One More Rumination on the Burden of Fiscal Deficits

You would think that everything that needs to be said about this topic has been put on the table in the past few weeks.  (I will skip the links; these posts have already been linked to death.)  And you might be right, but I’ll offer a different take anyway.

The debate has been cast in an aggregative framework in which the set of welfare-relevant individuals includes both those who pay taxes tomorrow to repay today’s deficits and those who hold the bonds and receive payments.  Fine, but let’s consider a narrower question, one that most economists apparently think is beneath discussion: what it is the purely fiscal burden of public debt?

Well it’s obvious, isn’t it?  Either you pay off the debt in the future or you roll it over and pay more interest.  Either way you bear a fiscal burden, and they are the same in present value terms.

Well, try this.  In thinking about the fiscal burden, it may help to imagine a country with two types of citizens.  One type pays taxes but owns no financial assets; the other owns financial assets but pays no taxes.  (We’re getting there....)  The government runs a fiscal deficit in period 1.  In subsequent periods will there have to be offsetting transfers from the taxpayers to the bondholders?

First step: I rule out the scenario in which any significant portion of the debt is paid down.  This is not a deduction from theory, just an empirical observation.  Fiscal surpluses are few and far between.  Tomorrow’s taxpayers will no more be paying off the public debt incurred by the current generation than today’s taxpayers are paying off the debt bequeathed to us by our parents and grandparents.

So let’s get to step 2 and consider interest payments on the debt.  Here the critical move is to regard the burden not as a sum of money but a fraction of income, the debt service to GDP ratio.  This goes up if and only if the percentage increase in debt exceeds the corresponding percentage increase in income, given a constant interest rate.  (I abstract from the issue of real versus nominal incomes and interest rates.)

Now, why would anyone think that the incremental effect of a fiscal deficit on future income growth would be positive?  Two reasons.  First, if the deficit finances public investment, and if this investment is more productive than the use to which the money would have otherwise been put, income will grow commensurately.  Second, if the deficit reduces an otherwise stubborn income gap, hysteresis effects are likely to boost potential income in future periods.  The extent to which income growth attributable to deficits offsets debt service obligations and therefore raises or lowers the future fiscal burden is uncertain.

But that’s the point.  I would say it is an open question whether any particular deficit will be burdensome in the most restricted meaning of that term.  The answer is likely to vary from one macroeconomic context to another, from one program of public spending to another, according to the extent of the deficit, and so on.  The bottom line, however, is that, even if all the government bonds are owned by Martians so that taxpayers and bondholders are completely different species and transfers from the first to the second constitute a pure welfare loss, there is still no determinate relationship between more deficits today and more burden tomorrow.

Arrow v. Taylor Debate at Stanford

Aaron Sekhri provides a summary of a discussion at Stanford between Kenneth Arrow and John Taylor. I wish I had attended but based on this summary, Taylor is very confused about the role that fiscal policy plays during a recession even after Arrow stated the standard Keynesian position when the economy gets stuck in a liquidity trap:

He went on to discuss the disadvantages of what Obama opponents see as key fixes, namely, reductions in government spending. “Spending cuts are not productive,” he argued. “The real problem is the underutilization of resources. We can’t cut down what is really an investment in the future.” … Arrow then began a discussion of the need for government spending at a time when interest rates bottom out, as they did after the 2008 financial crisis. “The problem with monetary policy is that when the interest rate gets to zero, you hit a limit. That’s what happened in the Great Depression, and I’m probably the only one in the room who remembers that time,” joked the 91-year-old Arrow. Taylor argued in response that “temporary spending, such as the stimulus program, peter out very quickly and do not give you sustainable growth.”

Sustainable growth is what economists worry about in terms of full employment economies over the longer term. Does Dr. Taylor even get the basic premise that we have deviated from the long-term full employment path? Of course, Dr. Taylor has a simple solution to how we get back to full employment:

Comparing the federal government’s attitude towards change to the intransigence of the stubborn parent-teacher association at his child’s school, he asserted that the best route to economic wellbeing was to remove the incumbent administration and start anew.

In other words, make Mitt Romney President and everything will magically get better by itself. If you were not convinced by now that John Taylor has turned transformed himself from economist to political hack, this statement should make that case.

California’s Doomed-to-Fail Experiment in Carbon Regulation

The New York Times has a piece this morning on California’s new law to regulate carbon emissions, the corporately named Global Warming Solutions Act.  (Here is our new 2012 lineup of global warming solutions; pick the one that’s best for you.)  It is utterly uninformative about what is at stake in this new program and the damage it is likely to cause.

The author of the piece makes what must have been a pleasant journey to a redwood forest in order to talk with the folks who measure tree diameters: tree growth means carbon storage and provides a physical audit of carbon credits for forestry.  Journalists love this visual stuff, but accurate tape readings are almost irrelevant to the true problems predictable under the California law.

There are two huge issues, either one sufficient to sink the entire experiment.  The first is that carbon permits are given away to businesses based on historic emissions.  The second is the gaping loophole of offsets.

Giving away permits is very attractive to politicians.  Overnight they are in a position to grant or withhold vast sums of monetary equivalents, and this is sure to induce correspondingly large campaign contributions.  In other words, the logic of carbon giveaways is the same as the logic of our tax laws: they are convoluted and larded with special exemptions because otherwise there would be nothing to sell.

But worse, giving away carbon permits creates an unsolvable contradiction for policy.  On the one hand, freebie permits transfer money from consumers to businesses to the extent that the permits are scarce.  Issue fewer permits and prices go up, but costs to producers stay the same because the permits are free.  From an economic point of view it is a lot like the supply restriction enforced by cartels, except that here the government is in charge of squeezing the market.

Of course, what these handouts giveth to businesses they taketh away from the rest of us.  Voters don’t like to see the prices they pay go up, especially for highly visible items like gas and home heating.  They are even less likely to appreciate their contribution to the windfall profits of industry.  So here is the conundrum: permit giveaways are justified as the price that has to be paid to get business to go along with a climate plan, but the same system alienates voters and guarantees that serious limitations on carbon emissions will never occur.  You can see the outcome in the European Trading System, which ended up authorizing so many permits that they now have no value at all and no longer trade: the system “restricts” carbon emissions to the level that would occur in its absence.  My fearless forecast is that California will go the same route.

As for the problem of offsets, if accurate tree measurements is the main hurdle, we are in heaven.  Much more likely are two other glitches.  First, the criterion of additionality, that the green investments being subsidized would not have been made without the sweetener of an offset, is impossible to enforce.  How can anyone prove that a forest would or would not have been harvested in a parallel universe, exactly the same as our own, except for not having a Global Warming Solutions Act?  The history of the Clean Development Mechanism, set up under Kyoto to funnel carbon offset money to green investments in less developed countries, demonstrates that to a fault; independent audits have found that improper subsidies are the rule, not the exception.  On top of that, the criteria for offset eligibility are easily gamed, and many “green” projects are anything but, except in one narrow sense that allows the money to flow.  (Imagine how easy it would be to game any formal criteria for forestry offsets—cutting one forest more while collecting money by cutting another less, turning forests into tree plantations that trade sustainability for more rapid short-run growth, permitting practices that release more carbon from forest soils, etc.)

The offset game gets support from those whose noses are buried in the minutiae of carbon accounting.  Trees capture x amount of CO2 equivalent, equal to the combustion of so many barrels of oil or tons of coal, so why not trade one for the other?  Alas, this ignores the underlying logic of climate change.  The last century has seen a dangerous trend toward global warming not because of deforestation (which has been going on since the beginning of settled agriculture), but because of the release of large quantities of carbon that had been sealed away underground for hundreds of millions of years.  The bottom line of forestalling catastrophic climate change is leaving as much of that stuff in the earth as possible.

Specifically, there is enormous, and enormously complex, exchange between atmospheric, terrestrial and marine stores of carbon.  No one can say today how much of the carbon fixed in tree growth will be released over the next century, particularly since environmental conditions are certain to change radically.  For instance, those wonderful redwoods described in the Times article may turn out to be in the wrong latitude as temperatures rise.  This would be reflected in an increase in the frequency and severity of fires, which would send the carbon back up into the atmosphere.  Or people may not wait for fire to do the job; they could change the laws and start cutting the trees themselves.  What happens to carbon after it is extracted from the earth’s mantle is complex, fragile and reversible; it is the rate of extraction that has to change.

The good news is that this is just about California.  Governments in other places can try to do a better job.  Unfortunately, as the leading experiment in the US, the California system will be viewed as casting a verdict on all attempts to forestall climate change by pricing carbon, and its predictable failure will set back policies good and bad.  Those who care about this issue shouldn’t wait until the moment when failure becomes visible.  There is still a limited opportunity to construct an alternative narrative: this plan is so compromised that can’t work and isn’t a test of climate sanity.

The Neutrality of Money and the Supply and Demand Diagram

I just had an epiphany which I’d like to share with you: the neutrality of money is baked into the standard supply and demand diagram that enters the first-year economics brain and never leaves.

Recall the following point: putting together all the factors on which sellers base their preferences, and all the factors on which buyers base their preferences, an equilibrium price is determined.  If the actual price is above this equilibrium, excess supply will generate downward pressure until equilibrium is reached.  If the actual price is below, excess demand does the job.  It doesn’t matter what the price happens to be at the moment; it will gravitate toward the same equilibrium which has been determined by factors other than this price.

That embodies the neutrality of money.  By “money” I mean not simply the price level, but also the full range of effects generated by the financial system.  Financial activity can alter the prices of individual goods: commodities markets influence the price of minerals and agricultural products, markets in mortgages and their derivatives influence the price of homes, and so on.  The financial sector, in a money-neutral world, is determined by but ultimately does not determine the “real” world of production possibilities and preferences.  That is why finance can be an add-on to economic models that can be specified with or without it.  In a money-non-neutral world, everything really does determine everything else, with no distinction between “monetary” and “real”.

For some people the logic of the supply and demand diagram is a reason for accepting this neutrality.  For me it’s a reason to take a closer look at the model and question what subtle, long-lasting mental poisons we are releasing into the environment each time we (economics professors) teach it.

The answer, we know, is locked in those infamous ceteris paribus conditions.  This becomes transparent at the level of general equilibrium, where Sonnenschein-Debreu-Mantel tells us that changes in actual prices have the power to alter their equilibrium levels.  If you really, truly understand this, you see money and finance differently.  The problem is how to convey this same insight at the level of the simpler, more visible models on which introductory economics is based.  It’s hard to repair the damage caused by years of learning “the economic way of thinking”.

Rotwang strikes

http://www.huffingtonpost.com/ca-rotwang/mr-president-tweak-this_b_1954374.html?utm_hp_ref=politics

Read it and weep.

Jack Welch’s Ignorance Regarding Employment Data

Mark Thoma is very upset with the latest from Jack Welch and he should be. But let’s be calm and look at a couple of Welch’s two key claims:

In August, the labor-force participation rate in the U.S. dropped to 63.5%, the lowest since September 1981. By definition, fewer people in the workforce leads to better unemployment numbers. That's why the unemployment rate dropped to 8.1% in August from 8.3% in July. Meanwhile, we're told in the BLS report that in the months of August and September, federal, state and local governments added 602,000 workers to their payrolls, the largest two-month increase in more than 20 years.

The first claim is true – the labor force participation rate did fall from 63.7% to 63.5% but Welch conveniently omits the fact that this same rate rose from 63.5% to 63.6% as of September. And who told Mr. Welch that reported government employment shot up by over 600 thousand workers in just two months? I guess this person may have been Neil Cavuto or perhaps Donald Luskin because when I checked out the same series per FRED, I see an increase of only 55,000 over the past 3 months. As our graph shows, we have seen a very mild reversal of the unfortunate downward drift of government employment (I'm using seasonally adjusted data here - Mr. Welch didn't say what he was using and his claim is not even consistent with the data not seasonally adjusted). In all of his rants, Mr. Welch has proven only one thing – he is utterly clueless per the employment statistics that the professionals at the Bureau of Labor Statistics report. Before he decides to attack their integrity again – might I suggest he actually learn something about what they report?

Could the Recovery from the Great Recession Been Faster?

ABC’s This Week invited Nobel Prize winning economist Mary Matalin to debate known liar Paul Krugman. OK, I think I got this backwards even though Matalin did say:

I don’t make up numbers ... you have lied about every position and every particular of the Ryan plan on Medicare from the efficiency of Medicare administration to calling it a voucher plan ... You are hardly credible on calling somebody else a liar.

Actually - it was established a long time ago that Mary Matalin is a partisan hack but what about this claim:

Has there ever been this not be true in history that the deeper — the deeper the recession, the steeper and stronger the recovery. There is no such thing as a deep recession with a moderate recovery.

Poor Mary had not read this:

Fact-checking financial recessions is a salient issue, especially in a US election year. On the one hand, the incumbent faces criticism that the recovery is slow. In August the Mitt Romney campaign invoked US history to argue that performance has been poor: “The 2007-2009 financial crisis produced a severe recession ... But GDP growth has been anaemic since then, averaging just 2.2% per year since the trough. This pattern is unusual. The past ten recessions have been followed by faster recoveries, and GDP has fairly swiftly recovered to the previous trendline.” On the other hand, none of the last ten US downturns coincided with a financial crisis. In his convention speech nominating Barack Obama a month later, Bill Clinton intimated that the usual pattern in normal recessions was not relevant in this instance: “The difference this time is purely in the circumstances… no president, not me, not any of my predecessors, no one could have fully repaired all the damage that he found in just four years.” ... We reach back into the historical record over 140 years, examining the experiences of 14 advanced countries, to document the pervasive cyclical influence of credit in the economic fortunes of nations … The more excess credit in the preceding expansion, the worse the recession and subsequent recovery appear to be ... By this reckoning the US has done quite well, steering out of the to-be-expected financial recession range based on the inherited level of excess credit, especially if the shadow system is considered. Most importantly a deep financial recession was avoided at the outset, and this level effect remained intact ... To assume that this US recovery would resemble previous “normal recession” is to use the wrong benchmark.

There is a very simple way to think about this using standard IS-LM thinking. The 10 recessions from the late 1940’s to 2001 (see this for the dating of US business cycles) differed from the Great Recession as well as the Great Depression in terms of the ability of conventional monetary policy to quickly reverse these milder recessions. In those 10 situations, we could have and actually did reverse these recessions by allowing interest rates to fall. Some of these recessions (notably the ones from 1969 to 1982) were started by deliberate monetary contractions to “Whip Inflation Now” as President Ford once quipped. The ability to rely on monetary expansion had lead many economists including myself to wonder if we ever really needed fiscal stimulus to manage downturns in the modern business cycle. Yes – more fiscal stimulus would have been called for during the Great Depression but not in the modern US economy – unless we fell victim once again to the liquidity trap. The financial crisis in other nations such as Japan should have warned us that falling into a liquidity trap was a real possibility but I guess we had to relearn the lessons of history on our own. When Barack Obama prevailed in November 2008, he seemed to realize the need for a massive and effective stimulus package but alas didn’t push hard enough for what Christina Romer recommended. And alas, US fiscal policy has recently drifted towards austerity. So while I agree with those who argue that policy responses to severe financial crisis are different than policy responses to garden variety recessions, all this really means is that we may have to look beyond conventional monetary policies to have quick and effective remedies to downturns in aggregate demand. Alas the Republican Party and Team Romney to date has been opposed to fiscal stimulus unless it is of the military Keynesian brand.

Romney Insults Spain as He Shows His Ignorance of Macroeconomics

Bradley Klapper thinks the story is that Mitt Romney insulted Spain during the Presidential debates. Perhaps but let me extract the relevant economic portion of this story:

“I don’t want to go down the path of Spain,” Romney said Wednesday night during the first presidential debate. He argued that government spending under Obama has reached 42 percent of the U.S. economy, a figure comparable with America’s NATO ally. “I want to go down the path of growth that puts Americans to work.” … No one contests that Spain’s situation is dire, its economy in deep recession and unemployment hovering around 25 percent. But Spain’s level of government spending is actually low by European standards, and significantly less than Germany and Scandinavian countries with far healthier economic prospects. Spain’s woes were chiefly caused by the collapse of a property bubble that had fueled more than a decade of booming economic growth.

Klapper is properly noting that the U.S. recession and the Spanish recession were both caused by similar private sector events. The U.S. has fared less badly than some countries because we at least tried a bit of fiscal stimulus for a little while. Romney has been confused whether we should follow the UK’s disastrous austerity or use military Keynesianism. As far as Spain Matt Yglesias provides a nice graph showing how fast the changed in nominal government spending in Spain has declined:

If the entire argument is really over whether or not this Noteworthy Mercatusward Change in Spanish fiscal policy deserves to be called "cuts" rather than "rapid deceleration" then I suppose we've all wasted our time.

This may not have been the headline lie among all of Romney’s lies during the debate. And maybe Romney was less being dishonest than just completely ignorant of the facts in Spain. But it is very evident that he is either completely ignorant of the macroeconomic situation in the U.S. or is being incredibly dishonest. But hey – what else is news?

Modeling a Rational Romney

Sorry, I can’t help it.  Despite all my protestations, in my bones I must be an economist: if I see strategic behavior I have to consider how it could be represented as an outcome of rational calculation.  To be honest, however, I did not actually see the first Romney-Obama debate—I am willing to suffer for The Cause but only up to a point.  Instead, I am relying on hearsay.

What I gather is that Romney interrupted Obama repeatedly, employing an aggressive personal style and confronting his opponent with one egregious misrepresentation after another.  Obama responded with self-discipline to the point of distancing, acting as though he were conducting a calm seminar on politics; he allowed himself to be cut off, and he never confronted Romney with accusations of dishonesty.  Score one for Romney; apparently that’s what all the commentators did.

Now put yourself in the shoes of Romney and his advisers.  Given the political constraints both candidates face, what is the optimal strategy in the debate game?  I think Romney played his cards absolutely right: he provoked Obama to the maximum extent without going so far as to portray himself as a sociopath.  The debate moderator (and especially this particular moderator) was not in a position to challenge him.  The only resistance could come from Obama himself, and Obama faces the profound constraint of being a black man in America.

Look at it this way: what outcome from this debate would have been even better for Romney?  Answer: if Obama had lost his temper, showed personal anger toward Romney and called him a liar.  That would have proved to white America that, despite his post-racial stylings, underneath it all Obama is still the angry black militant that evokes a primal fear.  Romney can hope, of course: he can think up provocations that would really annoy Obama and make it difficult for him to stay on script.  But if Obama draws back from the challenge that’s OK too, as we’ve seen.

If I’m right, we are likely to see more of this in the future.  Can Obama fight back without invoking the racial stereotypes that would destroy him?  Can he be relaxed and smiling and still twist the knife?  That’s a thin line to walk, and if he gets it wrong there would be no recovery.  His whole political career has been based on avoiding white panic over aggressive, and therefore threatening, black males.  Perhaps his best move is to allow Romney to take all of these debates on points and trust that he has enough other resources to pull out a victory in November.  His TV ads can trash Romney without limit, of course, since the voices and images that express anger in them are not black.

None of this has anything to do with political substance, except insofar as racialized judgments regarding acceptable behavior still constitute an important part of American politics in our enlightened year of 2012.

Sesame Street Economics

You’ve likely seen all the documentation you need to know how much Mitt Romney serially lied last night. After all – he never proposed cutting taxes by $5 trillion. And of course he’ll create 12 million new jobs by doing nothing. Actually what offended me more than this was his attempt to deny that part of the Republican agenda was to just sit back and let cash strapped state & local governments lay off public school teachers. But he did admit to one thing - Big Bird should be fired! After all – saving $445 million a year is all we need to do to magically balance the budget if you scribble it on Art Laffer’s cocktail napkin. And we all know austerity is the path to prosperity. Too bad we didn’t have The Count as Romney’s running mate so we can make sure the math all works out just right. But don’t worry about Big Bird as I hear that he is moderating the next debate.

What Was the Value of DoubleClick When Romney Gifted Shares to His Kids?

Jesse Drucker wrote on September 27:

In January 1999, a trust set up by Mitt Romney for his children and grandchildren reaped a 1,000 percent return on the sale of shares in Internet advertising firm DoubleClick Inc. If Romney had given the cash directly, he could have owed a gift tax at a rate as high as 55 percent … Romney or his trust received shares in DoubleClick eight months before the company went public in 1998. The trust sold them less than a year after the IPO … In January 1999, Romney’s trust sold $746,000 worth of DoubleClick shares, for a gain of about $674,000, or an almost 1,000 percent return

Via Brad DeLong we see that Daniel Shaviro claimed:

The extreme undervaluation certainly looks like tax fraud. Key evidence would be the close proximity of the valuation date and the sale date

What was the fair market value of this DoubleClick stock when Romney set up this trust fund? Drucker and Shaviro are certainly arguing that the fair market value was much higher than what was claimed at the time these shares were gifted. We should note, however, that the value of Doubleclick shares has had a controversial history even up to the time that Google purchased the company for over $3 billion during April 2007. About two years earlier, a private equity firm had purchased the company for just over $1 billion:

DoubleClick shareholders will get $8.50 in cash for every common stock share, a 10.6 per cent premium over the average closing price of the company's stock in the last thirty trading days. The valuation is very low compared to DoubleClick's valuation in its hey days.

We should also note that two people commented over at Brad’s place that stock valuations were quite volatile if not exuberant during the late 1990’s. Mind you that I’d be the last to cast doubt on this Drucker-Shaviro claim that Mitt Romney hired some hack appraiser:

But back to the estate attorney who has a Rolodex of appraisers who will give him any whore answer for the right fee. The appraiser/whore that is chosen to evaluate the fair market value of the business has three tricks up his (her) sleeve ... Doesn’t the IRS have their own appraisers that can effectively rebut the bogus valuation reports commissioned by the estate attorney? One would think so – but read most of the Tax Court decisions in this area and realize that even the National Review looks smart and honest by comparison.

Shaviro’s “Key evidence would be the close proximity of the valuation date and the sale date” reminds me of the “expert” testimony in Nestle v. Commissioner of the Internal Revenue Service which involved the value of the various Carnation trademarks and other intangible assets both at the time the U.S. affiliate of Nestle purchased Carnation (January 1985) and when this affiliate sold them to the Swiss parent, which was on April 30, 1985. Nestle had commissioned one appraiser to argue that the value of the intangible assets was approximately $425 million at both dates. The IRS, however, argued that the value of the intangible assets was only $175 million as of January 1985 but accepted the $425 million value for the intercompany sale price as of April 30, 1985. I’m sure if one wished to read the trial court decision which accepted the IRS view one could mock at the quality of analysis by both sides, and the Appeal Court ultimately rejected the IRS position for its own silly reasons. But note that the IRS never bothered to explain why the intangible assets in such a mundane industry could more than double in a period of less than four months. Which is to simply say – both sides often play games when it comes to valuations for tax purposes.

RIP Francis Newton

"Francis Newton" is the pseudonym Eric Hobsbawm employed for his jazz criticism written for The New Statesman and collected in a book called The Jazz Scene.

An extraordinary historian,  a good man, and a decent jazz critic to boot, is dead.. RIP

The Catalalunya (Catalonia) Card

According to a column in FT Weekend by David Gardner, sometime this month the annual parade in Barcelona, capital of Catalonia (standard spelling; or Catalunya, the Catalonian spelling, get used to it), honoring the dead from the defeat in 1714 of the Catalans at the end of the War of the Spanish Succession in which they supported the incumbent Hapsburgs against the victorious Borbons, was attended by over a million people calling for Catalan indepence from Spain.  Since then, Catalan Generalitat President, Artur Mas, went to see conservative Spanish PM Rajoy in Madrid trying to negotiate a fiscal agreement that would make Catalunya like the Basque country, able to collect their own taxes.  Currently, Catalunya sends 9% of its GDP to Madrid in revenues net, with that twice the figure in most Eurocountries for rich areas sending funds to poorer regions, with the province also having the largest individual provincial debt (not an issue in the discussion).  The Basques send little.  On top of this, the Spanish constitutional court overturned an agreement passed by the previous Socialist government that granted Catalunya substantial autonomy. Since then the Catalan independence movement has erupted big time.

Mas was long a moderate on all this, supported by the lead author of the 1000 page "Bible" of grad micro theory courses, Andreu Mas-Colell, former Catalan fin minster. They want out.  Mas has now called for a an election in November, with him calling for full independence.  This is viewed as a prelude to a full referendum on the independence issue, even though the Spanish central government says that this would be unconstitutional.  Si, we shall see.

The EU, and particularly its Eurozone part, is unhappy about all this.  It coincides with a broader fiscal and financial crisis in Spain, with bonds now above 6%, triggering all kinds of alarm bells and a renewed slide of the euro after the Bernanke support (Yes, kids, when things look good and the US stock market goes up, the US dollar goes down against the euro).  So, the negotiations by the Spanish central government with the troika of the ECB, IMF, and ESB, with the Germans running the whole show anyway, are seriously muddled by this constitutional crisis, and that is exactly what it is.

This is serious stuff.  I have long been declaring that most of the constantly repeated forecasts of doom and gloom for the euro have been overdone, with US commentators from both the right (mostly), Martin Feldstein and the late Milton Friedman, and the left, most prominently Paul Krugman, with all of these claiming the euro could never get off the ground in the first place and only too eager too trumpet the current problems as showing that they were not total fools in the first place, gag.

Anyway, me the pollyanna on the euro thinks this might be the real banana (the word used to name that which could not be named back in the Ford [or Carter?] administration).  It will take some time to work out, and I can easily see them muddling through yet again; but this one will be much tougher than almost any they have to deal with so far.

Heck, Greece does not involve them trying to beat up on the poor Macedonians or the Turkish Cypriots as they so like to do completely idiotically, given their utter fiscal irresponsibility and outright fraud and lying.  This is more serious.  The Eurozone can dump Greece, but it cannot dump Spain.  That would be the end of the game.

The Thirties: The Arts In Italy Beyond Fascism

Not the usual fare here, but there have been a lot of people claiming that "liberalism is fascism" (and socialism and nazism and communism, all in one) lately, to the point where it is a regularly repeated mantra in certain inane circles. Often cited for this argument is the racism and oppressiveness of Woodrow Wilson, along with certain FDR initiatives being modeled on ones in Mussolini's Italy, and of course the true fact that Mussolini himself was initially socialist.  Indeed, he did engage in nationalizations of some companies, ones that held well into the post-WW II era, in contrast with the "National Socialist" Nazis who in fact nationalized nearly nothing.  In any case, an art exhibit in Florence, Italy with the title of this post sheds both light on the complicatedness of the fascist era and raises more questions than it answers about that tangled period.

First, we must note Mussolini's socialist background. However, at his core he was a militarist nationalist dictator, and his initial fame came from his splitting with the Italian Socialist Party in WW I, with that party taking a pacifist position and opposing Italian entry into the war, in contrast with those in France and Germany.  Mussolini became the leader of the warmongering faction of that party, soon setting off to lead his own.  In the aftermath of the war, he became the champion of frustrated veterans, and these would always be at the core of the Italian Fascist Party, which gradually moved to the right over time, eventually adopting the racism and anti-Semitism of the Nazis in the late 30s, along with a repressive attitude to culture and the arts, pushing forward certain schools and approaches, although, still less repressive than Germany, there remained some room for dissident artists and movements.

There has been very little effort in Italy to straighten all this out, I think due to how deeply embedded fascism was in Italy, ruling for nearly a solid 20 years, from 1923 to 1943.  Movements and individuals moved in and out of favor and few have been made to face up to what they did or did not do.  As it is, this exhibit claims to approach all this "objectively," and I would say it makes a brave effort, helped by the fact that by now all the artists involved are finally dead.

So, certain movements were not favored by the fascists, notably abstract art and metaphysical art, the latter a particularly Italian movement founded by Giorgio de Chirico, who spent the entire period out of the country in Paris.  One 1936 abstract painting shown was vandalized by fascists.  Besides various hackneyed efforts to look back to the Church or the Renaissance or Rome, the leading pro-fascist movement was the monumentalist Novocentisti one, which indeed combined some of these elements, while looking a lot like the "classical" period of Picasso right after WW I.  The most complicated movement was futurism, which in the teens was followed by many on the left, including the later Soviet poet, Mayakovsky, but which came to be used by the fascists as part of the pro-technology and modernization movement, even as they harked back to antique models (the symbolic "fasces" themselves being a symbol from the Roman era).  In the late 1930s the Novecentisti would be glorified, while the metaphysical and abstract schools were vilified at about the same time the Germans were pushing "Aryan art," and also denouncing "degenerate art."  This coincided with the Italians finally adopting the racist laws of the Germans.

Nevertheless, this exhibit raises many loose ends and questions.  These are symbolized by the strange and unexplained case of Carlo Carra.  He was initially a political anarchist and a futurist painter in the mid-teens.  After that he would become one of the most important followers of de Chirico and the Metaphysical School.  Indeed, the only works of his I had previously seen were from this period.  However, throughout the early part of this exhibit it became clear that by the late 1920s he had become one of the leading Novocentisti and was a major influence on other artists to follow this approach.  Despite that, the exhibit showed an article from 1938 denouncing the politically unacceptable schools and specifically denounced the metaphysical paintings by Carra.  No explanation was given regarding whether he then got in trouble or how this related to his later Novocentisti move or any of this.  After seeing the exhibit I went online and found a big fat zero on this, other than one source indeed noting that he followed the Novocentisti approach after his futurist and metaphysical periods.  This complete lacuna in the records regarding this rather important figure simply makes it clear to me that there is a lot more to all this in the broader cultural history of the period, and probably in other areas as well, which simply have not been delved into in any serious way.  Maybe this exhibit is the harbinger of an impending major reexamination of what it was really all about?

Did Matt Ygelsias Really Endorse Lowering the Tax Rate on Capital Income?

Greg Mankiw seems happy that Matt is now educating the rest of us silly economists on the wonders of reducing the tax rate on capital income. While it is true that Matt walks us through a discussion of the incentives to consume now versus save but he also adds this:

Empirically, it's a bit difficult to verify that variations in capital gains tax rates and the like really are making a material difference to investment levels. But then again the data is noisy. What's more the thing we have the most real-world experience with is measures like George W. Bush 2003 tax cut for investment income which was financed with government borrowing rather than higher wage taxes, consumption taxes, or spending cuts. It's not at all clear that the basic theoretical considerations in favor of low taxes on investment income apply to the case of a debt-financed tax cut. This is also separate from the question of whether hedge fund and private equity fund managers should be allowed to pretend their labor income is really investment income by calling it "carried interest" and paying at a low rate.

Indeed we had another experiment with lowering tax rates on capital income that actually increased real interest rates and lowered investment – that being the original Reagan “supply-side” tax cut. Of course, Team Romney keeps wanted to pretend they have found some magic recipe for deficit neutral ways of reducing taxation on capital income. The problem, however, as Howard Gleckman notes is that when Team Romney member Kevin Hassett was forced to defend the revenue neutral proposition he had to basically admit you cannot do that without abandoning the reduction in tax rates for the well to do. But I think there is another fatal flaw in Matt’s defense of lower tax rates on capital income. Let me start with Matt’s example:

You imagine two prosperous but not outrageously so working people living somewhere—two doctors, say, living in nearby small towns. They're both pulling in incomes in the low six figures.

OK – now let’s give the microphone to Dean Baker who was discussing a similar argument by Dylan Matthews:

Matthews rests his case on some arguments in the literature concerning scenarios in which we both look to an infinite future horizon and we have identically situated individuals, meaning that we all have the same wealth and the same opportunity to gain income. When these assumptions are relaxed, the case for preferential treatment of capital income becomes considerably weaker, as argued in a recent Journal of Economic Perspectives article by Peter Diamond and Emmanuel Saez … If we have some individuals who inherit immense wealth so that they can live entirely off their capital income and other individuals who must work for their income, a policy that subjects capital income tax to a lower rate of taxation than labor income means that we are taxing the rich at a lower rate than the middle class and poor. It is difficult to see how this is either efficient (we are giving disincentives to work for middle class people as a result of a higher than necessary tax rate) or fair. Furthermore, as a result of having a lower tax rate on capital income than labor income we are giving people an incentive to game the tax code by concealing labor income as capital income. While most workers may not have much opportunity to play such games, higher end workers, such as doctors or lawyers with their own practices would have ample opportunities for such gaming. This is both unfair and leads to a waste of resources as these people employ accountants to rig their books.

Team Romney can pretend all they want that we all have similar endowments of initial resources and that any change in the tax code will somehow magically be paid for by offsetting fiscal restraint, but actual policy decisions must be made in the real world where things are not nearly as magical.