Deflation??

A pretty good economic journalist, David Leonhardt, finds the happy side of falling prices. Let's look into the issue more.

The New York Times / December 17, 2008
Economic Scene: Finding Good News in Falling Prices
By DAVID LEONHARDT

Very few Americans alive today can remember a time when prices across the economy were falling. But they're falling now.

The cost of fruits, vegetables, clothing and vehicles are all dropping. Housing prices have been falling for more than two years, and a barrel of oil costs about $45, down from $145 in July.

The inflation report released by the government on Tuesday showed that the Consumer Price Index was 3 percent lower last month than it had been three months earlier. It was the steepest such drop since 1933.

Note that most of the prices that are falling are "commodity" prices that are inelastically supplied and demanded (like those of gasoline, fruits, veggies, etc.) The economist Michal Kalecki (who developed a lot of Keynesian economics before Keynes) called this the "demand-determined price" sector. We should expect falling demand to hit this sector hardest.


In general, significantly falling prices have not spread to the manufacturing or service sector (where prices are mostly determined by costs), with the obvious exception of autos.

By the way, falling housing prices do not show up in a big way in the usual measures of the "cost of living," which only cover newly-produced goods and services. The falling house prices that Leonhardt points to are like falling stock prices in that they refer only to assets, not newly-produced items. So they don't show up in the CPI or similar measures.

The cost of living measures do not assume that each person buys a house each year (or some period like that). Instead, they measure what the statisticians believe people would pay if they rented the houses. Thus, as house prices fall, that might affect the rental cost of housing and the cost of living. But actual rents did not rise as much as the asset price of housing in the late bubble, so they're not likely to fall as much either. Most workers -- who are mostly renters -- won't benefit much.

In any event, falling house prices will not be a benefit to those of us who are strapped for cash due to lay-offs or stagnant income and have a really hard time borrowing. Mostly, they will hurt those who (partially) own houses, pushing them in the direction of being "upside down" (having negative equity in the house). Many have already achieved that fate. This encourages the recession by depressing consumer spending further.

These [price] declines have raised fears of a deflationary spiral — fears that help explain the Federal Reserve's surprisingly large interest rate reduction on Tuesday. And there is good reason to fear deflation. Once prices start to fall, many consumers may decide to reduce their spending even more than they already have. Why buy a minivan today, after all, if it's going to be cheaper in a few months? Multiplied by millions, such decisions weaken the economy further, forcing companies to reduce prices even more.

This "expectations effect" is only one reason why deflation is a bad thing. In addition, deflation raises the real value of the debts of the debtors. It's true that it also raises the real value of the assets of the creditors. But debtors are usually the bigger spenders, so the net effect is to depress demand. Further, as the debtors are squeezed, more and more of them go bankrupt. This undermines the real value of the winnings of the creditors, further depressing demand.

In simple terms, if you borrowed a bunch of money last year and your money income falls now, then you discover very quickly that your interest and principal payments have not fallen, pushing you to the wall.

One rule is that the more debt people and companies have accumulated in the past, the more they and the economy suffer due to deflation. We in the US have just ended a monumental debt-powered splurge, at least among consumers. So avoiding deflation is especially important.

In passing, it's interesting to note that the very orthodox economist Irving Fisher developed his "debt-deflation theory of great depressions" back during the last serious deflation (the early 1930s). Somehow, the role of debt has been elided.

But a truly destructive cycle of deflation is still not the most likely outcome. For one thing, the price of oil cannot fall by another $100 in the next few months. For another, the federal government will soon, finally, be fully engaged in trying to stimulate the economy.

In mechanical terms, the Fed's rate cut is actually a decision to pump more money into the economy (which will cause short-term interest rates to fall). Starting next year, the Obama administration is planning to spend hundreds of billions of dollars on public works and other programs.

It should be mentioned that the Federal Reserve has just run out of interest rate ammunition to stimulate the economy. Maybe "Helicopter Ben" can do something just by printing a lot of money, but we'll see how effective that is. On the other hand, Obama's stimulus plan will not happen for months... Who knows what will happen in the meantime or how large the deficit hawks will allow the stimulus to be.

All else being equal, more money sloshing around an economy causes prices to rise. In this case, it will probably keep them from falling as much as they otherwise would have.

Right.

So amid all the legitimate worries about deflation, it's worth considering what may be the one silver lining in the incredibly bad run of recent economic news: The cost of living is falling.

Jobs are disappearing, bonuses are shrinking and raises will be hard to come by. But the drop in prices, which isn't over yet, will make life easier on millions of people. It's possible, in fact, that the current recession will do less harm to the typical family's income than it does to many other parts of the economy.

There's a lot of truth to this (Leonhardt's main point). My grandparents used to tell me about how they (who weren't hurt by the 1929 Crash or the 1929-33 Collapse) were able to get real bargains because of the deflation then, even buying luxury goods that they normally couldn't afford.

But a lot of other people suffered big time. My research has found that the amount of nutrition received fell significantly. Per capita food energy per day fell about 5% between 1929 and 1933.

The reason is something called the sticky-wage theory. Economists have long been puzzled by the fact that most businesses simply will not cut their workers' pay, even in a downturn. Businesses routinely lay off 10 percent of their workers to cut costs. They almost never cut pay by 10 percent across the board.

The Post-Keynesian economist Paul Davidson also praises the sticky money (nominal) wage as a nominal anchor that prevents deflation.

The stickiness of money wages is crucial, because without it, falling prices could start a downward wage-price spiral, with wages falling due to falling prices and prices falling due to falling wages. It's this spiral which represents true deflation, the kind of deflation that's been so destructive in the past. A merely temporary fall in prices does not have this kind of negative effect.

Traditional economic theory doesn't do a good job of explaining this [wage stickiness]. During a recession, the price of hamburgers, shirts, cars and airline tickets falls. But the price of labor does not. It's sticky.

In the 1990s, a Yale economist named Truman Bewley set out to solve this riddle by interviewing hundreds of executives, union officials and consultants. He emerged believing there was only one good explanation.

"Reducing the pay of existing employees was nearly unthinkable because of the impact of worker attitudes," he wrote in his book "Why Wages Don't Fall During a Recession," summarizing the view of a typical executive he interviewed. "The advantage of layoffs over pay reduction was that they 'get the misery out the door.' "

This makes a lot of sense. I hope that orthodox economists are going to follow this lead and return to the 1930s fashion of actually talking to businesscritters and workers as a way of finding out the nature of economic behavior, to supplement the standard abstract/deductive or statistical techniques.

However, it's not true that "Traditional economic theory doesn't do a good job of explaining" downwardly sticky wages. The problem instead is that the dominant schools of economists ignore a very traditional reason why workers resist or resent money-wage cuts (perhaps because of an obsession with "representative agent" models). It's a version of the prisoners' dilemma.

The standard story is that if workers accept a nominal wage cut, it will lead to falling prices, ceteris paribus. Thus, real wages won't fall much, but they will fall a bit, raising employment. The problem with this story is that each group of workers fear that no other groups of workers will take wage cuts. If one group takes a money-wage cut and others don't, prices won't fall much and the group will suffer real wage declines. There won't be a significant increase in employment (especially given the aggregate demand failure). Fearing this fate, most groups of workers resist nominal wage cuts. This means that the only price decreases are in the commodity sector (gasoline, food, etc.) and assets (houses, stocks, etc.)

If money wages in the manufacturing and service sectors don't fall, but the demand for products is falling, then employers will employ lay-offs because their profits will be squeezed. They will also refrain from expanding their operations (as they're doing right now). This encourages further falls in employment.

Lay-offs mean that the average money wage of the entire labor force (employed and unemployed) may fall even though that of employed workers does not. Falling asset prices will also hurt those workers who own houses or other assets, discouraging consumer spending. This encourages further production cut-backs and lay-offs. A downward spiral can occur even though money wages don't fall.

Wage stickiness, by the way, is likely less important in the U.S. economy than it was a generation ago. That's because of the "neoliberal policy revolution" of the 1980s and after (starting with the resistable rise of Paul Volcker to power in August 1979). This revolution has meant that more and more workers are treated as commodities. Fewer and fewer of them belong to labor unions (outside of the government sector). So it's more and more likely that nominal wages will fall during the current recession.

It's just possible the neoliberal policy revolution, which aimed at returning the economy to its pre-1929 state, has brought back the deflationary disaster of the 1930s. Of course, we won't know until it happens. If the reflation efforts of the Fed and the federal government succeed, any undermining of the sticky wages phenomenon is irrelevant in practice.

If the anti-government rhetoric of the neoliberals is to be taken seriously, it's ironic that its policies have put so much responsibility has been put in the Fed's and federal government's hands.

Companies resort to cutting jobs and giving only meager pay increases, increases that are even smaller than the low rate of inflation that's typical during a recession. This recession may well be the worst in a generation — but thanks to the stickiness of wages, the pay drop for most families may not be much worse than that of a typical recession.

The forecasting firm IHS Global Insight predicts that prices will fall by an additional 1 percent in 2009. That would bring the total drop, from the summer of 2008 to the end of 2009, to roughly 4 percent. But you can be sure that most executives will not force their workers to take a 4 percent cut in their paychecks. The fears about morale will be too great.

Should we rely on this forecast? I doubt it. The accuracy of economic forecasts has dived even lower in recent years. Forecasts seem better measures of what people expect than of what might actually happen in the world.

Strange as it sounds, the drop in prices will keep real incomes — inflation-adjusted incomes — from dropping too much.

I don't mean to make things sound better than they are. The economy is bad and getting worse. A deflationary spiral remains a real threat, even if it's not the most likely result. No matter what, unemployment is headed much higher.

People who keep their jobs, meanwhile, will suffer through some stealth pay cuts — higher health insurance premiums, for instance. Raises will also remain meager in 2010, even if prices start rising again. Like every other recent recession, this one will force families to take an effective pay cut, and a significant one.

Alas, "stealth pay cuts" are not really stealthy: they hit people directly in the pocketbook, having the same effect as non-stealthy pay cuts. Higher health insurance premia reduce the amount of income left over for other purposes. And they're hard or impossible to avoid, just like a payroll tax increase. They encourage resentment -- and cut-backs in consumer spending -- just like non-stealthy pay cuts.

But the drop in prices will still soften the blow. And at this point, American families can use any bit of economic help that they can get.

E-mail: leonhardt@nytimes.com

Copyright 2008 The New York Times Company

True, but methinks that Leonhard is a tad too optimistic.
--
Jim Devine

Goldman Sachs, Income Taxes, and Transfer Pricing

Bloomberg reports:

Goldman Sachs Group Inc., which got $10 billion and debt guarantees from the U.S. government in October, expects to pay $14 million in taxes worldwide for 2008 compared with $6 billion in 2007. The company’s effective income tax rate dropped to 1 percent from 34.1 percent … The rate decline looks “a little extreme,” said Robert Willens, president and chief executive officer of tax and accounting advisory firm Robert Willens LLC. “I was definitely taken aback,” Willens said. “Clearly they have taken steps to ensure that a lot of their income is earned in lower-tax jurisdictions.” U.S. Representative Lloyd Doggett, a Texas Democrat who serves on the tax-writing House Ways and Means Committee, said steps by Goldman Sachs and other banks shifting income to countries with lower taxes is cause for concern.

There may be lots of reasons for the drop in the effective tax rate but the most recent 10-Q filing for Goldman Sachs admits the following:

The firm is subject to examination by the U.S. Internal Revenue Service (IRS) and other taxing authorities in jurisdictions where the firm has significant business operations, such as the United Kingdom, Japan, Hong Kong, Korea and various states, such as New York. The tax years under examination vary by jurisdiction. During fiscal 2007, the IRS substantially concluded its examination of fiscal years 2003 and 2004. Tax audits that have been substantially concluded in other jurisdictions in which the firm has significant business operations include New York State’s examination of fiscal years through 2003, the United Kingdom’s review of fiscal years through 2003 and Hong Kong’s review of fiscal years through 2001. The firm does not expect that potential additional assessments from these examinations will be material to its results of operations … The effective income tax rate for the first half of 2008 was 27.7%, down from 29.5% for the first quarter of 2008 and 34.1% for fiscal year 2007. The decreases in the effective tax rate were primarily due to changes in geographic earnings mix.

In other words, less taxable income has been declared in high tax areas such as the US, Japan, and the UK. I wonder if the IRS Examination will scrutinize the transfer pricing policy for this company which recently received debt guarantees from the U.S. government.

Deflation

David Goldman reports:

The Consumer Price Index, a key inflation reading, fell 1.7% last month, according to the Labor Department. That was much weaker than October's 1% drop and exceeded the 1.3% decline forecast by a consensus of economists surveyed by Briefing.com. Prices fell by the greatest amount since the Department of Labor began publishing seasonally adjusted changes in February 1947. Though falling prices may seem like a good thing for consumers, deflation is generally bad for the economy. If prices fall below the cost it takes to produce products, businesses will likely be forced to cut production and slash payrolls. Rising unemployment would cut demand even further, sending the economy into a vicious circle. Deflation usually represents a system-wide contraction in demand, with consumers waiting on the sidelines as they wait for prices to decline even further. Economists expect more drops in consumer prices for several months, but most say deflation is still a long way off. Deflation usually represents large, sustained drops in consumer prices, but so far the economy has only recorded two consecutive declines. "It's a bit premature to say we're in a period of deflation," said Anika Khan, economist at Wachovia. "We've had two months of record declines, [and] deflation may be a far-off worry if that continues."

Is it really premature to worry about deflation? Then why is the yield on inflation indexed government bonds for 5-year and 7-year maturities higher than the yield on their nominal counterparts?

Kudlow on Corker’s Plan to Save GM

Forgive me but I did a silly thing this morning – I ventured over to read what the National Review was saying about the automobile bailout controversy. Is Lawrence Kudlow guilty of more mendacity or stupidity or both:

“Who lost the U.S. car business?” Right after the UAW vetoed a compromise, bankruptcy-lite, Detroit-little-three rescue plan put together by Tennessee Republican Bob Corker, UAW president Ron Gettelfinger played the blame game by blasting Corker and the Republican party for “singling out” union workers to shoulder the burden of reviving the U.S. car business. In truth, the UAW is to blame. If Sen. Corker’s plan had prevailed, with UAW support, many believe it would have had 90 votes in the Senate. GM could have gone forward with a clean-as-a-whistle balance sheet under a three-part restructuring plan that included a $60 billion bond-refinancing cram-down, a renegotiation of the $30 billion VEBA health-care trust, and a pay-restructuring plan that would put Detroit compensation levels in line with those of foreign transplants Honda, Toyota, Nissan, and BMW. Average compensation for the Detroit little three is $72.31. Toyota’s average wage is $47.60, Honda’s is $42.05, and Nissan’s is $41.97, for an average of $44.20. So Corker’s idea was to bring that $72 a lot closer to that $44.

Kudlow should know by now that this $72 an hour compensation claim is a crock. Count this claim as mendacity. But 90 votes in the Senate for Corker’s plan – that is off the charts! As far as a clean-as-a-whistle balance sheet, doesn’t Kudlow know how to read a balance sheet with GM’s showing about $170 billion in liabilities exceeding the book value of its assets by about $60 billion.

The ultimate whopper in this Kudlow canard was that Corker was trying to negotiate in good faith while the “UAW refused to make concessions”. If I were a conservative, I’d be completely embarrassed with the serial garbage that gets published under the name The National Review.

The concept of illegal and illegitimate debt

Last month a special debt audit commission in Ecuador released a report charging that much of that nation's foreign debt was illegitimate or illegal. "The commission evaluated all commercial, multilateral, government-to-government and domestic debt from 1976-2006".

Perhaps the most critical element of this commission's ruling is the charge that Paul Volker's decision to hike US interest rates to extraordinary and unprecedented levels in the late 1970s [1] constituted a "unilateral" increase in global rates that compounded Ecuador's indebtedness.

The loans to Ecuador, according to John Perkins in his 2004 book 'Confessions of an Economic Hit Man' were denominated in US dollars and designed from the outset to "to foment conditions that make [Ecuador] subservient to the corporatocracy running our biggest corporations, our government, and our banks." The conditions of the infrastructure loans were that "engineering and construction companies from our own country must build all these projects. In essence, most of the money never leaves the United States; it is simply transferred from banking offices in Washington to engineering offices in New York, Houston, or San Francisco." [2]

How legitimate can it be for, on the one hand, political leaders to be accepting loans on terms that leave their nations economically vulnerable, and on the other for the US to have the power to 'unilaterally' and unjustly increase loan liabilities for the world's poorest (and other) nations?

The long-term outcomes of such an international lending regimes have been disastrous. Since 1970 – in the period known as the ‘oil boom’ in Ecuador the official poverty level grew from 50 to 70 percent and under or unemployment increased from 15 to 70 percent. Public debt increased from $240 million to $16 billion. At the same time "Vast areas of rain forest have fallen, macaws and jaguars have all but vanished, three Ecuadorian indigenous cultures have been driven to the verge of collapse, and pristine rivers have been transformed into flaming cesspools."[3]

Ecuador's use of legitimacy as a legal argument for defaulting on their loans sets a major precedent in international finance and the global economy. "Indeed, the mere formation of a debt auditing commission does so." [4] There is no doubting, however, that the rapidly increasing poverty and hunger along with the dire state of the world's living environment means attention to the impacts of unreasonable and unjust debt regimes is long overdue.



[1] Paul Volker was then chairman of the US Federal Reserve.
[2] Confessions of an Economic Hit Man by John Perkins
Plume, 2005, paperback, 280 pp.,
http://www.ecobooks.com/books/ecohitman.htm
[3]Confessions of an Economic Hit Man by John Perkins
Plume, 2005, paperback, 280 pp.,
http://www.ecobooks.com/books/ecohitman.htm

As Crisis Mounts, Ecuador Declares Foreign Debt Illegitimate and Illegal
By Daniel Denvir, AlterNet. Posted November 26, 2008.
http://www.alternet.org/audits/108769/as_crisis_mounts,_ecuador_declares_foreign_debt_illegitimate_and_illegal/

Shock Doctrine in California

California is undergoing its own shock treatment. The Republicans are a minority, but they have enough votes to block the supermajority required to pass a budget. They have all signed a no tax pledge. They have a plan to balance the budget without taxes, by drastically cutting spending and destroying environmental and labor protections, such as giving employers flexibility to demand as much work for as many hours without overtime pay on any single day, so long as the number of hours does not exceed 40.

http://sacbee.com/topstories/story/1475895.html

Labor Shortage Among Immigrant Workers?

TalkingPointsMemo points us to an interesting article by Miriam Jordan:

The economic downturn is forcing tens of thousands of Hispanic immigrants to withdraw from the U.S. labor market, according to a new study, a development that suggests the migrants are facing unprecedented competition for blue-collar jobs that may prompt them to return to their countries of origin. In the third quarter of 2008, 71.3% of Latino immigrant workers were either employed or actively seeking work compared with 72.4% in the same quarter a year earlier, according to a new study by the Pew Hispanic Center, a non-partisan research organization. The 1.1 percentage point drop "marks a substantial decrease in the labor market participation of Latino immigrants," says Rakesh Kochhar, the Pew economist who prepared the report ... During the economic boom, immigrants entered the U.S. at the rate of more than one million each year. Last year, however, the country's foreign-born population grew by just half that, or about 500,000. Latin American workers bore the brunt of the collapse of the construction sector, which employs 20% to 30% all foreign-born Hispanics. As the housing market tumbled last year, they lost jobs in ever-greater numbers

.

I have one small nitpick – TPMs lead was “Study: Labor Shortage Driving Immigrants Out Of the Labor Market”. Jordan was clearly describing a labor market with excess supply – not excess demand. The folks over at TPM are smart enough to know the difference so I trust they will properly adjust their lead.

The report can be found here and notes that the decline in this group’s employment-population ratio was even greater as their measured unemployment rate rose.

Drop in Housing Values and Consumption Demand

CNNMoney reports:

American homeowners will collectively lose more than $2 trillion in home value by the end of 2008, according to a report released Monday. The real estate Web site Zillow.com calculated that home values have dropped 8.4% year-over-year during the first three quarters of 2008, compared with the same period of 2007.

Life-cycle models of consumption tend to suggest that a drop in wealth would lead to a decline in consumption. If one assumed that each $1 decline in wealth leads to a $0.05 decline in consumption, this $2 trillion estimated decline would mean a $100 billion decline in consumption. Real consumption (all figures 2000$) declined by almost $80 billion on an annualized basis last quarter. Since 2006QIV, consumption has increased by only $142.2 billion per year even though real GDP increased by $355.9 billion. Had the ratio of consumption to GDP remained at its 2006QIV level of 71.5 percent, we would be seeing an additional $112 billion in consumption demand.

Maybe a rise in savings might be seen as a good thing if investment demand were also rising, but currently the fall in investment demand is so large that it is largely wiping out the progress in export demand. As private consumption declines, we will need a boost from government purchases if we are to avoid what Keynes called the paradox of thrift.

Speaking of the paradox of thrift – check out this cartoon with hat tip to an Angrybear.

Stupidity, Cowardice, Stimulus

by the Sandwichman

In his "Tour of German Inflation" (in One-Way Street), Walter Benjamin singled out the expression, "things can't go on like this" as exemplifying the "stupidity and cowardice constituting the mode of life of the German bourgeois". Embedded in the expression is the unfounded conviction that, somehow or other, unpleasant conditions cannot be enduring ones. However, as Benjamin noted, "to decline is no less stable, no more surprising, than to rise."

Yesterday, in the New York Times, nine economists weighed in on what, in their opinion, would constitute the ideal stimulus package, given the constraints of a $500 billion total to be either spent, returned in tax cuts or some combination of the two. Of course, the underlying premise of any stimulus package is the growthodox conviction that "things can't go on like this" -- that the accustomed "economic growth" of the recent past should be the norm and interruption of that growth can only be an anomaly.

Get over it, suckers. Bernie Madoff had the economic stimulus package meme down pat. Madoff's estimated $50 billion Ponzi scheme was already 10% of the proposed $500 billion package. O.K., then, in twenty five words or less, what's the difference between a stimulus package and a Ponzi scheme (bearing in mind the operative concept, "German Inflation"; see also "Uh Oh...")?

GM, Chrysler and the Recovery Program

Time to shift frames on the auto bailout. The question lurking behind current thinking is “How can these companies make money again producing and selling cars?” This explains the obsession with labor costs, future product lines and the like. The short answer is probably, they can’t. Even if they do everything right from now on, a steadily shrinking car market is the logical implication of serious, grown-up carbon regulation. (I will post on that topic soon, focusing on the news from Europe.)

For an alternative, step back into history and consider the story of Lucas Aerospace, brilliantly chronicled by Hilary Wainwright and David Elliott in The Lucas Plan: A New Trade Unionism in the Making? Lucas made military aircraft and was facing devastating (but socially desirable) cuts in demand for their wares. Seeing the handwriting on the wall, production workers teamed up with engineers and conducted a detailed inventory of their firm’s capacity: what skills and resources they comprised. Then they canvassed a range of nonprofit organizations to find out what kinds of products served important social needs but were not being provided in the market, like improved prosthetic devices and equipment for upgrading railroad crossings. Putting two and two together, they proposed production plans to give the company a new lease on life. The final piece, however, never materialized. The social agencies needed the government to allocate funds for these new products, but the government didn’t come through, and Lucas eventually folded.

You can probably see where I’m going with this. Obama is proposing to spend hundreds of billions of dollars on public projects to restart the economy, and forward-thinking observers, like Jamie Galbraith, are pointing out that we need long-term restructuring, not just a quick burst of stimulus. Who will build the transit systems, smart two-way electrical grids and other components of a clean, green America? If the auto companies are liquidated, we lose a ton of capacity it will be difficult and expensive to replace.

Message to the Obama team: begin formulating the reconstruction plan as a set of receivables and be ready to energize producers from the outset, perhaps with contracts having a loan component.

Message to the UAW and progressive-minded professionals in the auto industry: don’t wait for your top management to shuck the business plans they’ve staked their careers on. Begin a Lucas-like process of discovering what you can produce, and convey this directly to the federal recovery folks.

Senate Republicans First Shot Against Organized Labor

Countdown discussed a memo entitled "Action Alert - Auto Bailout," which was sent to Senate Republicans Wednesday morning and states:

This is the democrats first opportunity to payoff organized labor after the election. This is a precursor to card check and other items. Republicans should stand firm and take their first shot against organized labor, instead of taking their first blow from it. This rush to judgment is the same thing that happened with the TARP. Members did not have an opportunity to read or digest the legislation and therefore could not understand the consequences of it. We should not rush to pass this because Detroit says the sky is falling.

But didn’t many of the same Senate Republicans who filibustered the auto bailout bill vote for TARP? Jonathan Chait notes a little irony in how these Senate Republicans played their hand:

if the White House follows through on its suggestion that it might use TARP funds to stave off bankruptcy, the GOP maneuver will have been a total disaster. Remember, the Republicans have leverage because they still have 49 Senate seats and the auto companies need their loans right away.And, indeed, Republicans have used their leverage to force wage concessions and not force the auto companies to start producing low-emissions vehicles. But if they've overplayed their hand to the point where the White House floats a loan until January, then the GOP's leverage will nearly collapse. When the new Senate and White House convene, the Democrats will cut a much better deal for themselves, with fewer or no wage cuts for workers and tougher environmental standards.

In other words, their ploy may have failed and now we know their true motivations was to let millions of workers lose their jobs for raw partisan purposes.

Uh Oh, Is the Dollar About to Collapse?

So, recently here Peter Dorman and I were commiserating over having largely called most of the current crises, only to fail to have seen the surge of the dollar as people "flew to quality," leading ultimately to the absurdity of negative yields on 90 day Treasury bills just a few days ago. A number of other commentators also have been beating themselves over the head for failing to foresee the dollar's strength (Brad DeLong and Arnold Kling, among others), although none of them were as prescient on other matters as Peter and me (ooh, ooh, such self-puffery).

However, in the last two days the euro to dollar rate has gone from about 1.27 to 1.33. Does this mean that the other shoe is about to drop, and that the world is about to become fed up with the dollar and run for their lives in the face of our ongoing massive current account deficit and historically unprecedented net foreign indebtedness, not to mention so much other baloney?

Senate’s Failure to Pass Automobile Bailout

As David Herszenhorn report this sad news, I have a few questions:

The Senate on Thursday night abandoned efforts to fashion a government rescue of the American automobile industry, as Senate Republicans refused to support a bill endorsed by the White House and Congressional Democrats ... So far, the Federal Reserve also has shown no willingness to step in to aid the auto industry, but Democrats have argued that it has the authority to do so and some said the central bank may have no choice but to prevent the automakers from bankruptcy proceedings that could have ruinous ripple effects … the Senate failed to win the 60 votes need to bring up the auto rescue plan for consideration. The Senate voted 52 to 35 with 10 Republicans joining 40 Democrats and 2 independents in favor ... The automakers would also have been required to cut wages and benefits to match the average hourly wage and benefits of Nissan, Toyota and Honda employees in the United States.

First of all – if only 40 Democrats voted for cloture, where were the other guys? Secondly, what is it that the Federal Reserve might do to keep the Big 3 alive until we have a new Congress and White House? Finally, when Mitch McConnell says he wants the UAW to eliminate their gap between their hourly compensation and that of those US employees of the Japanese car manufacturers, does he still (mistakenly) think that their current compensation is over $70 an hour?

Hilzoy suggests that the behavior of McConnell and his minions is not responsible. It is certainly true that some of their arguments against this bailout proposal have been dishonest.

Preemptive Coverup on Wall Street

The Wall Street Journal reported today that securities firms have a claw back clause that allows them to call back bonuses from people whose screw ups turn out to cost the company big bucks. ok. But Morgan Stanley's contract includes "reputational harm": which sounds like it would include people who tell tales out of school:

Grounds for invoking the provision include "the need for a restatement of results, a significant financial loss or other reputational harm to the Firm or one of its businesses," the memo said. Morgan Stanley's rule applies to 2008 bonuses and cash payouts vesting over a three-year period. The roughly 7,000 employees covered by the policy range from top brass to midlevel workers.

Patterson, Scott. 2008. "Securities Firms Claw Back at Failed Bets." Wall Street Journal (10 December).

Walking Backward into the Future...

by the Sandwichman

For a while in the 1990s I used a quote from a book review by Canada's new Liberal leader, Michael Ignatieff, in my signature file: "Only in mediocre art does life unfold as fate." As fate would have it, 12 years later I can now Google search the phrase and come up with 70 or so of my own musings from a decade ago. I was only able to find the originl source of the quote, "The Illusion of Fate" in the February 13, 1995 New Republic, by truncating the phrase.

Side-shadowing speaks to the contingent and haphazard way our lives unfold. This contingency leaves us with a haunted sense of lives that we might have lived, choices that we might have had good reason to make. Only in mediocre art does life unfold as fate. Yet all of us yearn, in Bernstein's words, for the possibility that our biography "will be revealed as destiny," and that "the life we ended up having was, from the outset, actually the only possible one." This is what makes us suckers for bad books.

Earlier in his review -- commenting on the demise of the "grand narratives" of Marx, Freud, Weber, Durkheim, etc. -- Ignatieff observed that the passing of those commanding theories "leaves us in a curious state of intellectual denudation. For theories of the past are always maps of a possible future. Now we are walking backward into the future, and without maps."

I wonder if Ignatieff will now, as Liberal leader, advocate a "contingent and haphazard" party program.

On Krugman's Nobel Prize Speech

One can access Paul Krugman's Nobel Prize speech at http://nobelprize.org/mediaplayer/index.php?=1072. In it he gives a pretty clear description of the new trade and new economic geography approaches, with some interesting discussion of how this fits with the broad history of urbanization in the US. Unsurprisingly he once again fails to cite important predecessors of these ideas, with him basically deserving credit for linking them and doing a good job of publicizing them with his clear models. The two names not mentioned that most deserved to be were Avinash Dixit, co-developer of the Dixit-Stiglitz model that is the key to "Krugman's" theories, with Krugman briefly noting that the theory ultimately came from industrial organization. The other was the first person to apply the Dixit-Stiglitz model to economic geography, who would be Masahisa Fujita, 1988, "A monopolistic competition model of spatial agglomeration: a differentiated product approach," Regional Science and Urban Economics, vol. 18, pp. 87-13124. Krugman is a better writer than the Japanese Fujita, but Fujita has done far more innovative work in this area than Krugman ever did, which I think Krugman knows as he later coauthored with Fujita, even as he did not cite him in his much cited 1991 paper in the JPE that used the same approach as Fujita. Having Dixit and Fujita share the prize with Krugman would have been appropriate and also given the prize to someone from East Asia for the first time. I hope that Krugman finally gets it right for the written version of his speecch and cites the even longer list than this of people who preceded him and deserve recognition for it by him. The model here is Stiglitz, whose reference list for his Nobel Prize speech paper goes on for 13 pages in the AER.

As for his remarks on the auto industry in Detroit, in the end his only explanation is that wages and medical care costs are too high in Detroit compared to the Deep South (no mention of legacy pension costs). Supposedly he was going to explain the problems of the auto industry in Detroit by his theory, which supposedly explains "agglomeration," but he made no reference to his theory other than a vague statement that economies of scale are declining, which supposedly has been going on since about 1965, according to him. However, how or why they have been declining was not explained by him. This rather puts to shame his bragging that he has explained "agglomeration," in contrast to all those pathetic people prior to him, whom he assiduously avoids citing, except for a couple of ancient scribes who used no math, so he can present himself as the great savior who uses math to lead us all to enlightenment regarding these important matters. If Detroit arose because of the factors laid out in his model, he does not say how this happened nor how they stopped holding so that Detroit is now doomed. Blaming high wage and medical care costs amounts to nothing more than de facto union bashing with no link to any version of his model discernible at all. A pretty pathetic performance all in all, especially after he went after Brian Arthur some years ago in Slate for supposedly overselling his role in describing increasing returns, which took Kenneth Arrow to come in and defend Arthur, noting that he, unlike Krugman, actually cited his appropriate predecessors.

Ignore the Guantánamo Confessions

So five accused planners of Sept. 11 want to confess, avoid a trial, and enter paradise via lethal injection. Their wishes should have no bearing on their cases. First, there is an alarming incidence of false confession, to the extent that, if guilt cannot be established by evidence, confession alone should not be decisive. One of the causes of false confession according to the Innocence Project, by the way, is torture and the threat of torture—not that this would have any relevance to Guantánamo inmates, of course. The second thing to consider is the larger significance of the legal case against these men. The damage done to America’s global reputation and to popular views about justice at home cannot be erased, but the first step toward recovery is a public embrace of the rule of law. If the evidence against them is sufficient, put them on trial. Demonstrate a commitment to truth and fairness of judgment. If they did in fact plot murder against innocent thousands, show the cruel calculation of their planning. And if the evidence isn’t there, the confessions don’t take its place.

Investing in Our Cities

Keynesian macroeconomics suggests that we need some sort of quick but temporary spike in government purchases to get us back to full employment. We would also want to spend these funds on high value projects. I used to drive on Los Angeles roads, which I know need a lot of work. It seems my former mayor is onto something:

Mayors across the country are calling on President-elect Barack Obama to invest in their cities when he takes office in order to get the economy back on track. A group of mayors met in Washington on Monday to lobby for federal funding for what they say are "ready-to-go" infrastructure projects. They want funding to go directly to their cities instead of being distributed on a state level. "Over the last eight years, there's been ... an absence of investment in cities, whether it's the infrastructure, public transportation, bridges, highways, schools, hospitals," Los Angeles, California, Mayor Antonio Villaraigosa said at a news conference on Capitol Hill. "We are here not for a bailout, but to present a recovery plan."

Now that I live in New York, I don’t drive as I ride our subways and my current mayor has chimed in:

The news conference coincided with the Conference of Mayors' release of a list of 11,391 "ready-to-go" infrastructure projects that would cost $73.1 billion. The report surveyed 427 cities across the country and includes roads, bridges, schools, city halls and other public works projects. The report says that those projects would create 847,641 jobs. "All of these projects and more involving our bridges and schools are ready to go. They've gone through the design and approval process. They've gone through all of the political requirements. They just need money," said Michael Bloomberg, mayor of New York City. The president-elect said over the weekend that he supports an economic stimulus plan that includes an overhaul of the nation's roads and bridges. According to a report by the American Association of State Highway and Transportation officials, roads and bridges in the United States need critical repairs that would total $64 billion, and construction could begin within six months if the federal government makes the funds available. That report found 5,148 road and bridge projects that are considered "ready to go." The mayors say that investing in their metropolitan economies is the most direct path to create jobs and jump-start the economy.

One of my big concerns is the proposed cutbacks in subway service and the proposed downsizing of the MTA workforce. It’s not that there is too little demand for subway services but rather a projected MTA deficit that has generated these fiscal contraction proposals. Maybe Mayor Bloomberg can ask the Federal government for some direct revenue sharing so the MTA does not have to initiate these cutbacks. With a little imagination, there are plenty of areas where high value investments in our cities can be found, which would also have beneficial Keynesian effects. The story continues with a debate as to whether having the governors oversea this would lead to a better allocation of resources versus just the slowing the process down.

Of course, I’d rather spend our Federal funds on local infrastructure than more war machines.

Update: I have included a graph showing government spending (Federal, state, and local) on transportation (TRAN) and education (EDUC) as shares of GDP from 1959 to 2007. The 1.8% share for transportation is certainly less than what between 1959 and 1976 with this share declining over time. The education share peaked in 1975 at 5.66% and was 5.4% last year. Whether or not we spend too much or too little on schools, however, cannot be ascertained by anecdotal evidence on how recently a school has been refurbished as one follows Bill Kristol around.

Kristol’s Fiscal Stimulus Proposal – Make War Not Schools

Bill Kristol finally admits it – modern day Republican leaders have not been championing smaller government:

Five Republicans have won the presidency since 1932: Dwight Eisenhower, Richard Nixon, Ronald Reagan and the two George Bushes. Only Reagan was even close to being a small-government conservative. And he campaigned in 1980 more as a tax-cutter and national-defense-builder-upper, and less as a small-government enthusiast in the mold of the man he had supported — and who had lost — in 1964, Barry Goldwater. And Reagan’s record as governor and president wasn’t a particularly government-slashing one. Even the G.O.P.’s 1994 Contract With America made only vague promises to eliminate the budget deficit, and proposed no specific cuts in government programs.

Tiny correction – any fall in nondefense Federal spending under Reagan was offset by the increase in defense spending with the ratio of Federal spending to GDP being unchanged during the Reagan years as President. So Reagan did not cut taxes – he deferred taxes. But let’s fast forward to what Kristol would do with Federal spending today:

Similarly, if you’re against big government, you’ll oppose a huge public works stimulus package. If you think some government action is inevitable, you might instead point out that the most unambiguous public good is national defense ... Obama wants to spend much of the stimulus on transportation infrastructure and schools. Fine, but lots of schools and airports seem to me to have been refurbished more recently and more generously than military bases I’ve visited.

Kristol in other words opposes government investment in schools and roads but supports spending on items that would at best not be used and at worst kill people and destroy infrastructure – obviously inconsistent with long-term growth or credible supply-side economics!

Thoughts from the Great Depression

As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.

(Eccles, Marriner S. 1951. Beckoning Frontiers: Public and Personal Recollections (New York: Alfred A. Knopf): p. 76



Eccles ran the Fed under Roosevelt

Some people who contributed to creating the preconditions for the Depression developed understood that their greatest contribution would be to get out of the way.

In December 1932, Calvin Coolidge spent an afternoon in idle talk with an old friend. "We are in a new era to which I do not belong," he finally said, "and it would not be possible for me to adjust myself to it. These new ideas call from new men to develop them. That task is not for me who believe in the only kind of government that I know anything about". In another three weeks, Coolidge was dead.

Schlesinger, Arthur. 1957. The Crisis of the Old Order, 1919-33 (Boston: Houghton, Mifflin): p. 457, internally citing Stoddard, Henry Luther. 1938. It Costs to be President (New York: Harper & Brothers): p. 146.

"Lunatic Scheme" a Qualified Success

by the Sandwichman

In the wake of Friday's dismal employment report, New York Times editor Adam Cohen is channeling the Sandwichman:

One way to reduce the need for layoffs would be to cut back on hours, spreading the available work among more employees. This was an idea that had considerable currency in the Great Depression. In 1933, the Senate passed a “30 Hour Bill” that would have barred from interstate commerce goods made by workers employed more than 30 hours a week. Its sponsor, Senator Hugo Black of Alabama, said the bill would create six million new jobs. It made no sense, he insisted, for some employees to work 70 hours a week "while others are driven into poverty and misery from unemployment."

But didn't they try this in France and wasn't it a fiasco -- a "lunatic scheme" that brought "seven years of rising unemployment, economic stagnation, and general malaise"?



Well, no. The 35-hour policy was a "qualified success." But you wouldn't have known that from reading the English speaking press. Sandwichpal Anders Hayden tells the story:

France’s 35-hour workweek is one of the boldest progressive reforms in recent years. Drawing on existing survey and economic data, supplemented by interviews with French informants, this article examines the 35-hour week’s evolution and impacts. Although commonly dismissed as economically uncompetitive, the policy package succeeded in avoiding significant labor-cost increases for business. Most 35-hour employees cite quality-of-life improvements despite the fact that wage moderation, greater variability in schedules, and intensification of work negatively impacted some—mostly lower-paid and less-skilled—workers. Taking into account employment gains, the initiative can be considered a qualified success in meeting its main aims.

Sandwich man!

The New York Times
November 21, 2008

Bebeto Matthews/Associated Press
Caption: "Paul Nawrocki of Beacon, N.Y., wore a signboard this week in Midtown Manhattan advertising his need for a full-time job with benefits. He said he has been looking for work for nine months."

See also: Business Week.

New Radio Interview

I just had a wonderful time talking with Kris Welch about the economic crisis for the second half of her hour long show on KPFA. She is such an enthusiastic host that she brings out the best in her guests.

http://aud1.kpfa.org/data/20081205-Fri1200.mp3

Sandwichman's KEYNESIAN Stimulus Plan

by the Sandwichman

The concept of the Sandwichman's stimulus plan is extremely simple: a basic income guarantee of $145.68 a week combined with a voluntary annual cap on hours of work at 1,600 hours. The rationale for this approach is that this is not your grandfather's depression. The nature of work has changed. It is not feasible to continue treating the environment as if it was an economic "externality". Historical evidence and real economic theory (as opposed to textbook lore) support the strategy outlined in the Sandwichman plan.

The Sandwichman plan would create an estimated 12.5 million jobs! Yes, but is is Keynesian?

Although the total cost of the stimulus plan is indeterminate, a maximum is easily calculated at $1 trillion for an annual payments of $5,827.20 to 200 million non-retirement age adults. As the payments themselves will be taxable income, the actual outlays are reduced by, say 15 percent. But even that amount would be reduced again by the fact that some of the payments will act as replacement for current income support payments such as welfare, unemployment insurance, disability pensions and so on. The $5,827.20 amount comes from basing the figure on the median wage ($18.21) times eight hours for 40 weeks (assuming 10 current statutory holidays and two week vacation).

Part-time workers and low-wage earners would get an income boost from the median wage supplement. Similarly, it is proposed that other income support payments should not be reduced by the full amount of the basic income guarantee.

Furthermore, because the hours cap will be voluntary, a portion of the total will be clawed back as the result of higher-income earners choosing to work longer hours. The cap on annual hours of work will provide for a deduction of $18.21 for each hour worked beyond 1,600 a year. Some flexibility could be added by a provision enabling banking of, say, a maximum of 200 hours a year for up to seven years. In such cases the clawed-back amount could be reserved in a registered sabbatical saving account.

The 1,600 hour cap is based on an assumed four-day, 32-hour work week, with two weeks annual vacation. But those 40 freed days could be taken in a block as extra vacation time.

Job creation in the Sandwichman plan results from the massive volume of hours of work "released" back into the labor market through the reduction of the annual hours of work. The raw numbers (from the 2007 American Community Survey) are mind-boggling. There are somewhere around 240 billion hours worked a year in the U.S. Obviously, not all of those hours can be spread around. But according to Bosch (2000) "most studies" find an employment result in the range of 25 to 70 percent of the "arithmetically possible effect."

The Sandwichman, however, is skeptical about the job creating potential of overly long work weeks. In the ACS survey, some people reported working 99 hours a week or more. I don't consider such statistical noise as productive work that can be parceled up into three pieces. To get around that problem, I've marked down to 2400 hours all current annual hours in excess of that amount. That reduces the "arithmetically possible effect" of the stimulus plan to a mere 31,000,000 jobs!

Assuming Bosch's estimate of 25 to 70 percent of that effect, that suggests somewhere between 6.5 million and 18 million jobs, with 12.5 the happy medium between those two figures.

How Large of a Keynesian Multiplier Do You Want?

David Tufte is not happy with some claim that the multiplier can be as high as 5:

UB suggests that it has a multiplier of 5. If they did, this would be like the goose that laid the golden egg. My gosh, all they'd have to do is appropriate $140B to UB, and they could pay for the whole $700 Federal bailout ... A more telling multiplier is the economic impact divided by the whole UB budget of $832M, to get a multiplier of 1.8. I think that seems a lot more reasonable than 5 to 1.

A multiplier of 1.8? That is what Dani Rodrik comes up with if we keep our international markets open but:

The size of this multiplier depends in turn on three things in particular, the marginal propensity to consume (c), the marginal tax rate (t), and the marginal propensity to import (m). If c=0.8, t=0.2, and m=0.2, the Keynesian multiplier is 1.8 (=1/(1-c(1-t)+m)). A $1 trillion fiscal stimulus would increase GDP by $1.8 trillion. Now suppose that we had a way to raise the multiplier by more than half, from 1.8 to 2.8. The same fiscal stimulus would now produce an increase in GDP of $2.8 trillion--quite a difference. Nice deal if you can get it. In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do--but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care?

Maybe SUNY-Buffalo has figured out a way to make sure that its extra spending does not leak out into the surrounding communities – which would mean a multiplier larger than what David Tufte considers reasonable!

The world-wide web of misinformation

So I give a test that asks students something about Ricardian equivalence, which we had studied using two-period framework a la Fisher. We had looked in particular at the difference between the effects on the interest rate of changes in deficit-financed tax cuts (zero) and deficit-financed government spending increases (positive). Well a certain false sentence kept popping up in several exams - say 10%. I immediately suspected the web, and sure enough, in the Wikipedia article on Ricardian equivalence, I read:

Ricardian equivalence states that a deficit-financed increase in government spending will not lead to an increase in aggregate demand. If consumers are 'Ricardian' they will save more now to compensate for the higher taxes they expect to face in the future, as the government has to pay back its debts. The increased government spending is exactly offset by decreased consumption on the part of the public, so aggregate demand does not change.

This is not just wrong, it is flagrantly wrong. I'm sure everyone has their favorite examples of Wikipedia falsehoods, so I'm not saying anything new here. File under: The Wisdom of Crowds: NOT!

A Bleak Employment Situation

BLS reports the bad news:

Nonfarm payroll employment fell sharply (-533,000) in November, and the unemployment rate rose from 6.5 to 6.7 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. November's drop in payroll employment followed declines of 403,000 in September and 320,000 in October, as revised. Job losses were large and widespread across the major industry sectors in November ... In November, the labor force participation rate declined by 0.3 percentage point to 65.8 percent. Total employment continued to decline, and the employment-population ratio fell to 61.4 percent.

The household survey showed an employment decline of 673,000. BLS also notes:

Over the month, the number of persons who worked part time for economic reasons (sometimes referred to as involuntary part-time workers) continued to increase, reaching 7.3 million. The number of such workers rose by 2.8 million over the past 12 months. This category includes persons who would like to work full time but were working part time because their hours had been cut back or because they were unable to find full-time jobs.

The rise in the unemployment rate sounds bad but the situation is actually worse as the fall in the labor force participation (LFP) rate masked the effect on employment relative to the population (EP). Our graph shows the two series ever since January 1999 to give some context as to how the labor market is faring today as opposed to almost 10 years ago. The need for some sort of aggregate demand stimulus could not be more clear.

Big 3 Automobile Woes and Union Wages

Kendra Marr and Steven Mufson blame the UAW:

Over the past three decades, they have lost ground to more agile foreign rivals that favored smaller cars built by non-unionized labor at lower wages.

Really? So what are the wages for the foreign rivals? They don’t tell us. Last night – Rachel Maddow did - $25 an hour. Oh, but UAW wages are $70 – right? No, try $28 an hour. Hat tip Dean Baker who adds:

Actually, many of these cars were built in unionized factories in Japan, South Korea, and Germany. Unions didn't keep foreign manufacturers from producing high-quality popular cars in these countries. Even when these companies set up shop in the U.S. they have been able to work well with unions. Toyota operated a plant in California where the workers were represented by the UAW for decades (it may still be open). There may have been problems with the way the Big Three management dealt with unions, but other car companies have been able to operate very effectively with a unionized workforce.

We will likely learn in a few hours that more workers have lost their jobs. And yet incompetent writers for the Washington Post still have theirs?

Dead Keynes Blogging

by the Sandwichman

The Sandwichman is still wondering how economists make up their guesses about how $x billion dollars of fiscal stimulus (AKA "deficit spending") will create y million jobs.

Yves Smith says they find them on the back of an envelope. Greg Mankiw says econometrics doesn't always confirm the predictions of textbook Keynesian models. Martin Wolf mentions something about how "deficits aimed at sustaining demand will be piled on top of the fiscal costs of rescuing banking systems bankrupted in the rush to finance excess spending by uncreditworthy households via securitised lending against overpriced houses." Don't you love that house-that-Jack-built volute?

Whew! It can be easy to forget that the issue here is unemployment. As Paul Krugman notes, the US employment report comes out tomorrow, Friday. "The economy is falling fast. We’ll see what tomorrow’s employment report says, but we could well be losing jobs at a rate of 450,000 or 500,000 a month."

Coming Soon: The Sandwichman Stimulus Plan. I'll show you my back of the envelope calculations.

A Golden Oldie: Invest in People

Now that stimulus is just around the corner, we are hearing more discussion of what form it should take. There is a general desire to prop up state budgets, so that legislatures are not forced to cut spending on services in the middle of a slump—a good idea. There is also an interest in putting money into roads and bridges, usually referred to as our “crumbling infrastructure”—another good idea. Here I want to broach a third.



The ranks of the unemployed are increasing by as much as half a million a month. Even if we can stop the plunge, we are in for a long, slow season, and the need for structural change in the economy guarantees that large numbers of us are going to have a rough time getting our working lives back on track. The silver lining to this very dark cloud is that it gives us an opportunity to take time out, to go back to school to get new skills, perspectives and perhaps even life goals. Already applications are up at two- and four-year colleges around the country. Meanwhile, however, the credit crunch is making it hard for prospective students to find loans, funding cutbacks are driving rapid tuition increases, and higher education is being starved for the resources it needs to continue at the same level of service, much less the increased level needed to meet the demand.

So the solution is clear: the third big piece of the coming stimulus, overlapping somewhat with revenue sharing, should be a commitment to education—to turn the tragedy of unemployment into the promise of a new beginning. Our universities, community colleges and other institutions have a model that is intrinsically scalable; give them more money and very quickly they will be able to create more seats in more classrooms, with little or no reduction in quality. There is a vast body of economic research that shows that this is one of the most productive investments we can make as a society, one that will bring returns to us as individuals and as a country long after the immediate crisis has passed.

One nice twist to this idea is that it could be accompanied by introducing a new system of tuition financing that works on both the individual and macroeconomic levels. It goes like this: students take out loans from a government agency, but instead of paying back the precise amount they borrowed, they agree to a modest tax surcharge on their earning for several years after they graduate. If they end up with high-paying jobs, they pay back more into the student loan system. If they end up with lower-paying jobs, they pay less. The overall terms, the percent of the surcharge and the number of years, are set so that, over all the graduates combined, the money borrowed is equal to the money returned. This is a progressive approach that scales the financial contribution of those who benefit from college to their ability to pay, and it reduces the pressure on borrowers to take the most lucrative jobs rather than the ones that appeal to their interests and ideals. (More schoolteachers and fewer bond traders would be a small but positive benefit of this approach.) I don’t know who first came up with this idea, but I associate it with the late, great Ben Harrison.

From a macro point of view, instituting this reform at the same time fiscal deficits are being jacked up to pay for the immediate expansion of education sends a strong signal that those deficits are temporary. They will help pull us out of the slump, but over the longer term we are putting in place a mechanism to more fully finance tomorrow’s students. The US Treasury is currently able to borrow as much as it wants at a near-zero interest rate, but this will not last forever. At some point skepticism about the fate of the dollar will start to mount, and it will be necessary to demonstrate that fiscal policy is sustainable. Reforming tuition finance is not everything, but every $50 billion or so helps.

Mark Sanford, John McCain, and Herbert Hoover

Rich Miller and Matt Benjamin report that one of John McCain’s economic advisors during the campaign is now calling for $1 trillion in fiscal stimulus over the next two years:

economists from across the political spectrum are raising the ante on how much the government should lay out. Some are now calling for at least a $1 trillion boost. Kenneth Rogoff, a Harvard University professor who was an adviser to Republican presidential candidate John McCain, and Joseph Stiglitz, a Nobel Prize winner who served in President Bill Clinton’s White House, are among those who say President- elect Barack Obama should push for a package of that size. “They need a stimulus of $500-to-$600 billion a year for at least two years to counter what is going to be a collapse in consumption,” said Rogoff, a former chief economist at the International Monetary Fund.

Mark Sanford on the other hand wants fiscal restraint:

South Carolina's Gov. Sanford is resisting the urge to propose or accept raising taxes. Faced with a shortfall, Gov. Sanford reconvened the state Legislature in October, and it made $488 million in targeted budget cuts. Gov. Sanford, unlike most of his colleagues, speaks out against any federal bailouts, including a fiscal stimulus bill that is likely to include state aid. "When times go south you cut spending," Gov. Sanford said. "That's what families do, that's what businesses do, and I don't think the government should be exempt from that process."

Publius calls this Sanford-nomics:

This is of course dead wrong -- and confuses microeconomics with macro, as any student of Econ 101 could tell you. The micro-considerations of an individual family or business has nothing much to do with what governments need to do to get the larger economy moving again. (Or just go read someone who actually knows what he's talking about - Krugman). Even worse, it's often affirmatively harmful to adopt microeconomic solutions to macroeconomic problems. Hoover: Ain't that the truth ... One larger point here is that, while "rising stars" like Sanford and Jindal may be individually compelling, they must operate within a Republican Party that has enthusiastically embraced ignorance on a whole host of subjects, economics included. The issue is whether they can escape these constraints.

Despite the fact that Kenneth Rogoff tried to advise John McCain during the campaign – McCain also called for reductions in government spending. Go figure.

Is it true that foreigners finance American debt? - Update 2

The inexplicably high relative value of the US dollar, in the context of a badly-managed domestic economy that is now in recession - prompts the question as to why the demand for this currency worldwide is so large. Who is actually purchasing the US Dollar and why?

Are foreigners denied other currency options under the weight of US dollar hegemony? Perhaps many of these foreigners are not 'foreign' at all but merely the international subsidiary branches of US corporations. A Hong Kong based economist Enzio von Pfeil makes the point that many politicians and trade theorists still apply "the thinking and measurement of trade balances that was developed 500 years ago in Italy." He says that this is innapropriate in a world now vastly changed and where giant Western multinational corporate conglomerates dominate cross-border international exchange.


A huge portion of international trade could be more accurately described as NON-MARKET/NON-TRADE. Intra-corporate 'trade' between branches of the same (mostly US) transnational corporations. “In North America trade associated with U.S. parent multinationals or their foreign affiliates accounted for 54 percent of U.S. exports of goods and 36 percent of imports. Forty percent of trade between the US and Canada in 1998 was intra-corporate. “Forty percent of the US-Europe trade is between parent firms and their affiliates, and in respect of Japan and Europe, it is 55 per cent; with regard to US-Japan trade, it is 80 %.”[2]

Enzio von Pfeil logically asks: “What is meant by "foreign ownership?...Are we talking about "pure" foreigners, or also about U.S. citizens as well as MNCs with overseas financial vehicles? He points to problems with the official Treasury records that detail the owners of US 'foreign' debt - "there appear to be no data available on how much U.S. Treasury debt is held by U.S. MNCs . What, he says, do U.S. MNCs do with at least a portion of all of that money they are making in their fabulously successful overseas operations? Optically, there is an extremely good "fit" Between the overseas investments of U.S. MNCs and "foreign" ownership of America's federal debt. This suggests that plenty of U.S. government debt is held legally by American MNCs in legitimate foreign tax havens.” [1]

International trade (and global intra-corporate transactions) is dominated by the use of a single currency - US dollars.

"...At present, approximately two thirds of world trade is conducted in dollars and two thirds of central banks' currency reserves are held in the American currency which remains the sole currency used by international institutions[3] The US provides the world - but mostly itself- with these dollars by buying goods (such as oil and other commodities), and services produced by US corporations in foreign countries. Since the US does not have a corresponding need for foreign currency, it sells far fewer goods and services in return...." [3]

Clearly, the privileged position of the US, in terms of its relative lack of need to earn foreign currencies, is a large contributer to an ongoing over-valuation of its currency. But the huge global shadow financial system must surely have an even greater impact.

When we look at trade deficits, rather than financial deficits, the UK and US do not fare well and these nationas are also the homes of the largest transnational corporations. Clearly the governments of these two countries have actively encouraged this paradigm of trade imbalance in the first instance. They have heavily subisided their corporations on an ongoing basis, given generous grants for them to extend their operations in other nations and their artificially high exchange rates have allowed these large MNCs to accumulate foreign productive assets relatively cheaply in other countries.[4] Essentially it is corporate imperialism by another name.

Finally, there's the third world debt crisis. One created by the deliberately lax lending policies of large US (and London) banks [5]. Euromarket 'cowboy' salesmen from Citibank and others pushed unaffordable loans onto the leaders of 'developing' nations and the consequent debt repayments have acted as a heavy tax on every household within their borders. A tax that had to be paid (again) in overvalued US dollars [6]. This debt, as such, has been used as an instrument of exploitation and control and its repayment continues to perpetuate and worsen global currency and trade imbalances.

[1] Trade myth five : foreigners finance America by Enzio von Pfeil, Hong Kong.
http://www.asiasentinel.com/index.php?option=com_content&task=view&id=1482&Itemid=469&limit=1&limitstart=1
Also see: http://k.daum.net/qna/view.html?qid=3gnR7

[2] It's NOT international trade. Don't be fooled. Brenda Rosser. Thursday, July 24, 2008
http://econospeak.blogspot.com/2008/07/its-not-international-trade-dont-be.html

[3] 'Petrodollar or Petroeuro? A new source of global conflict.' By Cóilín Nunan. Accessed on 8th August 2008. http://www.feasta.org/documents/review2/nunan.htm

[4] Now that these same corporations are caught in a recession with high levels of debt are we now seeing a taxpayer-funded bailout of these same multinational corporations?

[5] And those London banks also involved in Euromarket lending.

[6] Witness Paul Volker’s raising of US interest rates to usury levels in October 1979 to maintain US dollar hegemony when the currency came under attack the year before. The most alarming result was that much of the third world debt ‘sold’ by large US banks became permanently unpayable.

Where I Was Wrong About The Current Economic Crisis

There seem to be lots of econoblogsters confessing their sins of bad forecasting out there. I will do so also, perhaps especially because I have been parading around the econoblogosphere bragging about having called the housing bubble, the derivatives mess, and that the whole thing would lead to a recession, without having called the latter too early as some who are now being widely praised did. My error was to think that the crash of the housing bubble would lead to a long-awaited crash of the dollar, given that perhaps the most extreme of deep imbalances in the world economy is the massive US current account deficit that has led to the US becoming by far the largest net foreign debtor in world history. I thought the housing and derivatives crashes would catastrophically crash the dollar. I was wrong.

Instead we had that old bizarre phenomenon of the dollar as the ultimate "safe haven," with US Treasury securities being the ultimate safe haven within the safe haven, even as measurable risk spreads on such securities have widened noticeably in this crisis (heck, nothing is safe). So, instead of the dollar crashing, it has risen noticeably in the last few months, from a low of around 1.6 to the euro to around 1.26 today, or thereabouts. And 90-day Treasury bills are yielding an astoundingly low one basis point, which is effectively negative in nominal terms, given purchase fees, and while looking like a nasty liquidity trap, does not at all indicate any problems for the US Treasury in borrowing money, despite our massive foreign indebtedness and dependence on the kindness of strange foreigners, especially the Chinese, to fund our forthcoming fiscal stimulus.

Jonah Goldberg’s Stimulus Proposal – Temporary Tax Cuts

If you want your kids to learn economics, do not send them to the National Review school of economics:

But rather than blow money on a lavish reenactment of the New Deal, or continue bailing out undeserving corporations, why not really think outside the box? Rep. Louie Gohmert (R., Texas) suggests an across-the-board reprieve on paying 2008 income taxes. This would leave an extra $1.2 trillion in the hands of Americans, who are the best stewards of their own money.

I guess Mr. Goldberg never heard of the Ando-Modigliani life-cycle model of consumption or Milton Friedman’s permanent income hypothesis. These models would predict that much of this tax rebate would be saved and not consumed. Hey, wasn’t that the explanation for why Bush’s version of this did so poorly as far as stimulating aggregate demand?

Update: I emailed Mr. Goldberg a link to this post and he was not particulary amused. His retort?

Heaven forbid Americans save their money, which usually amounts to putting it in the market, 401ks

That confirms it - he has no idea that the issue at hand is insufficiency of aggregate demand yet he deems himself qualified to write a post on this topic. Go figure!

Cost and Benefits from a Fiscal Stimulus: Baker, Krugman, and Even the FED Chairman Tend to Agree

Dean Baker says Greg Mankiw gets something slightly amiss in Greg’s praise of Keynesian economics:

Greg Mankiw must know better than he indicates in his analysis of debt in today's NYT. He complains that efforts to use large-scale stimulus to boost the economy may put excessive burdens on our children.

Dean’s accounting is a must read and makes sense if one accepts the fixed interest rate version of the Keynesian multiplier. Paul Krugman has a similar take and explains:

Right now there’s intense debate about how aggressive the United States government should be in its attempts to turn the economy around. Many economists, myself included, are calling for a very large fiscal expansion to keep the economy from going into free fall. Others, however, worry about the burden that large budget deficits will place on future generations. But the deficit worriers have it all wrong. Under current conditions, there’s no trade-off between what’s good in the short run and what’s good for the long run; strong fiscal expansion would actually enhance the economy’s long-run prospects. The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing “crowds out” private investment — that the government, by issuing lots of debt, drives up interest rates

Paul seems to think we are in a liquidity trap where monetary policy is powerless and fiscal policy’s potency is not offset by this crowding-out effect. Ben Bernarke appears to be saying similar things:

Federal Reserve Chairman Ben Bernanke said Monday that further interest-rate cuts are "certainly feasible," but he warned there are limits to how much such action would revive an economy likely to stay weak well into next year. The Fed's key interest rate now stands at 1 percent, a level seen only once before in the last half-century … "Although further reductions ... are certainly feasible, at this point the scope for using conventional interest rate policies to support the economy is obviously limited," Bernanke said in the speech. The Fed can lower its key rate only so far — to zero — and it's getting ever closer to that threshold. Bernanke said there are other ways that the Fed might bolster economic activity. The Fed, for instance, could buy longer-term Treasury or agency securities on the open market in substantial quantities, he said. This might lower rates on these securities, "thus helping to spur aggregate demand," Bernanke said. Given the limits to how low the Fed can go in reducing interest rates, the central bank over the past year has resorted to a flurry of other radical — and often unprecedented actions — with the hope of busting through credit jams and getting financial markets operating more normally.

This Federal Reserve deserves a lot of credit for doing what it can to alleviate the recession – but clearly it needs help from the fiscal side as well. Even Greg Mankiw agrees with this Keynesian premise. Let’s hope Congress goes along with the President-elect on this one.

Breaking News – Recession Started a Year Ago

MarketWatch reports:

The U.S. economy entered a recession in December 2007, a committee of economists at the private National Bureau of Economic Research said Monday. The economy reached a peak in December and has been declining since, according to the business cycle dating committee of the NBER.

While this sounds about right, many of us have been saying we’ve been in a recession for many months now. Glad the NBER finally made it official and here’s hoping we don’t have to wait very long for the recovery. Oh wait – we have to wait another 50 days to have a real President. Ahem!

The Second Coming of J. Maynard Keynes

by the Sandwichman

It's official. Big fiscal stimulus package is the flavor of the day! Let's get fiscal, fiscal. I wanna get fiscal. Let's get into fiscal. Let me hear your money talk, your money talk, Let me hear your money talk.

Sandwichman was wondering, though, "how do they get from $X billion of fiscal stimulus to X million jobs created?"

Dean Baker must have been reading my mind. "Assuming that employment is roughly proportional to output..."

Is that all there is?

Percent of GDP in additional government spending times multiplier equals percent increase in GDP and -- assuming an employment effect roughly proportional to output -- equals percent increase in employment?

Is that actually how economists estimate the employment effect of a fiscal stimulus package? Because if it is, the old Sandwichman has news for you economist folks:

EMPLOYMENT IS NOT ROUGHLY PROPORTIONAL TO OUTPUT.

But you already knew that, didn't you?

New Deal Economics: George Will Trumps Amity Shlaes for Stupidity

Paul Krugman has busy keeping up with the nonsense from Amity Shlaes and George Will so we should forgive him for not covering every point.

I was going to let the following Schlaes line go even if this graph shows that total government spending and revenues did not significantly rise as a share of GDP during FDR’s first two terms:

New Dealers raised taxes again and again to fund spending.

But then Will had to compound the nonsense with:

But people whose recipe for recovery today is another New Deal should remember that America's biggest industrial collapse occurred in 1937, eight years after the 1929 stock market crash and nearly five years into the New Deal. In 1939, after a decade of frantic federal spending -- President Herbert Hoover increased it more than 50 percent between 1929 and the inauguration of Franklin Roosevelt -- unemployment was 17.2 percent.

One graph in this post does show an increase in Federal spending as a share of GDP during Hoover’s Administration - but for the 1929 to 1937 period, the increase in Federal revenues offset the increase in Federal spending. But could someone tell Mr. Will that Hoover was not President during the New Deal era?

Paying Interest on Bank Reserves

Since Peter Dorman has been questioning the Fed’s decision to pay interest on bank reserves, I thought it would be interesting to note how Real Time Economics posed the case for this decision:

Banks are required by law to hold a certain fraction of their deposits in reserve accounts at the Fed, but receive no interest on these deposits. Having the authority to pay interest would solve two technical headaches for the Fed. If they earned interest from the Fed, banks would have no incentive to lend out excess reserves for less. That would make the Fed’s benchmark federal-funds rate, which banks charge on overnight loans to each other, less likely to plunge below the Fed’s official target — now 2% — on days when the banking system was awash in cash. In addition, the Fed could theoretically combat the credit crunch by buying securities or extending loans without limit without causing the federal-funds rate to fall to zero, something that could fuel inflation or distort markets.

In other words, the concerns were that banks would hold too few reserves and that we would end up with higher inflation. But today’s concerns seem to be that banks are holding onto too many reserves and that we may be in for a deflationary spiral and inadequate aggregate demand.

This post also noted that Congress originally intended for interest to be paid on reserves starting in 2011 out of concern that the government might lose income to private banks. While pumping a few extra millions of dollars into the private sector right now might be good Keynesian economics, perhaps delaying this new policy until 2011 would have been better given the collapse of the money multiplier.

Conservatives – Relax: Government Ownership of Banks Will Not Be Permanent

Phillip Stevens seems worried that we’re turning into socialists:

We are watching a bonfire of the old orthodoxies as well as of the vanities. This week Barack Obama promised to spend hundreds of billions of taxpayers’ dollars to prop up the sinking US economy. Gordon Brown’s British government announced it would soak the rich to pay for an economic rescue package … "Something big is happening. What started out as a series of pragmatic ad hoc responses by governments and central banks is moving the boundary between state and market. Politicians are now overlaying expediency with ideology. Government is no longer a term of abuse. Things could move still faster in the months ahead. With their myriad rescue schemes and loan guarantees, the US and British governments have nationalised their respective banking systems in all but name. The banks pretend they are still answerable to their shareholders, but it is a charade. They survive only with the explicit financial guarantee of the state. Still, the markets remain frozen, starving business of the oxygen of credit. Unless things change soon, the politicians will have little choice but to take direct control, and quite possibly, ownership, of the banks. Nationalisation could be the first act of an Obama presidency.

Please! The free market is not working that well right now so government has to step in lest we face a major recession. Paul Krugman calmly explains what we should be doing:

What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. Reform of the weaknesses that made this crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policymakers around the world need to do two things: get credit flowing again and prop up spending ... The obvious solution is to put in more capital. In fact, that's a standard response in financial crises. In 1933 the Roosevelt administration used the Reconstruction Finance Corporation to recapitalize banks by buying preferred stock—stock that had priority over common stock in terms of its claims on profits. When Sweden experienced a financial crisis in the early 1990s, the government stepped in and provided the banks with additional capital equal to 4 percent of the country's GDP—the equivalent of about $600 billion for the United States today—in return for a partial ownership. When Japan moved to rescue its banks in 1998, it purchased more than $500 billion in preferred stock, the equivalent relative to GDP of around a $2 trillion capital injection in the United States. In each case, the provision of capital helped restore the ability of banks to lend, and unfroze the credit markets … My guess is that the recapitalization will eventually have to get bigger and broader, and that there will eventually have to be more assertion of government control—in effect, it will come closer to a full temporary nationalization of a significant part of the financial system. Just to be clear, this isn't a long-term goal, a matter of seizing the economy's commanding heights: finance should be reprivatized as soon as it's safe to do so, just as Sweden put banking back in the private sector after its big bailout in the early Nineties. But for now the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots. Nothing could be worse than failing to do what's necessary out of fear that acting to save the financial system is somehow "socialist."

Exactly. Paul also turns his attention to the need to increase government spending:

The next plan should focus on sustaining and expanding government spending—sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.

We should also keep in mind that this boost in spending will not be a permanent increase in the size of the government. The President-elect has already told us he intends to find ways of scaling back portions of Federal spending over the longer-term. Conservative critics would do well to stop and think about the difference between the short-term economic crisis versus long-run economics before writing silly things like this op-ed from Mr. Stevens.

Collapse of the Money Multiplier

Paul Krugman writes:

A central theme of Keynes’s General Theory was the impotence of monetary policy in depression-type conditions. But Milton Friedman and Anna Schwartz, in their magisterial monetary history of the United States, claimed that the Fed could have prevented the Great Depression — a claim that in later, popular writings, including those of Friedman himself, was transmuted into the claim that the Fed caused the Depression. Now, what the Fed really controlled was the monetary base — currency plus bank reserves. As the figure shows, the base actually rose during the great slump, which is why it’s hard to make the case that the Fed caused the Depression. But arguably the Depression could have been prevented if the Fed had done more — if it had expanded the monetary base faster and done more to rescue banks in trouble. So here we are, facing a new crisis reminiscent of the 1930s. And this time the Fed has been spectacularly aggressive about expanding the monetary base.

Paul graphs the monetary base, which increased by 72 percent from September 10 to November 19 of this year. We should also note that the money supply – whether measured by M1 or by MZM – has increased by less than 1 percent. Over the same period, this has been a very substantial increase in bank reserves. Much of what the Fed has been doing has been to accommodate this increase in bank reserves so as to avoid a fall in the money supply.

A Better Stimulus Plan

From a quarter millennium ago:

"that they deceived every man into his own ruin; and ruined the nation, to enrich the directors and themselves: They sold their own stock, and that of the directors, under false and fictitious names, contrary to the obligation of their bond to the City, which obliges them to declare the name of the seller to the buyer, as well as the name of the buyer to the seller; for they knew that no man would have been willing to buy, had he known that the brokers and directors were in haste to sell. Thus they used false dice, and blinded men’s eyes, to pick their pockets. “And surely, Mr. Ketch,” says the counsellor, “if he who picks a man’s pocket is to be hanged, the rogues that pick the pockets of the whole country, ought to be hanged, drawn, and quartered.”

Matter and Antimatter: How to Create a Crisis: A Thanksgiving Rant

Skilled physicists do not know how to take nothing and turn it into matter and antimatter, but finance behaves as if it had the capacity to do something similar. Imagine a simple market economy about to create a bubble. I want to tell the story of this bubble, only to put the current, crazy stimulus package into perspective.

Somebody says to me they have a piece of paper worth $1 million. I can buy for half the price. I borrow the money to cover most of the cost. People are willing to lend me the money confident in the belief that my paper will increase in value. Other people are engaging in the same transaction, spreading confidence that these papers are now increasing in value, say to $600,000.

The seller of the paper now has a half-million dollars, having given up nothing but blank piece of paper. I have a capital gain of hundred thousand dollars. My lenders have a credit with a half-million dollars. We are all better off, even though nothing has been produced.

Feeling secure in the increasing value of our paper, I along with the other "investors" now start consuming more, spreading prosperity for the economy. Virtually everybody is enjoying the benefit of the bubble. Within a short period of time, people throughout the economy making decisions based on the increasing appearance of health and the economy.

At some point, people realize that this paper is nothing more than a blank sheet of writing paper. The bubble may have stimulated some investment that is capable of producing real economic benefits, but mostly it has induced people to consume and commit themselves to pay back debts.



Remember, this prosperity was built out of nothing. In the end, matter and antimatter collided. The lenders have lost their money. The speculators and consumers are in debt. Most lack the wherewithal to repay their debts. But in the case of the current bubble, the economy does not have the productive capacity to put everything together. The loans came from abroad and so did many consumer goods.

At the same time, the government loans are ultimately dependent on another set of loans, also largely from abroad. How will these loans ever be repaid? Will new loans keep coming as the bubble engulfs the rest of the world?

Should the government come in and give me a half-million dollars so that I can repay my loan? Should I be rewarded for my stupidity and naïveté? Will that policy really make the economy healthy? Or will it policy just facilitate the creation of even greater bubbles?

Obviously, the most sensible decision would be to put the money into making a more healthy economy, one less susceptible to speculation -- something impossible under capitalism, but that is another question. Eventually, somebody will have to pay the piper. The policy today seems to be an effort to shield the very people who created the crisis, placing the burden on the most innocent.

The graphic picture of the stimulus package that I posted yesterday suggests a government response just as foolish as the speculations that set off the bubble in the first place.

Happy Thanksgiving.

EU Economic Orthodoxy Stumbles On

In the same survey of stimulus planning, the NY Times reported on the latest EU fiscal initiative, which calls for contributions of 1.2% GDP on the part of most member countries. This infusion, which is much too small relative to the impending output gap, will still bump up against the Maastricht criteria. What to do?

The monetary affairs commissioner, Joaquín Almunia, said that countries that breached the deficit ceiling of 3 percent of G.D.P. would face official reprimands, but would be given longer than usual to bring their budgets back into line because of the exceptional circumstances.

In other words: we know the criteria are absurd under the current conditions, but we will pretend that they still apply.

The EU has been built on a grand compromise, a broadly progressive stance in social and environmental policy and rigid orthodoxy in economic affairs. As in the academic version, the left got the sociology department and the right was given economics, finance and business. It was a bad deal, since misguided economics can do damage faster than the social workers can clean it up. So now Europe has a central bank with hardly any lender of last resort tools and fiscal guidelines that all but rule out serious countercyclical measures.

The current economic crisis should be put to positive political use. You can’t have a “Social Europe” with double-digit unemployment. (You also can’t have a sustainable Europe without getting the economic part of sustainability in place.) There needs to be a shift within the economic regime, and not just in the balance between “economic” and “social” interests. As for fiscal guidelines, they need to be flexible enough to permit rational economic management, and they also have to be responsive to regional trade imbalances. In fact, to constrain fiscal deficits without managing trade aggregates is to put all the recycling burden on private debt, and we are still in the process of finding out where that leads.

China and the US: Stimulus vs Bailouts

In its latest roundup of crisis management from around the world, the NY Times discusses Chinese monetary policy initiatives. Cutting reserve requirements for banks seems counterintuitive to me, but perhaps there are aspects of banking in China that justify it. What really jumped out, though, is this:

To give banks an extra incentive to lend money instead of hoarding reserves, the central bank also lowered by 0.27 percentage points the interest rates that it pays banks for reserves deposited with it.

That does make sense, and it is exactly the opposite of policy in the US, where the Fed has raised the interest it pays on these reserves. But, of course, we need $400 billion in excess reserves to finance the bailout program, so that losses from bad investments can be transferred to the public. This is so much more important than getting new finance out into a frozen economy.

The Absurdity of the Stimulus Package

Here is a graphic from the Wall Street Journal regarding the size of the stimulus package.

I hope to comment on it more tomorrow.