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Meanwhile, Back at Home…

August 5th, 2011 . by economistmom

chart_ws_index_dow_20118414253top(Chart from CNN-Money)

Back at “home” with the real-world economy, right now

Like many policywatchers, Ezra Klein wonders if we’re running out of policy tools to combat the right-now threats to the U.S. and global economy:

Washington likes to talk about the economy in terms of things it can control. Spending and deficits. Stimulus. Policy uncertainty.

But the Dow Jones industrial average isn’t diving because spending has risen, deficits have grown or stimulus policy has changed. It’s diving because of forces Washington can’t control, and in many cases, doesn’t understand very well…

Washington just spent two months arguing over whether it would pay its bills or spark an unnecessary financial crisis.

Congress resolved that question this week, and the markets are tanking. Which suggests that Washington is asking itself the wrong question.

The right question is simple enough: Where will the recovery come from? The problem is that no one has an answer. And as one hopeful hypothesis after another is dashed, the markets are beginning to panic.

It might seem as if the government’s fiscal policy hands are tied in terms of addressing any short-term fragility, given that all we’ve be talking about over the past several months is how to reduce (not increase) the deficit–and that even with the continued weakness in today’s economy, no one (not even liberals who scream that focusing on deficit reduction is clueless or even evil) is suggesting that the bleak longer-term fiscal outlook doesn’t have to be addressed very soon with at least a plan that starts to steer us in a better direction.

Is new fiscal stimulus not at all a possibility, given that the country will have “no appetite” for more deficit spending?  I think adding to the level of short-term deficit spending would be hard if not impossible, politically.  But economically, it’s not a bad constraint to have, because it would make for an overall better fiscal policy if the federal government were forced to stick to a certain level of deficit spending devoted to “stimulus” (encouraging demand for goods and services) and made sure that any projects, transfer payments, or tax cuts funded by this limited pot of deficit-financed stimulus money were those that “won the contest” for “highest bang-per-buck.”

I’m suggesting that budget constraints are tough these days, given our concerns about the longer-term outlook.  We start to fail on the goal of “overall better fiscal policy” whenever we let deficit-financed policies in the door in the name of “stimulus” but then let them hang out with us more permanently even when they’ve worn out their welcome and eaten us out of house and home.

Could we consider a deficit-neutral swapping out of low bang-per-buck deficit-financed “stimulus” policies–whether spending or tax cuts–for a swapping in of higher bang-per-buck policies, those policies most likely to encourage immediate business and consumer demand for goods and services (and hence jobs)?  We can go back to this analysis by CBO that reminds us what works and what doesn’t.  (Hint:  tax cuts for the rich are at the bottom of the list; see Table 1 on page 22.)

Could we even consider combining shorter-term and longer-term economic goals by steering some of that high bang-per-buck spending toward areas of the economy that would be good for our longer-term fiscal sustainability as well?  Remember, “sustainability” has two sides:  keeping deficits under control, yes, but also making sure our economy is growing in a healthy way.  Are there fiscal policies that could immediately stimulate the economy but also leave us on a path to better support the human capital accumulation and economic capacity of younger generations (through education, health care, environmental quality, etc.)?

Wouldn’t it be nice?

10 Responses to “Meanwhile, Back at Home…”

  1. comment number 1 by: Brooks

    A couple of times over the last couple of years (the “stimulus” era) I raised a question that I still haven’t seen answered amid the consensus mantra (which I’m not qualified to challenge) among economists in the media that “now is not the time to reduce deficits” because the economy is too weak. (Perhaps the consensus is not as strong as when we were in actual recession, but I think it’s still the conventional wisdom).

    The question is:
    Is the debt/GDP outlook — over short, medium and/or long-term — actually better (or at least no worse) if, on Keynesian grounds, we implement/maintain policies that mean higher deficits now? (and the same question applies to prior stimulus already implemented, and to any other stimulus that has been proposed)

    We’ve all seen economists in the media implying and even stating explicitly that the answer is a clear, absolute “yes”. The latest I’ve seen is http://www.msnbc.msn.com/id/26315908/#44028185. I refer to such a view as the strong “demand-side” view, akin to the strong supply-side view that holds that “tax cuts increase revenues”.*

    Many other economists may have been (and I would guess indeed have been) merely implying that, although the answer is likely “no” (over some/all time horizons), nevertheless amid very high unemployment and recession or very low growth there is very substantial revenue feedback from fiscal stimulus (in general, obviously more or less depending on the particular policies chosen) and that the humanitarian case is strong, and thus they wouldn’t advocate immediate deficit-reduction.

    It is unfortunate that so many economists opining and educating the public in the media have so many times, in the context of commenting on concerns re: our fiscal imbalance, repeated the same vague mantra about now “not [being] the time” to reduce deficits (and even to adopt/maintain deficit-financed stimulus) without making any effort (that I’ve seen) to answer this question.

    The economist in that clip to which I link above at least does give his answer to the question, albeit on a hyperpartisan program and thus probably chosen to appear because of his view.

    But why don’t less partisan economists in the media (new & old media) give us any idea of their respective answers?

    Policy choices are generally about trade-offs, and we usually rely on experts to inform us of those trade-offs. Seems to me economists should tell us if a given level and type(s) of stimulus are a win-win all around (lower unemployment and higher incomes today AND better outlook for debt/GDP) or if we are trading off exacerbation of the debt/GDP outlook for mitigation of pain today.

    Perhaps some of the OMB or CBO or other reports have laid out projections for debt/GDP with vs. without adopting/maintaining a given stimulus policy (or with or without any form of deficit-reduction via spending “cuts” in general), and if anyone has links, please provide. At least then I’ll have that for my own benefit. But more importantly, expert commentary in the media on this matter has been sorely lacking.

    * A a note, both/either of the supply-side or “demand-side” could in the cases of some commenters refer to the combination of revenue feedback effects and incremental GDP growth to result in net lower debt/GDP

  2. comment number 2 by: Dave

    I generally encourage the idea of infrastructure investment, but there are caveats. Certain infrastructural investments during the WPA were useful because they anticipated future needs (ie. demand function, not politics) of the consumer in the years which followed. Example: electrification and hydro programs. Insull’s electric enterprises had identified a strong consumer demand for electric power. The WTP was quite high, at least once the economy rebounded a bit. So, the TVA, Hoover Dam, and rural electrification were spot on good choices. They were completely in line with post-Depression consumption demand.

    What the programs did was to shift production back in time to a lower-wage environment. We got durable goods which would later be much in demand at a bargain price because of the high unemployment.

    Suppose you tried this with a nondurable, such as shoes? Well, recipients would simply cut back their demand at the store by the amount of the publicly-provided footwear. No stimulus as it just gets adjusted out of inventory.

    How about private durables like fridges? Well, then, today’s publicly provided fridge shifts down the future production schedule for fridges over the useful life. Not a stimulus.

    It really only works with public capital goods, not government cheese.

    How about the Obama administration’s desire to hire unemployed young people (a notoriously low-productivity labor category) to perform home energy audits? Well, first, they’re not going to be the efficient provider, just the free one. (think: deadweight loss)

    Secondly, since home energy audit is an available private sector good, you’re just shifting output from one sector to another, causing layoffs in the private arena. How about those audits which are undertaken because they are free but would not have been under private provision?

    Well, the Market says you provided something for which there is no demand. So your value-added in this case is negative except to the degree you contend that consumers are too stupid to know what’s good for them. (When the Soviets calculated the aggregate surplus, they assumed consumers were unable to properly price goods, so Gosplan priced them. When the wall fell, most of those goods had zero demand in free markets.)

    And this is the dangerous paternalism that I hear in much of the administration’s discussion of stimulus. Forcefeeding projects and services no one values because they meet some bureaucrat’s ideological agenda, such a ‘greenness’.

    Similarly, when a Senator demands that the Pentagon buy an aircraft it doesn’t want and won’t use because it’s from his district. Or bridges to nowhere.

    No, CBO is assuming fundamentally apolitical stimuli, efficiently delivered. And I don’t hear anyone talking about doing that.

    I’d be somewhat more interested in proposals in which Treasury funds large qualifying infrastructural investments by an independent Board of Governors from the private sector not appointed by or otherwise beholden to Washington. One would expect some requirement to spread expenditure over regions, but certainly not by district. Oh, and no earmarking whatsoever.

  3. comment number 3 by: Jim Glass

    We can go back to this analysis by CBO that reminds us what works and what doesn’t … see Table 1 on page 22.

    Note that by that table the highest “cumulative effect on GDP, 2010-2015, per dollar of budget cost” is 1.9, the next highest is 1.3, and “investing in infrastructure” is 1.2.

    Assuming that this increase in GDP is recovered at a 20% rate via federal taxes — a generous assumption — each $1 spent on fiscal stimulus *at best* increases the permanent deficit by 62 cents, while $1 spent on infrastructure increases the permanent national debt by 76 cents.

    That is, as far as the national debt is concerned, nothing works.

    If we didn’t have $100 trillion of unfunded entitlement liabilities soon about to start rolling into the debt owed to the public in a *big* way, we could afford to burn some money inefficiently today to boost employment. But we *do* have that $100 trillion… so while we DO need stimulus we need *monetary* stimulus.

    And this is the best for fiscal stimulus by theory. In practice, as I’ve mentioned before, $350 million of stimulus money sent to NYC to fund construction of the infamous Second Avenue Subway was taken by the transit workers union for an *11% wage raise* … this while the subway system was going so broke that in addition to a fare increase and service cutbacks the state had to impose a regional tax on communities up to 80 miles away from the nearest subway station to subsidize it. Multiply that event by “countless”.

    I saw Krugman on Charlie Rose recently explain stimulus this way: “The roads of this city are filled with potholes. The unemployment office is filled with lines of the unemployed. You hire the unemployed and pay them to fill potholes. The stimulus spending both increases employment and improves the roads for everybody’s benefit”. He repeated this like a prepared talking point.

    If only! In 1933, maybe. But listening to Krugman I couldn’t tell if he was just spinning a line or is such a naif that he really believes this.

    In 2011, this city’s municipal workers union isn’t going to allow any hiring of any unemployed to do their work filling potholes any more than the transit workers union was going to allow non-member outsiders paid with stimulus money to “take their work” on the Second Avenue Line. If money is to go to such projects it goes *to them*, same workers, same work rules, same ouput, more input, higher cost.

    A generation ago Gov Rockefeller built what locals in Westcheter County call “Rocky’s Road to Nowhere”, a beautiful four-lane divided highway that dead-ends *literally* in a hospital parking lot. Of course it was built to get the support of politically influential local contractors and construction unions, and its cost is still being rolled over in the state debt. When stimulus money arrives does one suppose it goes to finally, at last, fix Bullet Hole Road (also a real place) in an uninfluential upstate county, or to give Rocky’s Road another round of landscaping?

    Are there fiscal policies that could immediately stimulate the economy but also leave us on a path to better support the human capital accumulation and economic capacity …

    Well, truly *productive* investments by the govt should be encouraged at all times.

    But as Obama himself said he’s learned, “There’s no such thing as a shovel-ready infrastructure project”, nor are there any “shovel ready” investments avialable in new science and technology, education, medicine, human capital, etc. Such *productive* investments thar really pay off always take serious research and planning, and when you are finally ready to make one you don’t *not* make in good times when you can afford it — and delay all those investment returns — so you can stockpile it to be ”shovel ready” maybe many years later when a bad recession hits.

    The sad fact of the matter is that the US govt just isn’t about investing in anything any more. As the saying goes, it is becoming an a mass entitlement program with nuclear weapons. Last year, payments to individuals exceeded 100% of revenue. Doesn’t that say it all about the political system’s priorities?

  4. comment number 4 by: Jim Glass

    “Assuming that this increase in GDP is recovered at a 20% rate via federal taxes — a generous assumption — each $1 spent on fiscal stimulus *at best* increases the permanent deficit by 62 cents…”

    That would be “permanent debt”. One never sees one’s stupid mistakes until after a comment system that doesn’t allow corrections publishes them.

    Well, I suppose one is lucky when able to see them then.

  5. comment number 5 by: Vivian Darkbloom

    “I saw Krugman on Charlie Rose recently explain stimulus this way: “The roads of this city are filled with potholes. The unemployment office is filled with lines of the unemployed. You hire the unemployed and pay them to fill potholes. The stimulus spending both increases employment and improves the roads for everybody’s benefit”. He repeated this like a prepared talking point.”

    This and “shovel ready projects” reminds me of the remark, perhaps apocryphal, Milton Friedman was said to have made when told the reason some workers he observed were using shovels rather than bulldozers was to create more jobs. Friedman was said to have retorted “why not have them use spoons”? Indeed, why not have them fill those potholes with spoons (and better, at “prevailing” (invevitably union) wages as required by Davis-Bacon)?

  6. comment number 6 by: Vivian Darkbloom

    “We can go back to this analysis by CBO that reminds us what works and what doesn’t. (Hint: tax cuts for the rich are at the bottom of the list; see Table 1 on page 22.)”

    That’s not exactly what the table says, but perhaps EM is reading something more into it. What the table does suggest is that there is a low multiplier effect on GDP and employment for extending the tax cuts (in the short term); however, this is not only the “tax cuts for the rich”; it is the tax cuts for everyone. This is presumably because much of that tax cut would be saved rather than spent and perhaps the assumption here is that the rich would save more than the middle class.

    What the table also suggests is that the best thing we can do to increase GDP (and employment? See Figure 1) in the short-term is to hand out bigger checks to the unemployed (1.9 multiplier). Presumably, this gives a big short-term kick because those folks will go out and immediately spend the funds (on worthwhile investment projects, I’m sure). I don’t know if these enhanced payments are designed to be bigger checks, checks for a longer period, or both, but why does my intuition tell me that it might be better to hire them all at a higher wage level (say to compensate for the “social security and medicare “taxes” to be paid on that employment) to fill in those potholes with spoons?. Would that not, at least, fill the potholes and reduce unemployment to zero? Obviously, this may not be the best of policy choices, but if Krugman was actually advocating the latter in place of the former, would that not represent at least some progress over the status quo? Or, does the 1.9 multiplier for the former mean that it is still better policy because it is greater than the 1.2 multiplier on the latter?

    These economic models are a real conundrum to me.

  7. comment number 7 by: Brooks

    Jim,

    Re: Assuming that this increase in GDP is recovered at a 20% rate via federal taxes — a generous assumption — each $1 spent on fiscal stimulus *at best* increases the permanent [debt] by 62 cents

    First, thanks for referring to that CBO table, which I had not yet checked out.

    Our concern is not impact on debt level per se but rather impact on debt/GDP.

    Leaving aside the fact that the table’s projected impact is limited in time horizon (2010-2015), and taking their figures as surrogates for infinite time horizon (at least for illustration), here’s my (possibly incorrect) reading of that data point:

    Each $1 of fiscal stimulus at best increases GDP cumulatively by $1.9, and if we assume (very roughly) 20% taxation, reduces revenues cumulatively by $0.62, therefore increasing debt by $0.62.

    So as for debt/GDP, every $1 of fiscal stimulus adds $0.62 to the numerator and $1.9 to the denominator. That change, viewed in isolation, is incremental debt/GDP of 32.6%. Adding it into the mix brings down the average, i.e., lowers total debt/GDP. Repeated infinitely (just theoretically, for illustration) that would bring total debt/GDP down (hyperbolically) to 32.6%.

    Now, I haven’t yet read much of the report, and I don’t know if CBO is truly taking a holistic approach, considering, for example, all the costs and effects of incremental debt (e.g., potentially higher interest rates and thus lower GDP; or negative impact of eventually paying down that much more debt), and it’s possible I am misinterpreting what their figure represents. But if I’ve got something wrong here, please let me know.

  8. comment number 8 by: Brooks

    To be clear, my entire comment refers to that “at best” form of stimulus and high end of estimate range per the CBO table.

  9. comment number 9 by: Brooks

    Also I’d note that the timing of related cash flows matters (”time value of money”, DCF, etc.). I don’t know how that factors into calculations using the CBO estimates.

  10. comment number 10 by: SteveinCH

    It would be really nice if these econometric models had marginal multipliers rather than average ones. It’s the shocking thing about them. The impact is the same regardless of the amount of money put in. That alone makes them entirely bogus as policy tools imo.