Is U.S. Fiscal Policy Near the Tipping Point?

Of the various critiques of the empirical work presented by David Greenlaw, James Hamilton, Peter Hooper, and Frederic Mishkin, Ryan Avent nails it:

I was immediately concerned by the data sample: 20 advanced economies over 12 years. What's particularly distressing is that just over half of the sample countries are members of the euro zone. In choosing to study advanced economies, the authors specifically note the problem of "original sin" in studies of emerging markets—that countries which borrow in foreign currencies are subject to different debt dynamics—only to then use a sample in which most of the chosen economies are unable to print their own money.

For more on why this matters – see Paul Krugman. But to be fair, I am intrigued by the author’s dynamic debt modeling and this:

we calculate the level of the primary government surplus that would be necessary to keep debt from continually growing as a percentage of GDP. We argue that if this required surplus is sufficiently far from a country’s historical experience and politically plausible levels, the government will begin to pay a premium to international lenders as compensation for default or inflation risk.

The authors rightfully worry about the U.S. polarized political system and our political will to increases taxes enough to cover spending and pay down the debt slowly over time. I have to seriously question, however, why an 80% percent debt/GDP ratio is the tipping point. Let me explain with a simple and perhaps pessimistic version of their model, which really harkens back to Domar’s modeling and Sargent and Wallace’s unpleasant arithmetic. Let’s assume that the real interest rate (r) = 3% and the long-run growth rate (g) = 2% so the present value of primary surpluses expressed as a percent of GDP (s) is given by s/(r – g) which is 100 times the primary surplus ratio given our unpleasant assumptions. How hard would it be for U.S. fiscal policy to have taxes as a share of GDP to exceed government spending as a share of GDP by say 1 percent so we could readily handle the current level of debt in the long-run? I’ve been looking over government spending and revenue figures as shares of GDP over the past 60 years. I prefer to do this as overall government spending and revenues (Federal, state, and local) as we know the Federal government could push certain responsibilities such as Medicaid off to the states if Ryan Republicans have their way or could assist cash strapped states with more Federal revenue sharing if I had my way. Recall that we did manage to pay down the massive Federal debt after World War II despite the fact that we had a larger defense budget as a share of GDP than we even saw under President Reagan or Bush43. OK, we have higher state and local government purchases now than we did in the 1950’s and transfer payments as a share of GDP have risen over time. But notice that in the late 1990’s, we did see total taxes as a share of GDP reach 31%. So can we get back to that level and keep spending at 30% of GDP? Well we did have government purchases drop below 18% of GDP in the 1990’s even as state and local purchases being 11.5% of GDP and nondefense Federal spending being 2.5% of GDP by telling the Pentagon that they get less than 4% of GDP. Oh, I know Republicans hated the decline of the military industrial complex but I would argue this is just smart policy. So the trick on the spending side will be to limit government spending on health care to 6% of GDP if we maintain Social Security benefits at 6% of GDP. While that will be a real challenge, the other challenge will be to find some political agreement on how to raise taxes as a share of GDP. We Democrats should admit that we are loathed to increase the tax burden on the working class even as that is really the Republican’s secret desire. And we know the Republican agenda is to insure that their rich political masters see an even less tax bite than they face today. But if we can get past this class warfare, avoiding fiscal default is something we know how to do.

Fiscal Space Cadets

I had intended to write something about the strange empirics in this paper on the supposed dangers of our fiscal path, but then I figured that others, and certainly Paul Krugman, would take up the task, and I was right.  So no additional criticisms.

Nevertheless, the issue of US fiscal space is too important to be left to the ideologically blinkered.  (There is no other explanation for the crude methods employed in Crunch Time.)  No country’s fiscal space is unlimited, not even ours—or Japan’s for that matter.  Here are four points to bear in mind.

1. The US borrows in its own currency, so it can’t be compared to countries that don’t.  This is the core of the many published critiques of Crunch Time.

2. A second consideration is whether a country is a chronic surplus accumulator or deficit secreter.  Japan, for instance, has had decades of surpluses (we are talking current account here), so there is a vast pool of domestic savings to draw on.  Taken in isolation, this call would go against the US: we are the biggest deficit country in history.

3. But the third point is that it also matters whether a country issues a reserve currency—and, in the case of the US, the denomination that accounts for about two-thirds of the global total.  As long as the US supplies the world’s primary money it has a lot of leeway to borrow.  The dollar’s strength is bolstered by the absence, for the time being, of a credible alternative; in particular, it helps the dollar’s cause that the Eurozone has often resembled a suicide cult.

4. Past experience is no guide at all, because there has never been a situation like this in all of human history.  We have a country that has run current account deficits ranging from large to mammoth for decades, that has large domestic debts, public and private, it cannot wind down, but also supplies the dominant reserve currency.  We are playing it by ear.

People are right to be worried, but this is not about fiscal deficits per se; the entire edifice of public and private debt in the context of continuing external deficits is unsustainable.  I can only speculate, but my guess is that it will all end suddenly, unexpectedly and unpleasantly.  2008 didn’t do the job, so we are headed to another seismic event.  Alas.

Only The Little People Pay Taxes

There have been lots of comments on the latest from David Brooks with my favorite being how Kevin Drum reacted to this:

My fantasy package, and I'm not running for office, would include a progressive consumption tax, and it would have chained CPI, and it would have a pretty big means-test of Medicare.

Kevin correctly noted:

Still, I have to chuckle when he complains about Obama not proposing a "politically plausible" plan, and then offers up an alternative that includes a progressive consumption tax, something that Republicans have been unrelentingly opposed to for decades in any reasonable form.

In the current negotiations that David Brooks and Ezra Klein were discussing, it is clear what the hold up is. The President is willing to accept some spending cuts if the Republicans accept a few roll backs for the preferential tax treatment for capital income but the Republicans have been steadfastly opposed to anything that would raise the tax bite for the ultrarich. This is nothing new as this has been the political debate for over 30 years. And the next time you hear a pharmaceutical executive complain about rising tax burdens - remember that their effective tax rate is likely to be less than 25 percent.

What’s the Matter with “Triumph of the Will”?

By your esteemed film critics,

Now that the Third Reich’s annual film awards are almost upon us, we are hearing voices that object to some of the entrants, especially Leni Riefenstahl’s stirring “Triumph of the Will”.  We have heard the objection, for instance, that Riefenstahl selectively showed smiling and enthusiastic faces, ignoring the many in the crowd who were bored, hostile or simply tired.  They say this is rewriting history.

Actually, this kind of nitpicking is little more than a pretext for debate over the politics of the movie itself.  These critics don’t like Hitler, and they are using “Triumph of the Will” as an opportunity to make themselves heard.  But this shows only that they don’t understand Art.

Films are about entertainment and beauty, not truth.  If they are true it is by accident.  And this applies to all literature and art: was Shakespeare “true”?  Karl May?

“Triumph of the Will” captured the imagination of the public because of its beautifully composed imagery and cinematic rhythm.  However accurate it might be about what actually transpired at that rally in Nürnberg, which is something we may never know, it did exactly what great movies are supposed to do.  The critics, on the other hand, express their contempt for the movie-going public.  They think that viewers are simply passive objects of government propaganda, unable to think for themselves.  Maybe they have more in common with Herr Goebbels than they know.

Invention remains one of the prerogatives of art and it is, after all, the job of writers, directors and actors to invent counterfeit realities. It is unfair to blame filmmakers if we sometimes confuse the real world with its representations. The truth is that we love movies partly because of their lies, beautiful and not. It’s journalists and politicians who owe us the truth.

The Terror of Solitude

For the first time in my life I am going to praise George Will.  I could easily spend an ultimately stupifyingly long (just like most of his columns) list of his erroneous and completetly stupid and ignorant columns that stretch so long, well; not worth the bother.

So, I must give serious moral intellectual legal and philosophical praise to George Will for making public the fact that the long accepted and deeply entrenched practice of holding prisoners in solitary confinement within the US is a violation of the 8th Amendment to the US Constitution (and the the Bill of Rights). That solitary confinement is severe punishment is without doubt to any person who actually understands these matters is without question. I will go further and state pubicly for the first time that both I and my wife (she more than me) have been on the receiving end of such "extraordinary" (well, without further enumeration of unpleasant details)....

So, I applaud George Will for standing seriously for human rights and liberty.

J. Barkley Rosser, Jr.

Don’t Take Nocera for an Answer

Joe Nocera has a rather muddled column in today’s New York Times about why, in his view, stopping the Keystone pipeline would do little to forestall climate change.  Along the way he confuses mitigation and adaptation and generally gets carts and horses all scrambled up.

Abstracting from sequestration, mitigating the buildup of greenhouse gases means just one thing, leaving fossil fuels in the ground.  The more we leave there, and the greater their CO2 equivalent, the less climate change we’ll have.  Switching to green energy, achieving conservation efficiencies and all the rest is about how we can do this with minimum adverse impact to our standard of living—how we can adapt to what we have to do to mitigate.  This is very basic stuff but easy to lose sight of.

What this means is that making it economically impossible to develop the Alberta oil sands contributes to mitigation, as long as it’s not coupled in some way with greater exploitation of some other resource.  So what happens if the Keystone pipeline is not approved?  First, no Alberta tar sands, assuming the pipeline to the Pacific is stopped too.  Second, greater scarcity of supply means some increase but certainly no decrease in the price for oil in the US.  Hence at least some of the Alberta sands will not be offset, and competing supplies at the moment have a lower CO2 equivalence, so from a mitigation perspective it’s a clear gain.

Of course, trying to keep oil in the ground one pipeline or coalfield at a time is an inefficient strategy; Nocera is absolutely right about this.  Much better would be a permit system that restricted the amount of fossil fuel entering the US economy.  Even a tax to restrict extraction and imports, as advocated by Hansen, would be a lot better.  But the US is politically incapable of passing such a law over the next two years and probably at least two more years after that, so, with the greenhouse gas clock ticking away relentlessly, we have to do what we have to do.  Stopping Keystone is a useful start, and it’s more than merely symbolic.

Incidentally, why would Nocera say that “we are far better off getting our oil from Canada than, say, Venezuela”?  Has he made a calculation about the economic good that US dollars would do in the pockets of oil sector workers and investors in Alberta compared to the social programs Chavez is funding with oil money in Venezuela?  From a purely economic point of view, what difference does it make to the US current account deficit whether we exchange our dollars for loonies or bolivars?  And if relations sour further between the US and Venezuela, does Nocera expect the Venezuelans to bankrupt themselves by refusing to sell their oil?  (Try that strategy out on Iran.)  Sorry to make such a big deal of it, but vacuous comments like this are truly annoying.

How to Think About Aggregate Labor Markets

The remarkable Tyler Cowen has me scratching my head again.  Here he is at the beginning of a critique of minimum wage laws and sticky-price Keynesianism.  (The latter is an oxymoron, as anyone who knows the history of Keynes’ dispute with the “Treasury view” knows, but we’ll let it pass.)

Let’s say your labor is worth $10 an hour but you won’t go back to work for less than $12, thereby leading to the unemployment of you. 

In essence you are self-imposing a minimum wage on that market, but the employer is responding by leaving you jobless.

You can guess where this is headed.

The interesting thing is that Cowen apparently has no inkling that most people would find his opening sentence insulting.  It implies that some significant portion of the unemployed are simply worth less than they think they are.  Imagine going up to someone who’s been without a job for a while and saying, “I’m sorry, but have you considered the possibility that your abilities are really not very valuable, and your job search has failed because of this delusion?”  If you insist on saying this, I’d advise doing it from a distance.

Now, of course some people have an inflated sense of self-worth, and others are too bashful.  It might be an interesting research project to see whether the distribution of these types is correlated with employment status.  I don’t have any priors about which would predominate where—do you?

What makes this interesting to an economist is that the popular perception of unemployment actually fits how we model the aggregate labor market pretty well.  Let me explain.  The view of most unemployed people, according to the interviews I’ve seen, goes something like this: “I’m looking for a job, and I’m willing to take something that’s worse than what I used to have, but I haven’t found anything yet.”  The unemployed person hopes that the job is out there but that the connection hasn’t been made.

This formalizes to the now-standard model of search and matching, for which Peter Diamond and especially Dale Mortensen and Christopher Pissarides split a Nobel.  Equilibrium in such models does not occur where the Beveridge curve crosses the 45-degree line, which it would if the criterion were supply equals demand, but depends on a larger array of factors.  The model is used to explain why the ratio of unemployed workers to vacant jobs is typically greater than one, even in “full employment”.

This is how knowledgeable economists study aggregate labor markets today.  Supply and demand, as deployed by Cowen, is a special and highly unlikely case that assumes away the complications that make the theory empirically relevant.  If you see someone drawing supply and demand curves for labor and trying to explain unemployment as a result of too-high wages, you know they are employing outmoded methods.

What’s striking is that the more high-powered model actually conforms better to popular intuition.  You have to have a rather uncharitable view of human behavior to believe that excess unemployment is due to people overestimating their true worth.

Joe Scarborough v. Paul Krugman on the Dollar Decline

Paul Krugman and Matt O’Brien are having some fun mocking Joe Scarborough and some senior economist at RAND. The line Paul seized upon was this:

From the beginning of 2002, when U.S. government debt was at its most recent minimum as a share of GDP, to the end of 2012, the dollar lost 25 percent of its value, in price-adjusted terms, against a basket of the currencies of major trading partners.

Paul notes that while the dollar did devalue – in particular during the 2002 to 2008 period, he questions whether or not Scarborough and this RAND economist have the right causation for the devaluation:

the decline in the dollar under Bush probably had more to do with what was going on in our trading partners than with what was going on here. And in any case, again, it was not a problem for America.

Of course those of us who were concerned about the trade deficit back in 2002 might have hoped that we would see a dollar devaluation that might increase net exports. One commenter at Paul’s place, however, argued that the trade deficit continued to increase even as the dollar fell. I checked the NIPA statistics as reported by BEA for how real net exports (2005$) behaved and sure enough, they rose to -$722.7 billion or 5.7% of real GDP by 2005 and were up to -$729.4 billion or 5.6% of GDP by 2006. But then the economy was expanding back in those days. Today, however, real exports are running at -$405.6 billion or 3% of real GDP per 2012. Cynics might say recessions do tend to lower imports and we’d hope that real GDP does eventually take off. A weak dollar, however, is not necessarily a bad thing especially when addressing a weak economy if it makes our goods more competitive in world markets. Of course, any good international macroeconomist would argue that we as well as Europe should be relying more on expenditure-adjusting policies than expenditure-switching policies to stimulate aggregate demand. But this realization seems to be well beyond the comprehension of Scarborough and his economic guru.

A Brief Reply to Tyler Cowen

My apologies for disappearing for several days; this is what happens when your teaching load bunches up on you.  Anyway, on to TC.

For those who may still care about this (and I realize the lifespan of topics in the blogosphere that people care about is measured in hours), I thought I noticed a Marginal Revolution post that exhibited elementary confusions about the income-expenditure identity in macroeconomics—as did Paul Krugman.  The link to Cowen’s original post is here.  I responded with this, Krugman with this, and Cowen with this.

Briefly:

1. Cowen followed the snip from Krugman with four paragraphs about how corporate money doesn’t just sit there but goes back into the economy, as if this called Krugman’s concern about the corporate cash hoard into question.  This is what Krugman and I were pointing to.  Someone who understands that income and expenditure (in a closed system) are identical, two ways of looking at the same transactions, doesn’t worry about demonstrating that money has to go somewhere.  It’s not about “going”.

2. It is true that, in his fifth paragraph, Cowen raises the issue of consumer spending.  If the other four paragraphs had never existed and he had written only #5, he would have a perfectly valid complaint.

3. Now that he mentions that paragraph and the chart that accompanies it, however, it is fair to point out that the data say exactly the opposite of what he says they do.  After four tough years retail sales have returned to where they were before the collapse.  At the moment they are growing slightly faster than the pace of the economy as a whole, but not much.  In this they reflect our overall problem: the economy is growing in fits and starts but making hardly any progress in closing the output gap.

4. I’m sorry that Cowen has taken offense at my point about macroeconomic thinking being hard, even for professional economists.  It is hard.  If you go looking for comments by economists that exhibit muddle you will find plenty of examples.  In the classroom I will think that I have just explained the system logic of macro in a perfectly lucid way to my students, and they will come back at me with papers and exams that show that my efforts at communication have failed.  And there are times when I too have to stop and think, even sometimes draw little pictures to remind myself what is going on.  As I’ve written elsewhere, the fundamental problem is that macroeconomics deals in both equations and identities, and they don’t mean the same thing, even though the mathematical manipulation is the same.  Our brains work readily in equation mode, where x determines y, and not in identity mode where x is y.

Climate Push 2013: A Cold-Eyed Look at Sanders-Boxer

Although it has a zero chance of getting past a Republican veto in congress, it’s good to see a new climate bill sponsored by Bernie Sanders and Barbara Boxer.  You need a concrete proposal to transform amorphous climate anxiety into political activism.  The fate of this bill will have little to do with its actual strengths and weaknesses, but we should still size it up carefully, since politics often has a way of digging channels that it eventually has to follow.

In some ways this is an evolutionary improvement on Waxman-Markey, which made it through the House in 2009 but died in the Senate.  Like W-M, its centerpiece is a framework for putting a price on carbon, a sine qua non for organizing a comprehensive response to the buildup of greenhouse gases.  Unlike W-M, it would position itself upstream, slapping a tax on fossil fuels as they leave the ground or enter the economy from abroad.  This is a huge improvement: it would cover a wider swath of carbon emissions and would avoid all the loopholes and backroom dealing that sector-by-sector coverage practically invites.

Also, it devotes three-fifths of all carbon revenues to per capita rebates back to the public.  This is essential for several reasons: it is good macroeconomics (more predictable muting of the dampening effect of higher energy costs), good social policy (turning regressive fuel price increases into progressive redistribution), and good politics (countering the understandable fear of households that rising energy bills will slash their living standards).  This is the right direction for policy.

The brief summary posted on Sanders’ website doesn’t make clear how long or complex the bill is, but from the looks of it, it should be simpler and more transparent than W-M.  That’s important too.

However, there’s another possible comparison to make: Maria Cantwell’s CLEAR Act.  This was introduced at the same time as W-M but didn’t get the endorsement of either the Democratic Party establishment or the major green groups.  It was a much, much better approach.

Rather than collecting money through a tax, CLEAR required permits to introduce fossil fuels into the economy, and these permits would be auctioned.  Permits have two large advantages over taxes.  First, the relationship between carbon prices and emissions is uncertain and likely to change over time.  By setting one, you allow the other to fluctuate.  If you are a climate hawk—and you should be—you want the price to vary and to control directly how much carbon we send up into the atmosphere.  Permits do this.  Second, as a practical matter, it will be difficult to pass a bill that does more than impose a token restriction on carbon emissions, at least initially.  S-B, for instance, starts low at $20 per ton of CO2 equivalent and programs a very modest rate of increase over the next decade.  In fact, it anticipates only a 20% reduction in emissions by 2025, not nearly what we need.  By itself, that’s OK; just getting a framework is a big deal.  But basing the framework on taxes means that, if we somehow manage to make S-B the law of the land, we are going to have to spend the next decade arguing for higher taxes on fossil fuels.  That’s tough not only because of the politics of taxes, but also because taxes are connected to climate outcomes only through a chain of effects that is complex and imprecise.  It would be much more powerful, politically, to be arguing about how much carbon to send up to the atmosphere directly, which is what you get from a permit system.  There’s a reason Bill McKibben’s outfit is named 350.org and not, say, $120-per-ton.org.

Also, CLEAR rebated nearly all of its revenues back to the public.  Rebating some of the money is a good idea, and the more you rebate the better it is.  That way you cover more of the public’s fears about energy costs, recycle more of the cost increases into other forms of demand, etc.  Ah, you say, but what about all the investments in clean energy we need to make?  Yes, we need to make them, but we don’t need any extra revenue: we could finance them almost entirely out of repurposing anti-environmental spending on fossil fuel subsidies, ag subsidies, a large portion of military spending, and so on.  You can even see that, camouflaged, in S-B.  It proposes to increase green investments of all sorts by $480B over ten years, along with ending fossil fuel subsidies—but then it would devote $300B of these savings (from ending subsidies) to reducing fiscal deficits.  In other words, the majority of the money that could have gone into rebates is going into financing the government—and this is based on just one of many possible changes in federal spending.  It is important to bear in mind that price increases for energy are highly regressive in themselves; so programming a more austere fiscal policy at the expense of lower income households is a double no-no.

So there you are: we have a new starting point that’s better than the “official” proposal last time around but worse than its better competitor.  The good and bad news is that we will have lots of time—at least two years and probably longer—to discuss what the best framework would look like.

Open The Doors To Immigrant Physicians!

Since I recently poked at my friend, Dean Baker, let me agree with him strongly on a recent post of his dealing with an important issue widely ignored, the need to relax our strict immigration rules for physicians.  It is widely agreed that the major threat to future US fiscal solvency is the rising cost of medical care.  US physicians are paid on average $250,000 per year, more than twice what European ones are, and simply higher than any others in the world.  If salaries were to fall to European levels, we would save $100 billion per year in medical costs. However, neither political party is pushing this, and it is rarely discussed among the many ideas that get put forward regarding controlling medical care costs.  Almost certainly this reflects the power of the AMA with both political parties. 

A sign of this ignoring is a recent NY Times article on STEM immigration that Dean links to.  He very reasonably points out how there is no mention of the physician issue, and indeed the US has a shortage of physicians, particularly of primary care ones.  He has also long complained about high income professionals such as doctors and lawyers being for free trade, but imposing immigration restrictions on potential competitors for themselves.  For more discussion, see http://www.cepr.net/index.php/blogs/beat-the-press/why-arent-they-talking-about-immigrant-doctors .

Is Dean Baker Wrong About Robert J. Samuelson On the S&P Prosecution?

I am usually in agreement with Dean Baker and jumping up and down on the case of Robert J. Samuelson of the Washington Post.  However, in this case of Dean dumping on Samuelson for raising questions about the recently announced DOJ case against the S&P ratings agency for fraud back prior to the 2008 collapse, see http://www.cepr.net/index.php/blogs/beat-the-press/robert-samuelson-is-worried-the-justice-department-is-persecuting-sap , I am not fully in agreement with Dean. Dean accurately points out that all parties involved were convinced that the real estate bubble was going to continue, but that fraud may still have occurred as the S&P raters may have changed their business model and were rating derivatives and CDOs as AAA without any solid support.

So, why I am defending the often indefensible RJS?  It is not because of any argument that he made.  The problems are two in my view.  One of them, mentioned by RJS, is that this is awfully long after the alleged crime (which indeed I think happened) to be finally be getting around to this.  The other, more important and not noted by either of them, is that this is the only ratings agency to be so prosecuted, with a very large fine being requested, one large enough to trigger a bankruptcy of S&P's parent company, McGraw-Hill.  Why is S&P the only one so charged?  What sticks out to me is that S&P was the agency that downgraded the US debt rating after the debt ceiling in 2011, much to the annoyance of the administration at the time. 

I happen to agree that this was somewhat questionable and obnoxious, although the breakdown of responsible decisionmaking in Washington was certainly something worthy of criticism, and it certainly was not illegal of S&P to make such a downgrade.  But there is all together too much scuttlebutt that this prosecution is in fact in response to this particular action by S&P.  They are being singled out among the various probably guilty ratings agencies for punishment possibly because they did something that annoyed the administration on policy grounds.  This is arbitrary action that strikes me as being an inappropriate way to proceed.  Either punish all of them, or none of them, and if punishing, then do it sooner after the alleged crime in question.  This smells of a political payback.

Why Aren’t Corporations Paying More in Dividends and Does It Matter to Aggregate Demand?

Tyler Cowen likely regrets writing this about Paul Krugman’s observation that corporations are hoarding a lot of cash:

I would understand it (though not quite accept it) if corporations were stashing currency in the cupboard. Instead, it seems that large corporations invest the money as quickly as possible. It can be put in the bank and then lent out. It can purchase commercial paper, which boosts investment. Maybe you are less impressed if say Apple buys T-Bills, but still the funds are recirculated quickly to other investors. This may not end in a dazzling burst of growth, but there is no unique problem associated with the first round of where the funds come from. If there is a problem, it is because no one sees especially attractive investment opportunities in great quantity. (To the extent there is a real desire to invest, the Coase theorem will get the money there.) That’s a problem at varying levels of corporate profits and some call it The Great Stagnation. The same response holds if Apple puts the money into banks which earn IOR at the Fed and the money “simply sits there.” The corporations are not withholding this money from the loanable funds market but rather, to the extent there is a problem, the loanable funds market does not know how to invest it at a sufficiently high ROR.If anything, large corporations are more likely to diversify out of the U.S. dollar, which could boost our exports a bit, a plus for a Keynesian or liquidity trap story.

Paul and Peter Dorman suggest Tyler is committing Say’s Fallacy (also known as Say’s Law which basically ignores the possibility of insufficient aggregate demand). As Peter puts it:

The problem is not that corporate money can’t find its way to ultimate investment, but that too much corporate money itself reduces the pull of final demand on the level of investment. The upshot isn’t that money disappears into cupboards, but that national income is lower than it would otherwise be.

I was going to add my two cents with the first one being on why corporations would be hoarding cash – but then Noah Smith has done a fine job on that query. To throw in my other cent – let me temporarily don the hat of a Barro-Ricardian equivalence type. Suppose that shareholders were all very rational agents with no borrowing constraints and that they recognized that all this hoarded cash was their wealth. Whether the corporation issued dividends or not, their wealth is unaffected. So maybe these households would be consuming the profits be they hoarded in cash or issued out in dividends. Now I know this equivalence theorem does not necessarily hold up that well in the real world so we can talk about tax cuts stimulating consumption for at least households that do face borrowing constraints. We liberals therefore tend to argue that tax cuts for the working poor tend to have a larger direct effect on aggregate demand than tax cuts for the ultrarich. So if the shareholder were someone who was borrowing constrained, hoarding cash rather than paying dividends does depress consumption demand. Then again – we liberals also tend to argue that a lot of shareholder wealth is owned by very rich individuals as opposed to being owned by the working poor. Non-Ricardians are welcome to tell me where this line of thinking has gone terribly astray!

The Difficulty of Thinking Macroeconomically, Exhibit C: Tyler Cowen and the Corporate Cash Hoard

Paul Krugman worries about the macro implications of corporations scarfing up unprecedented profits while sitting on a hoard of liquid assets.  Tyler Cowen doesn’t understand why:

I am confused by this argument.  I would understand it (though not quite accept it) if corporations were stashing currency in the cupboard.  Instead, it seems that large corporations invest the money as quickly as possible.  It can be put in the bank and then lent out.  It can purchase commercial paper, which boosts investment....If there is a problem, it is because no one sees especially attractive investment opportunities in great quantity.

Ah, but why are these investment opportunities lacking?  Could one of the reasons be that too high a fraction of national income is being funneled into corporate profits, rather than households inclined to spend it?  What Cowen has trouble with is seeing all the pieces simultaneously in true macro fashion.   The problem is not that corporate money can’t find its way to ultimate investment, but that too much corporate money itself reduces the pull of final demand on the level of investment.  The upshot isn’t that money disappears into cupboards, but that national income is lower than it would otherwise be.

I’m sympathetic with Cowen’s struggle: I see the same difficulties in my economics classes every year.  Students can usually see only one or two linkages at a time; it is really hard to see the whole thing as one simultaneous entity.  It doesn’t come easy even for professional economists, since writing a set of equations is one thing, but visualizing them on an intuitive level as an integrated system is another.

The fact is, there are a lot more Tyler Cowen’s in this world than Paul Krugman’s, which is one reason why it is so difficult to get a sensible discussion of macroeconomic policy.

Risk = Freedom?

There’s a review on the Dissent website by Steve Randy Waldman of Freaks of Fortune: The Emerging World of Capitalism and Risk in America by Jonathan Levy.  The book sounds interesting, but it is apparently based on a commonplace but false understanding of the relationship between freedom and risk-taking.

At the individual level it is absolutely true that we face a tradeoff between risk and freedom.  You can opt for a secure life, but only at the expense of creativity, individualism, moral courage and all the other Emersonian goodies.  Each one of us, every day, faces this choice.  Mostly it is just a matter of a tiny bit of risk-taking, but these moments add up, and from time to time there is a fundamental fork in the road.  We make our own freedom.

But the social level is another story.  Individuals take the array of risks as given; society can choose how much risk its members will face and what their risk-freedom tradeoffs will be, at least up to a point.  If the objective is to minimize all risk of any sort, especially all risks to health and income, the result will be stultifying.  But that’s not where we are on the Great Risk Curve.  Rather, the debates we have are about whether to cut back or extend social insurance programs like Social Security and Medicare, social protections like TANF and Medicaid, and more or less regulation of finance, pollution and such.  It seems clear to me that more security of this sort, which limits the downside risk individuals face in their personal lives, reduces the cost of living freely.

Examples are everywhere.  Ample unemployment insurance makes it easier to work for a startup or switch jobs in general rather than being held down by too strong a need for job security.  A stronger public pension system encourages entrepreneurship: people can hazard their savings by starting a business rather than hoarding everything for old age.  Social guarantees for basic needs make it possible for artists to risk making art their day job.  Professors with tenure (big time risk reduction) can take more controversial positions on public issues.  (I don’t say they always do this, but they do it more than they would if all professors were temps.)  In each case there is a real tradeoff between freedom and security at the individual level, but society can create programs that relax it, so it takes less courage to live freely.

That’s what I don’t like about the nanny state rhetoric.  Yes, of course the state can go too far and overprotect us from risks we would do better to face ourselves.  But the state we actually live in goes too far in the other direction.  With a stronger safety net we could have less risk and more freedom.