stimulated more rapid technological innovation as well as direct productivity gains from a better rested, healthier, better-educated workforce. Furthermore, the limitation of growth of consumption could have led to a focus on wiser, less wasteful consumption.
What if, sixty years ago, we had collectively decided to take 1/2 of all future productivity gains as more and better goods and services and 1/2 as reduced hours of work? We would now be working full-time jobs of three days a week, six hours a day -- the 18-hour workweek. And we would have reached that point around 10 years ago.
Of course, my calculation assumes that everything else would have remained the same, which is unlikely. The reduction of working time would have stimulated more rapid technological innovation as well as direct productivity gains from a better rested, healthier, better-educated workforce. Furthermore, the limitation of growth of consumption could have led to a focus on wiser, less wasteful consumption.
A neo-Monetarist perspective on FDR
The conservatives chime in with their vision of the Great Depression and FDR's response. And I clash my cymbals in reesponse, as shown in bold-face. His headlines are in italics.
The New York Times / November 23, 2008
Economic View
The New Deal Didn't Always Work, Either
By TYLER COWEN
MANY people are looking back to the Great Depression and the New Deal for answers to our problems. But while we can learn important lessons from this period, they're not always the ones taught in school.
The traditional story [by whom?] is that President Franklin D. Roosevelt rescued capitalism by resorting to extensive government intervention; the truth is that Roosevelt changed course from year to year, trying a mix of policies, some good and some bad. It's worth sorting through this grab bag now, to evaluate whether any of these policies might be helpful.
If I were preparing a "New Deal crib sheet," I would start with the following lessons:
MONETARY POLICY IS KEY As Milton Friedman and Anna Jacobson Schwartz argued in a classic book, "A Monetary History of the United States," the single biggest cause of the Great Depression was that the Federal Reserve let the money supply fall by one-third, causing deflation. Furthermore, banks were allowed to fail, causing a credit crisis. Roosevelt's best policies were those designed to increase the money supply, get the banking system back on its feet and restore trust in financial institutions.
This is simplistic, to say the least: the adherence to the gold standard (until 1933) prevented the use of monetary policy to stimulate the economy, while banks opposed such policies. The dominant view of the monetary establishment at the time (the Fed's Board, including the Secretary of the Treasury, Andrew Mellon) was that the economy would recover automatically after purging imbalances from the economy. In other words, the Milton Friedmans and Tyler Cowens of that day did not want to use monetary policy. Nature would take its course, automatically solving the economy's problems. The gold standard was part of the solution, not part of the problem.
(These folks were "Austrian" in their temperament: the 1929-33 recession was simply punishment for the sins of over-expansion during the 1920s. Expiation was needed. Interestingly, there are a lot of so-called "Austrian" economists where Cowen teaches. I wonder it he's arguing against them.)
In addition, this story ignores the steep fall in fixed investment and exports in the 1930s, which could not have been counteracted easily: fixed investment is hard to stimulate when unused capacity and/or debt is large (and expectations are pessimistic), while exports are hard to encourage when there's a trade war going on.
Once deflation hits, expansionary monetary policy loses its usefulness. Nominal interest rates can't go below zero, while falling prices raise the real interest rate. When real interest rates (which are what counts in affecting the economy's path) rise, that encourages recession. BTW, this problem is currently on the horizon, cramping Bernanke's style.
MF and A.J. Schwartz's Big Book is totally descriptive, by the way. It's not very analytical at all. They really don't posit any understanding of how the money supply affects the economy or how the Fed controls the money supply. They don't look at the political economy of the era at all. (Along with Capitalism and Freedom, the book is worshiped by the Chicago-schoolers like Cowen. This fits the way that MF is seen as their prophet and the free market as their one true God.)
A study of the 1930s by Christina D. Romer, a professor at the University of California, Berkeley ("What Ended the Great Depression?," Journal of Economic History, 1992), confirmed that expansionary monetary policy was the key to the partial recovery of the 1930s. The worst years of the New Deal were 1937 and 1938, right after the Fed increased reserve requirements for banks, thereby curbing lending and moving the economy back to dangerous deflationary pressures.
The economy was also stimulated by government deficits at the time. It's a mistake to look for only one cause. However, Romer is a good economist, whose research shouldn't be rejected before reading it.
Today, expansionary monetary policy isn't so easy to put into effect, as we are seeing a shrinkage of credit and a contraction of the "shadow banking sector," as represented by forms of derivatives trading, hedge funds and other investments. So don't expect the benefits of monetary expansion to kick in right now, or even six months from now.
Still, the Fed needs to stand ready to prevent a downward spiral and to stimulate the economy once it's possible.
Gee, isn't it doing so already?? Where has Cowen been?
GET THE SMALL THINGS RIGHT It's not just monetary and fiscal policies that are important. Roosevelt instituted a disastrous legacy of agricultural subsidies and sought to cartelize industry, backed by force of law. Neither policy helped the economy recover.
It was Hoover who started the ag. subsidies, while if expansionary fiscal and monetary policy aren't being used (as they weren't), cartels and the like prevent deflation, which was a total disaster. Cowen wants to put all the weight on monetary policy, it seems. Cartels aren't pretty, but they may have been what more sophisticated economists than Cowen call "second best" solutions. That is, when real-world markets don't work as desired and are not likely to work well in the near future, adding non-market elements (what Cowen would call "imperfections") can actually be beneficial. This is well-known to economists outside of George Mason University.
I'm no fan of agricultural subsidies, but why are they "disastrous"? more disastrous than the Depression itself? They seem to be so horrible because Cowen is comaparing an imaginary Eden of the Perfect Market to the one sullied by the Snake of subsidies.
He [FDR] also took steps to strengthen unions and to keep real wages high. This helped workers who had jobs, but made it much harder for the unemployed to get back to work. One result was unemployment rates that remained high throughout the New Deal period.
This is silly! Serious macroeconomists know that the main factor determining employment in a depression is aggregate demand and the amount of production, not the wage. Suppose real wages fall, as Cowen recommends. Why would an employer hire more workers, if the extra output can't be sold??
In any event, falling wages make matters worse on the demand side, as Keynes pointed out. Among other things, falling wages cause deflation, which even Cowen admists is a bad thing, encouraging depression.
Today, President-elect Barack Obama faces pressures to make unionization easier, but such policies are likely to worsen the recession for many Americans.
That's Cowen's opinion; he's anti-union.
DON'T RAISE TAXES IN A SLUMP The New Deal's legacy of public works programs has given many people the impression that it was a time of expansionary fiscal policy, but that isn't quite right [as has been known for a very long time, i.e., since E. Cary Brown's path-breaking research]. Government spending went up considerably, but taxes rose, too. Under President Herbert Hoover and continuing with Roosevelt, the federal government increased income taxes, excise taxes, inheritance taxes, corporate income taxes, holding company taxes and "excess profits" taxes.
Right. We should note, however, that raising taxes and government spending at the same time can stimulate aggregate demand, as in the famous but Cowen-forgotten "balanced budget multiplier" theorem.
When all of these tax increases are taken into account, New Deal fiscal policy didn't do much to promote recovery. Today, a tax cut for the middle class is a good idea — and the case for repealing the Bush tax cuts for higher-income earners is weaker than it may have seemed a year or two ago.
Right. In fact, at this point it looks like Obama is not going to abolish the Bush rewards for being wealthy and well-connected. Instead, he's just going to let them lapse. If he abolished them (a good thing to do), the middle-class tax cut or (even better) working-class tax-cuts would have to be larger to counteract the depressive effects of immediate abolition.
WAR ISN'T THE WEAPON World War II did help the American economy, but the gains came in the early stages, when America was still just selling war-related goods to Europe and was not yet a combatant. The economic historian Robert Higgs, a senior fellow at the Independent Institute, has shown in his 2006 book, "Depression, War, and Cold War," just how much the war brought shortages and rationing of consumer goods.
Right. We knew that: WW II started before the US got in -- as did the stimulative effects on the US economy. Cowen seems to be eliding the fact that the shortages and rationing happened only when the war became a total war.
By the way, even if war wasn't "the weapon" back at the cusp of the 1940s does not mean that it can't be so now. We can learn from history, but when dealing with the present it's a mistake to rule out alternatives that didn't actually happen in the past. Cowen could just as well say that monetary policy "isn't the weapon" because it wasn't used successfully during the 1930s.
While overall economic output was rising [once it had been stimulated by military spending], and the military draft lowered unemployment, the war years were generally not prosperous ones. As for today, we shouldn't think that fighting a war is the way to restore economic health.
War does promote the demand side, which is what the US economy needed at the time (in the late 1930s). In the long run, I think that war and military spending are bad for supply side growth (i.e., for long-term trend of real GDP) because they are tremendously wasteful.
On the other hand, WW II and the early Cold War may be the exceptions. The working class was strong enough to win the GI Bill (partly because our rulers remembered the negative effects of soldiers being abandoned after WW I), which helped supply-side growth. That, plus Cold War related infrastructural investment and subsidies for housing, helped create the so-called "golden age" of the US economy. Also contributing, of course, was US dominance in the manufacturing, financial, and military realms.
YOU CAN'T TURN BAD TO GOOD The good New Deal policies, like constructing a basic social safety net, made sense on their own terms and would have been desirable in the boom years of the 1920s as well.
Now there's an irrelevant point! Was Cowen around back in the 1920s to convince Coolidge and Hoover of this point? Can he guess why they opposed a social safety net?
The bad policies made things worse. [well, duh! ] Today, that means we should restrict extraordinary measures to the financial sector as much as possible and resist the temptation to "do something" for its own sake.
I don't know who it is who is proposing to "do something" simply for its own sake. This seems the old ruse of seting up a scare-crow, just to knock it down.
In short, expansionary monetary policy and wartime orders from Europe, not the well-known policies of the New Deal, did the most to make the American economy climb out of the Depression. Our current downturn will end as well someday, and, as in the '30s, the recovery will probably come for reasons that have little to do with most policy initiatives. [That's Cowen's faith.]
Tyler Cowen is a professor of economics at George Mason University.
Copyright 2008 The New York Times Company
--
Jim Devine / "Nobody told me there'd be days like these / Strange days indeed -- most peculiar, mama." -- JL.
The New York Times / November 23, 2008
Economic View
The New Deal Didn't Always Work, Either
By TYLER COWEN
MANY people are looking back to the Great Depression and the New Deal for answers to our problems. But while we can learn important lessons from this period, they're not always the ones taught in school.
The traditional story [by whom?] is that President Franklin D. Roosevelt rescued capitalism by resorting to extensive government intervention; the truth is that Roosevelt changed course from year to year, trying a mix of policies, some good and some bad. It's worth sorting through this grab bag now, to evaluate whether any of these policies might be helpful.
If I were preparing a "New Deal crib sheet," I would start with the following lessons:
MONETARY POLICY IS KEY As Milton Friedman and Anna Jacobson Schwartz argued in a classic book, "A Monetary History of the United States," the single biggest cause of the Great Depression was that the Federal Reserve let the money supply fall by one-third, causing deflation. Furthermore, banks were allowed to fail, causing a credit crisis. Roosevelt's best policies were those designed to increase the money supply, get the banking system back on its feet and restore trust in financial institutions.
This is simplistic, to say the least: the adherence to the gold standard (until 1933) prevented the use of monetary policy to stimulate the economy, while banks opposed such policies. The dominant view of the monetary establishment at the time (the Fed's Board, including the Secretary of the Treasury, Andrew Mellon) was that the economy would recover automatically after purging imbalances from the economy. In other words, the Milton Friedmans and Tyler Cowens of that day did not want to use monetary policy. Nature would take its course, automatically solving the economy's problems. The gold standard was part of the solution, not part of the problem.
(These folks were "Austrian" in their temperament: the 1929-33 recession was simply punishment for the sins of over-expansion during the 1920s. Expiation was needed. Interestingly, there are a lot of so-called "Austrian" economists where Cowen teaches. I wonder it he's arguing against them.)
In addition, this story ignores the steep fall in fixed investment and exports in the 1930s, which could not have been counteracted easily: fixed investment is hard to stimulate when unused capacity and/or debt is large (and expectations are pessimistic), while exports are hard to encourage when there's a trade war going on.
Once deflation hits, expansionary monetary policy loses its usefulness. Nominal interest rates can't go below zero, while falling prices raise the real interest rate. When real interest rates (which are what counts in affecting the economy's path) rise, that encourages recession. BTW, this problem is currently on the horizon, cramping Bernanke's style.
MF and A.J. Schwartz's Big Book is totally descriptive, by the way. It's not very analytical at all. They really don't posit any understanding of how the money supply affects the economy or how the Fed controls the money supply. They don't look at the political economy of the era at all. (Along with Capitalism and Freedom, the book is worshiped by the Chicago-schoolers like Cowen. This fits the way that MF is seen as their prophet and the free market as their one true God.)
A study of the 1930s by Christina D. Romer, a professor at the University of California, Berkeley ("What Ended the Great Depression?," Journal of Economic History, 1992), confirmed that expansionary monetary policy was the key to the partial recovery of the 1930s. The worst years of the New Deal were 1937 and 1938, right after the Fed increased reserve requirements for banks, thereby curbing lending and moving the economy back to dangerous deflationary pressures.
The economy was also stimulated by government deficits at the time. It's a mistake to look for only one cause. However, Romer is a good economist, whose research shouldn't be rejected before reading it.
Today, expansionary monetary policy isn't so easy to put into effect, as we are seeing a shrinkage of credit and a contraction of the "shadow banking sector," as represented by forms of derivatives trading, hedge funds and other investments. So don't expect the benefits of monetary expansion to kick in right now, or even six months from now.
Still, the Fed needs to stand ready to prevent a downward spiral and to stimulate the economy once it's possible.
Gee, isn't it doing so already?? Where has Cowen been?
GET THE SMALL THINGS RIGHT It's not just monetary and fiscal policies that are important. Roosevelt instituted a disastrous legacy of agricultural subsidies and sought to cartelize industry, backed by force of law. Neither policy helped the economy recover.
It was Hoover who started the ag. subsidies, while if expansionary fiscal and monetary policy aren't being used (as they weren't), cartels and the like prevent deflation, which was a total disaster. Cowen wants to put all the weight on monetary policy, it seems. Cartels aren't pretty, but they may have been what more sophisticated economists than Cowen call "second best" solutions. That is, when real-world markets don't work as desired and are not likely to work well in the near future, adding non-market elements (what Cowen would call "imperfections") can actually be beneficial. This is well-known to economists outside of George Mason University.
I'm no fan of agricultural subsidies, but why are they "disastrous"? more disastrous than the Depression itself? They seem to be so horrible because Cowen is comaparing an imaginary Eden of the Perfect Market to the one sullied by the Snake of subsidies.
He [FDR] also took steps to strengthen unions and to keep real wages high. This helped workers who had jobs, but made it much harder for the unemployed to get back to work. One result was unemployment rates that remained high throughout the New Deal period.
This is silly! Serious macroeconomists know that the main factor determining employment in a depression is aggregate demand and the amount of production, not the wage. Suppose real wages fall, as Cowen recommends. Why would an employer hire more workers, if the extra output can't be sold??
In any event, falling wages make matters worse on the demand side, as Keynes pointed out. Among other things, falling wages cause deflation, which even Cowen admists is a bad thing, encouraging depression.
Today, President-elect Barack Obama faces pressures to make unionization easier, but such policies are likely to worsen the recession for many Americans.
That's Cowen's opinion; he's anti-union.
DON'T RAISE TAXES IN A SLUMP The New Deal's legacy of public works programs has given many people the impression that it was a time of expansionary fiscal policy, but that isn't quite right [as has been known for a very long time, i.e., since E. Cary Brown's path-breaking research]. Government spending went up considerably, but taxes rose, too. Under President Herbert Hoover and continuing with Roosevelt, the federal government increased income taxes, excise taxes, inheritance taxes, corporate income taxes, holding company taxes and "excess profits" taxes.
Right. We should note, however, that raising taxes and government spending at the same time can stimulate aggregate demand, as in the famous but Cowen-forgotten "balanced budget multiplier" theorem.
When all of these tax increases are taken into account, New Deal fiscal policy didn't do much to promote recovery. Today, a tax cut for the middle class is a good idea — and the case for repealing the Bush tax cuts for higher-income earners is weaker than it may have seemed a year or two ago.
Right. In fact, at this point it looks like Obama is not going to abolish the Bush rewards for being wealthy and well-connected. Instead, he's just going to let them lapse. If he abolished them (a good thing to do), the middle-class tax cut or (even better) working-class tax-cuts would have to be larger to counteract the depressive effects of immediate abolition.
WAR ISN'T THE WEAPON World War II did help the American economy, but the gains came in the early stages, when America was still just selling war-related goods to Europe and was not yet a combatant. The economic historian Robert Higgs, a senior fellow at the Independent Institute, has shown in his 2006 book, "Depression, War, and Cold War," just how much the war brought shortages and rationing of consumer goods.
Right. We knew that: WW II started before the US got in -- as did the stimulative effects on the US economy. Cowen seems to be eliding the fact that the shortages and rationing happened only when the war became a total war.
By the way, even if war wasn't "the weapon" back at the cusp of the 1940s does not mean that it can't be so now. We can learn from history, but when dealing with the present it's a mistake to rule out alternatives that didn't actually happen in the past. Cowen could just as well say that monetary policy "isn't the weapon" because it wasn't used successfully during the 1930s.
While overall economic output was rising [once it had been stimulated by military spending], and the military draft lowered unemployment, the war years were generally not prosperous ones. As for today, we shouldn't think that fighting a war is the way to restore economic health.
War does promote the demand side, which is what the US economy needed at the time (in the late 1930s). In the long run, I think that war and military spending are bad for supply side growth (i.e., for long-term trend of real GDP) because they are tremendously wasteful.
On the other hand, WW II and the early Cold War may be the exceptions. The working class was strong enough to win the GI Bill (partly because our rulers remembered the negative effects of soldiers being abandoned after WW I), which helped supply-side growth. That, plus Cold War related infrastructural investment and subsidies for housing, helped create the so-called "golden age" of the US economy. Also contributing, of course, was US dominance in the manufacturing, financial, and military realms.
YOU CAN'T TURN BAD TO GOOD The good New Deal policies, like constructing a basic social safety net, made sense on their own terms and would have been desirable in the boom years of the 1920s as well.
Now there's an irrelevant point! Was Cowen around back in the 1920s to convince Coolidge and Hoover of this point? Can he guess why they opposed a social safety net?
The bad policies made things worse. [well, duh! ] Today, that means we should restrict extraordinary measures to the financial sector as much as possible and resist the temptation to "do something" for its own sake.
I don't know who it is who is proposing to "do something" simply for its own sake. This seems the old ruse of seting up a scare-crow, just to knock it down.
In short, expansionary monetary policy and wartime orders from Europe, not the well-known policies of the New Deal, did the most to make the American economy climb out of the Depression. Our current downturn will end as well someday, and, as in the '30s, the recovery will probably come for reasons that have little to do with most policy initiatives. [That's Cowen's faith.]
Tyler Cowen is a professor of economics at George Mason University.
Copyright 2008 The New York Times Company
--
Jim Devine / "Nobody told me there'd be days like these / Strange days indeed -- most peculiar, mama." -- JL.
Saturday, November 22, 2008
Why a New New Deal is No Deal
by the Sandwichman
The New Deal came about, according to historian Benjamin Hunnicutt, because Roosevelt needed to "do something" to ward off the Black-Connery 30-hour bill.
UPDATE: The new New Deal stimulus spending bandwagon is getting ready to roll, with cheer leading from Paul Krugman, Robert Reich, Brad DeLong, Eric Rauchway. But this time around is it sustainable?
The New Deal came about, according to historian Benjamin Hunnicutt, because Roosevelt needed to "do something" to ward off the Black-Connery 30-hour bill.
UPDATE: The new New Deal stimulus spending bandwagon is getting ready to roll, with cheer leading from Paul Krugman, Robert Reich, Brad DeLong, Eric Rauchway. But this time around is it sustainable?
In a letter to Arthur Schlesinger dated April 9, 1958, Leon Keyserling stressed that Roosevelt came to Washington without a "systematic economic program." The "highly experimental, improvised and inconsistent" programs of the first New Deal defy categorization. They were the products of "schools of reformers" that had been promoting diverse programs that Roosevelt, higgledy-piggledy, picked up.
According to Keyserling, the PWA, CWA, NIRA, and the rest were not parts of any systematic plan or overall purpose. The only coherence given these events came from outside the administration. It was the "desire to get rid of the Black bill" that prompted the administration to draw up such things as the NRA, "to put in something to satisfy labor." This same point was made by other notables in Roosevelt's administration, among them Raymond Moley.
Throughout the depression, 30-hour legislation goaded Roosevelt to action. The Black-Connery bill, introduced in each depression Congress until passed in highly modified form as the Fair Labor Standards Act [FLSA] in 1938, with all the work-sharing teeth pulled, continued to function as a sort of reverse polestar, enabling Roosevelt to chart his course by the simple expedient of sailing in the opposite direction. Roosevelt's instinctive reaction against 30 hours matured to positive approaches to industrial stabilization and reemployment. They were built on work creation, not work spreading, founded on industrial growth and increased spending as the wellsprings of progress. In the process, he and his administration discarded the century-old notion that work reduction had the potential for social and individual advancement.
From the point of view of someone like Representative William Connery, who pushed for 30 hours from 1932 to 1937, the New Deal had a coherence, a reason for happening when and as it did, that was lost on others not so positioned. From Connery's perspective, the New Deal was what it was because of its opposition to 30 hours. -- Hunnicutt, Work Without End, pp.248-49
Another Greenspan Gem
Here Greenspan describes the new technologies that have revolutionized banks' "basic business ... to measure, manage, and accept risk ... permitting ... the unbundling of risks, improvements in the measurement of risk, and revamping of risk management process."
"There are some who would argue that the role of the bank supervisor is to minimize or even eliminate bank failure; but this view is mistaken in my judgment. The willingness to take risk is essential to the growth of the free market economy …. [i]f all savers and their financial intermediaries invested in only risk-free assets, the potential for business growth would never be realized."
Greenspan, Alan. 1994. The New Risk Management Tools in Banking: Address to the Garn Institute of Finance, University of Utah, November 30, 1994.
http://fraser.stlouisfed.org/historicaldocs/ag94/download/27991/Greenspan_19941130.pdf
"There are some who would argue that the role of the bank supervisor is to minimize or even eliminate bank failure; but this view is mistaken in my judgment. The willingness to take risk is essential to the growth of the free market economy …. [i]f all savers and their financial intermediaries invested in only risk-free assets, the potential for business growth would never be realized."
Greenspan, Alan. 1994. The New Risk Management Tools in Banking: Address to the Garn Institute of Finance, University of Utah, November 30, 1994.
http://fraser.stlouisfed.org/historicaldocs/ag94/download/27991/Greenspan_19941130.pdf
Why Only 2.5 Million New Jobs?
The good news is that Obama wants to push fiscal stimulus ala public investment, but this seems way too conservative:
With the employment-population ratio at 61.8% and population at 234.6 million, creating 2.5 million new jobs NOW would still leave the employment-population ratio below 63%. Over the next couple of years, we would new about 2.5 million new jobs just to be around a 62% employment-population ratio. I hope his goals for a recovery are more ambitious than this sounds.
American workers will rebuild the nation's roads and bridges, modernize its schools and create more sources of alternative energy, creating 2.5 million jobs by 2011, Obama said in the weekly Democratic address, posted on his Web site.
With the employment-population ratio at 61.8% and population at 234.6 million, creating 2.5 million new jobs NOW would still leave the employment-population ratio below 63%. Over the next couple of years, we would new about 2.5 million new jobs just to be around a 62% employment-population ratio. I hope his goals for a recovery are more ambitious than this sounds.
Healthcare Debate: So This is Why Conservatives Hate Social Security
Michael Cannon of Cato comes out against Obama’s health care plan – no surprise there. James Pethokouskis makes it explicit as to Cannon’s real concern:
As Hilzoy notes:
Truth be told – this is a major reason why conservatives want to undermine the Social Security program. Yes – they do try to tell us it’s some sort of Ponzi scheme, which of course, is just blatant dishonesty. But the real reason that they hate Social Security is that it is popular – as well as good policy from the perspective of those who care at least as much about the working class as the investor class.
Update: Steve Benen takes us back to late 1993 and the Kristol memo:
Kristol does belong to the wing of the Republican where good policy and good politics have been at war for years.
Passage would be a political gamechanger. Recently, I stumbled across this analysis of how nationalized healthcare in Great Britain affected the political environment there. As Norman Markowitz in Political Affairs, a journal of "Marxist thought," puts it: "After the Labor Party established the National Health Service after World War II, supposedly conservative workers and low-income people under religious and other influences who tended to support the Conservatives were much more likely to vote for the Labor Party when health care, social welfare, education and pro-working class policies were enacted by labor-supported governments."
As Hilzoy notes:
An honest conservative might accept this claim and say: well, I guess our ideas are unpopular, so we'll just have to make our case more persuasively. But that's not the conclusion they draw. Pethokoukis and Cannon say: because people will like health care reform, if we do not block it, our party will lose support. So precisely because people would like it if they tried it, we need to make sure that it fails. At least they're honest about it.
Truth be told – this is a major reason why conservatives want to undermine the Social Security program. Yes – they do try to tell us it’s some sort of Ponzi scheme, which of course, is just blatant dishonesty. But the real reason that they hate Social Security is that it is popular – as well as good policy from the perspective of those who care at least as much about the working class as the investor class.
Update: Steve Benen takes us back to late 1993 and the Kristol memo:
Leading conservative operative William Kristol privately circulates a strategy document to Republicans in Congress. Kristol writes that congressional Republicans should work to "kill" - not amend - the Clinton plan because it presents a real danger to the Republican future: Its passage will give the Democrats a lock on the crucial middle-class vote and revive the reputation of the party. Nearly a full year before Republicans will unite behind the "Contract With America," Kristol has provided the rationale and the steel for them to achieve their aims of winning control of Congress and becoming America's majority party. Killing health care will serve both ends. The timing of the memo dovetails with a growing private consensus among Republicans that all-out opposition to the Clinton plan is in their best political interest.
Kristol does belong to the wing of the Republican where good policy and good politics have been at war for years.
My Lecture on the Economic Crisis
I have posted my talk for the San Francisco Peace & Freedom Party on the economic crisis at
Subscribe to:
Posts (Atom)