Perverse Fiscal Policy

Assuming a picture is worth a thousand words, our graph is offered as an illustration of some wise words from Mark Thoma:

We need a temporary increase in government spending to increase demand and employment through, for example, building infrastructure. That would help to get us out of the deep hole we are in. Instead, the government seems to be trying to make it harder to escape. We do need to address our long-run budget problems once the economy is healthy enough to withstand the tax increases and program cuts that will be required. But the idea of "expansionary" austerity has failed.

Real government purchases fell by almost $30 billion (annualized) last year with $20 billion of this decline shockingly coming from Federal purchases. While it is true that state & local purchases have been declining since late 2007 with the cumulative decline exceeding $90 billion per year, we have also seen a significant decline in Federal purchases over the past year. We should add that Keynesian macroeconomists have always worried about the implications those state & local balanced budget requirements, which force this kind of perverse fiscal reaction to recessions. But as Barkley Rosser noted over at Mark’s blog:

Is it not the case that the main source of this outright decline in G is coming from the state and local levels with their balanced current budget rules, along with the ending of fed stim support for them? Of course, this suggests that the easiest way to offset this would be renewed support by the feds for the states and locals, but obviously this is unlikely to happen in the near future.

Federal revenue sharing should be increased but then the leaders of the Republican Party seem hell bent on balancing even the Federal budget during this Great Recession.

For Once The Military Is Right

Despite the title here I absolutely support civilian control of the military in democratically ruled countries. However, in both the US and Israel we have a weird situation where the military and the intel establishments are not only better informed and more aware of the implications of current serious policy issues than their civilian political superiors, along with their media abettors, but they are right. The issue is the Iranian nuclear program where the disconnect between not only what military intelligence knows (yes, I know, hahahaha, milintel is an oxymoron (decrepitly old joke), hahahaha), and what the public discourse in the media and the political debates and what the official policymakers are saying (including amazingly enough US Nat Sec Advisor Thomas Donilon earlier this evening on Charlie Rose) are totally out disconnected.

The media reports on this recently have become blatant, and I apologize for not providing relevant links. But, last week WaPo and NYTimes reported on how Israeli milintel were saying Iran was not pursuing a nuclear weapons program currently. Then today the NYT was a mass of conflicting stories with the ones from top Israeli governmental leadership (somewhat backed up by NSC director Donilon on Charlie Rose) arguing that Iran is indeed pursuing nukes and when or how will either Israel or the US just bomb the heck out of them blah blah blah to stop it, despite the contrary claims of their respective military intel establishments.

Sorry folks, but the people who will have to do this, either the Israeli or US military, are not all that excited about this (much less convinced by the official reports that go against their offical intel assessments, see US NIE reports). Their leaders know what is not acknowledged by President Obama in his SOTU, or Natenyahu in his public statements, or certainly not by the GOP prez candidates (with the exception of Ron Paul), that in fact Iran is not actively or currently pursuing obtaining nuclear weapons. All the war whooping and hawkishness by the political leaders and their pathetic rivals and related media and much of the public is ignorant and stupid and worthless. But, they cannot speak up publically on this matter. Let us hope that we shall muddle through this without yet another worthless new war.

It’s a Bruegal World

I just returned from seeing “The Mill and the Cross”, the remarkable remake of The Way to Calvary by Pieter Bruegal the Elder.  Some quick reactions:

1. If you were an art history major you will have multiple orgasms.  Guaranteed.

2. Even if you weren’t, if your eyes are open you will be enchanted by images that occupy a gray zone between painting and live-action film.

3. The pace is extremely slow, which works if you allow yourself to be hypnotized.  Don’t go to see it on an empty stomach.

4. The crucifixion thing is overdone, even after allowing for the fact that Bruegel overdoes it too.

5. The scene with the crows eating a dead guy’s eyeballs is really gross.

6. The people in this window on 16th century Flanders are much too clean and healthy.  This is not only a distracting anachronism, it also distances us from the world we see in Bruegal’s paintings.

7. You can see why the Dutch fought so intensely to free themselves of Spanish rule.

8. If the movie doesn’t grab you, you will find it to be a mashup of Masterpiece Theater and Bread and Puppet, except that a rich banker would never be a good guy in a Bread and Puppet production.

9. This film is auteur theory on steroids: Lech Majewski not only directed it, he did camera work, art design and the musical score.  If you don’t like it, you know who to blame.

10. How do people do those slow, gently hopping dances that Bruegal paints so well?  Can we start a new craze?

The Blade’s Response to the State of the Union Address

The transcript of what Indiana Governor Mitch Daniels said can be found here. When the Blade claims Obama’s policies were pro-poverty, what he seems to be saying that in the face of insufficient aggregate demand, the right policy should have been austerity - cutting government spending. Talk about Herbert Hoover economics!

Governor Daniels also expressed concerns about the size of the Federal deficit. Folks give this governor too much credit for the fiscal shape of Indiana, which they assert has been dramatically improved by his policies. Lest we forget, however, that a source of revenues for Indiana was the one time sale of toll rights to the private sector. Sacrificing future toll revenues to collect cash that has a lower present value is not a long-term solution to a government’s fiscal follies.

Of course, we get this rhetoric:

There is a second item on our national must-do list: we must unite to save the safety net. Medicare and Social Security have served us well, and that must continue. But after half and three quarters of a century respectively, it’s not surprising that they need some repairs.

By repairs – does he mean the Paul Ryan plan to effectively eliminate Medicare?

Finally, we get this canard:

Contrary to the President’s constant disparagement of people in business, it’s one of the noblest of human pursuits. The late Steve Jobs - what a fitting name he had - created more of them than all those stimulus dollars the President borrowed and blew.

Rebuttal outsourced to Paul Krugman.

The Radical Right in the US and Europe

Today’s mandatory reading is a news report from the New York Times about a film shown in NYPD training sessions entitled “The Third Jihad”. You should read the whole thing, but here is the CliffNotes version:

1. The feature-length film portrays the entire Muslim world as engaged in a nefarious, secret plot to destroy non-Muslim institutions and achieve global domination.

2. It was shown to about fifteen hundred NYPD officers across all ranks as part of their routine training.

3. It was produced by an organization called the Clarion Fund, which has financial links to gambling tycoon Sheldon Adelson.

4. Adelson is also the principal funder of the super PAC whose support of Newt Gingrich has propelled him to the front of the GOP presidential pack.

Put the pieces together, and what you see is a glimpse of the extreme, xenophobic right, American-style. It is our answer to groups like the National Democratic Party in Germany, Finland’s True Finns, the Austrian Freedom Party, the Danish People’s Party, Hungary’s Jobbik, France's National Front and so on. They share an authoritarian traditionalism in culture, paranoia about immigration (especially from Muslim regions) and a profound hatred of secularism and the left.  The link between xenophobia and authoritarianism is the view, fundamental to fascism, that the “true” members of the nation have a common interest that can only be undermined by the give and take of democratic politics.

The European extremists are forced to organize their own factions, since the political mainstream, including the established conservative parties, see them as echoes of a fascism their societies had actually experienced and would like to see buried forever. This consensus does not exist in the US, and proto-fascist groups can operate freely within the Republic Party. There is a possibility that one of their anointed candidates will be elected president this fall.

Incidentally, this is not about Gringrich personally. Everything in his prior public career and private life tells us he is an opportunist, and he is simply seizing the opportunities that present themselves at the moment. Nor should we assume that his backers are the only financiers of xenophobic authoritarianism; Adelson is simply the one who shows up in this specific instance.

As an American who spends a lot of time in Europe, I am troubled by the laws against racist and fascist propaganda; I worry about the slippery slope that leads to criminalization of unpopular political expression. Maybe I should be worried about the opposite too—the view that all varieties of politics are equally legitimate, that there are no hard lines that respectable political figures cannot cross.

Is the Oil Price Scare From The Strait Of Hormuz Over?

Maybe not, but there is good reason to think that maybe it is over, even though US gasoline prices were still rising over this past weekend. But that is probaby just the pass-through of the earlier spikes in crude prices due to the scare arising from Iran's threat to close the Strait of Hormuz, which it is capable of doing, if the US follows through on its newest economic sanctions, which it appears to be doing. In the longer run higher oil prices would be useful for getting us onto a more sustainable energy path, but in the short run they certainly do not help get the world economy out of its prolonged slump of recent years. I see two signs here.

The first was the report last Wednesday that Israeli Defense Secretary Ehud Barak has announced that Israeli military intelligence has concluded that Iran is not currently in active pursuit of nuclear weapons and that any decision by them to bomb Iran is "far off" in the future. Needless to say, this undercuts some of the more hysterical "bomb Iran" presidential candidates in the US. But, of course, this does not remove the new economic sanctions that Iran was objecting to and which many think that the US and Europe were going along with partly to restrain Israel from such bombing efforts.

The other sign is that over the weekend the Iranian vice president has specifically denied that Iran is planning to block the strait. One can dismiss this, just as many dismiss the anti-nuclear weaons fatwas of Iran's supreme leader, Khamene'i (that is to say, some of those who actually know that he has issued such fatwas, not widespread public knowledge), but it does look as if Iran has backed off for whatever reasons. It now looks extremely unlikely that the Strait of Hormuz will be blocked, even though the US looks to be following through on the new sanctions, which most reports say are already hurting the Iranian economy. Three further thoughts.

One is that David Ignatius claims in WaPo that this was due to Obama putting pressure on Iran through back channels. Maybe, although this smells a bit like the administration giving itself too much credit and leaking this to Ignatius. I suspect that backing off by Israel has played a bigger role.

Another point is that Iran has enough outs to avoid the worst of the economic outcomes. The main method for these sanctions is to attack settlements of oil sales through the Iranian central bank. Yes, several major customers of Iran appear to be scaling back purchases, such as Japan and China. But there are limits to this, particularly if indeed oil prices go up rather than back down (or stay steady). More importantly, Venezuela and possibly other countries are apparently setting up financial arrangements that may allow for these contracts to be completed without being directly blocked by the sanctions. So, Iran may already have seen the worst economically.

And finally, the main evidence for problems is the decline of the Iranian currency. However, such a decline makes it easier for the non-oil sector of Iran's economy to compete with foreigners and even possibly export, Iran usually suffering from the well-known "Dutch disease" endemic to so many nations dependent on exports of a highly priced natural resource. They have a respite from this a bit, although of course imports are more expensive also. Iran is taking a hit economically, but in the end the sanctions will probably backfire politically in Iran, given the strong support even by the political opposition of their civilian nuclear power program.

Hedge Funds for Human Rights

At a time when finance is coming under intense scrutiny, it is heartening to learn about hedge funds' concern about human rights. Greece is wrestling with the idea of asking (forcing) investors to accept 32 cents on the dollar. Hedge funds have been buying up the paper in the expectation that they can force Greece to pay in full.

Now the hedge funds is toying with the idea to sue the country in the European Court of Human Rights on the grounds that Greece had violated bondholder rights, surely a more serious matter than the slaughter of a few dissidents demanding democracy.

At least we now know that capital is seriously concerned about more than maximizing profits.
Thomas, Landon Jr. 2012. "Hedge Funds May Sue Greece if It Tries to Force Losses." New York Times (19 January)http://www.nytimes.com/2012/01/19/business/global/hedge-funds-may-sue-greece-if-it-tries-to-force-loss.html?_r=1&pagewanted=all

Reviewing Econometric Papers

Chris Blattman helpfully links to the syllabus for his course on research design and causal inference.  At the end is a list of questions he thinks (and I agree) would provide a useful checklist for reviewers of econometric papers.  Take a look at it.

Of course, me being me, I have some issues.

Once More on Ricardian Equivalence

I can’t let this rest.  Why should anyone bother with this idea?  RE depends on the specification of an intertemporal government budget constraint: any increase in the fiscal deficit in the current period must imply a corresponding decrease in the future, so that the relationship between the present value of the tax and spending streams remains unchanged.  But why?

Here are three arguments against the assumption of such a constraint.

1. The government’s debt/GDP ratio can and does change permanently.  Governments can borrow a lot, run up this ratio and then continue to live at their new level of indebtedness.  There is no reason why the US government cannot continue at the current debt/GDP ratio rather than the one we had on the eve of the financial crisis.  There is also no reason why this ratio cannot be increased to some higher level and maintained in perpetuity.  No doubt there is some level of indebtedness that is not sustainable, but we don’t know what it is, and in particular there is no compelling argument that says we are up against that constraint today.  (Credit markets, for what it’s worth, think US debt sustainability is a non-issue, given that they do not require a risk premium.)

2. The debt/GDP ratio is predictably altered by changes in nominal GDP.  Both real and price level effects matter.  Robust real economic growth can reduce the debt burden with no contribution from fiscal stringency, and if deficit spending increases subsequent growth (both through capacity utilization and hysterisis effects on potential income) a portion of the debt burden is directly offset.  (Models that assume away such effects simply beg the question.)  Just as relevant is the price level impact: inflation can erode the debt burden, and the question of whether such erosion is “optimal” from a representative household point of view (whatever that means—probably nothing) is irrelevant to whether such inflation will actually occur.  Note, incidentally, that the net effect of inflation on private sector wealth depends on whether the country in question runs a persistent current account surplus or deficit.

3. Finally, what we should now know from history is that it is far more likely that governments will default on their debts than pay them off.  Show me an RE model that accounts for even the possibility of default.....I’m waiting.

What does it say about the state of economics that a theory with no apparent connection to reality can spawn untold dissertations and journal articles and even crowd out rational thinking about current policy alternatives?

John Maynard Keynes on Occupy Mitt Romney

"No man of spirit will consent to remain poor if he believes his superiors to have gained their goods by lucky gambling. To convert the business man into a profiteer is to strike a blow at capitalism, because it destroys the psychological equilibrium which permits the perpetuance of unequal rewards. The economic doctrine of normal profits, vaguely apprehended by everyone, is a necessary condition for the justification of capitalism. The business man is tolerable so long as his gains can be said to bear some relation to what, roughly and in some sense, his activities have contributed to society."

Who is Voting to Shrink the IRS?

On the whole, David Cay Johnston has a very important point:

Congress will spend a trillion dollars more than it levies this year, so how do Washington’s politicians respond to the 11th consecutive year of federal budgets in red ink? They plan to shrink the IRS … if you believe government is too big and that cutting everywhere is the best way to shrink government. But this is the staff that generates revenue, and there is easy money to be made.

But then he goes a little astray with the politics:

So why would President Barack Obama and Congress cut the IRS budget? Their actions illuminate the rise of corporate power and values, and the diminishing voice of Joe Sixpack, thanks partly to how we finance election campaigns.

The how we finance elections part may be right but let’s recall that Joe Sixpack votes Republican and it is mainly the Republican Party that wants to hamstring the IRS in its enforcement of the tax laws against the larger corporations.

Scott Sumner v. Paul Krugman on a Simple Identity

Sumner tried to tease out the proposition that a rise in government purchases has no effect on the real economy from an identity, which prompted Krugman to school him on comparative statics. Sumner replies by basically repeating himself:

If Krugman were right that consumption smoothing somehow refuted Cochrane’s argument, then it would be impossible for consumers to react to a $100 million dollar fall in after-tax income as follows: Spending on consumer goods falls by $20 million. Spending on new homes falls by $80 million. Or spending on inventory accumulation falls by $80 million. Now I’m not saying that would happen, but if it did it would validate Cochrane’s claim and yet would incorporate consumption smoothing. So consumption smoothing can’t be the issue; it plays no role in whether Cochrane is right or wrong.

Time to call a time out. It is not the existence of the national income identity that is at play here but rather Sumner’s claim that the rise in the sum of consumption and government purchases necessarily completely crowds out investment. Two points:

(1) Complete crowding-out would occur if we were at full employment or if we had some sort of insane Federal Reserve policy that mandated we stay as far below full employment as we are now. Of course, neither condition describes today’s economy.

(2) Even if we did have complete crowding-out, notice that Sumner left off the transmission mechanism here. In his example, real interest rates would rise to crowd out the investment spending. So there would be at least this real effect.

As the title of Sumner’s second post notes – it is what he didn’t say that is revealing.

Update: Noah Smith and Paul Krugman anticipated my argument. First Noah:

Accounting identities are mostly just definitions. Very rarely do definitions tell us anything useful about the behavior of variables in the real world.

Then Paul:

the question is how the identity gets reflected in individual motives — is it via the interest rate, via changes in GDP, or what?

The Irrelevance Of Bond Ratings

It was front page news today, top story in WaPo, that S&P downgraded France and Austria from AAA status. Eeeeek! Except that their bond yields fell in the wake of this. The same thing happened after the US downgrade. And Japan has been downgraded 13 times, only to have the world's lowest bond yields. Really.

United Airlines' New Frontier in Ripoffs

I had about $500 worth of electronics gear stolen from my luggage in June. I spent several hours figuring out how to download the claim forms. After I filled them out, I got a brief note indicating that they received my submission.

Then I heard nothing. I spent many hours -- my guess is more than 20, mostly spent on wait times -- trying to contact somebody. I could get to an Indian call center, which could not give me any information on what to do.

After several months, I was informed that I had not included the tag from my baggage, which I did. I resent it. Many weeks later, I learned that I never sent it according to their records. After several iterations, I learned that my claim was denied because the company never received the tags.

A lawyer friend sent a letter to United. Now in January, I received a letter informing me that United does not accept responsibility for lost electronics.

Monti’s Message

I won’t get into his “rescue” program for Italy, but Mario Monti is saying what needs to be said about the current moment in EU politics.  In a word, the situation is dangerous and moving in the wrong direction.

To begin with, the continent is clearly in recession.  Economies are in the process of contracting, and every indicator of future demand—fiscal policy, consumer sentiment, investment and exports—are pointing down.  Economic misery is already baked in for 2012.

The countries that will be hardest hit, like Greece, Italy, Spain, Portugal and Ireland, have no policy levers to defend themselves.  They gave up monetary policy when they joined the euro, and fiscal deficits can’t be financed.  They are in a terrible situation.

The combination of economic hardship and political blockage is a recipe for volatile politics.  People rightfully demand action to fight unemployment and cuts in services, but the established parties have nothing to offer.  Fringe groups will be the beneficiaries, and many of them will be practitioners of the worst forms of xenophobia.  Fascist movements, complete with paramilitary wings, are on the rise in Hungary and Greece, and I would be surprised if more countries are not added to this list in the coming year.

In this context, Monti’s urgent words need to be heard.  Germany in particular needs to listen, because resentment against German policy and its moralistic pronouncements (the grasshopper and ant business, the paranoia about printing presses) will only increase, with repercussions for the German position in Europe.  If the German public thinks that the post-WWII era of humility is over, they will be in for an unpleasant surprise.  This does not mean that Germany cannot behave as a “normal” country, but it cannot set itself up as the chief enforcer of economic punishment for what is seen elsewhere as the crime of being insufficiently German.  I am not taking sides: this is the real political context of European fracture.

On a practical level, Monti is also right about Eurozone policy.  The ECB has to step in and guarantee sovereign debt inherited from the past.  Without this, a massive wave of defaults, with all this implies for the fragile European banking system, is unavoidable.  It is a choice between a difficult but manageable situation and full-tilt disaster.  Why dither any longer?

Meanwhile, the recession demands a response: its economic as well as political costs are too great.  Most European countries are unable to finance the fiscal deficits rational economic policy now requires.  This means that those who can, like Germany and the other net exporters, need to do some of this lifting themselves.  Above all, it means that there is an urgent need for a Eurozone-wide fiscal entity that can carry on countercyclical policy as the situation requires.  The constitutional process for creating such an entity should be deliberative and methodical, but a temporary, ad hoc version can and should be put into place immediately.  The alternative is simply the breakup of the zone.

Behind these particulars lies the underlying political question: is there a European people corresponding to the institutions of the single market?  If there is, then there is a reservoir of solidarity to draw on and the basis for a politics that puts the common good above short-term self interest and pejorative moralizing.  If not, the European project was always an elite illusion, waiting to fail its first serious test.