What instead?

by on January 24, 2009 at 9:22 am in Economics | Permalink

Matt Yglesias asks a very good question:

So to pull a bit of the old burden-shifting, what’s the
stimulus-skeptics’ alternative prescription? At this point in time just
about everyone–liberal or conservative–agrees that it’s generally
preferable to eschew fiscal stimulus and let monetary policy do the
heavy lifting. The pro-stimulus analysis begins not with the idea that
fiscal stimulus is awesome, but with the observation that we’ve already
done a great deal of rate-cutting, can’t cut rates any deeper, and all
signs are of the situation getting worse. Is the anti-stimulus idea to
do nothing and hope for the best? To beg for the world’s surplus
countries (Germany, Japan, China, oil producers, Switzerland, etc.) to
do giant stimulus while we sit around? Are there “unconventional”
monetary policy tricks Bernanke needs to be trying?

Pulling together some previous posts, I recommend:

1. A certain amount of "defensive" fiscal policy aimed at keeping state and local government budgets roughly constant.  This will limit downside but it won't much "stimulate," for reasons which should be apparent in the graph shown by Matt.  In various emergencies it is inefficient that state and local governments are not allowed to run deficits but implicitly the Feds can do it for them.

2. Unorthodox monetary policy, as advocated by Robert Lucas and also, earlier, Keynes.  You can stimulate AD at much lower cost this way.  "Cutting short rates" is by no means synonymous with "monetary policy."

3. Bank recapitalization.  This will cost lots and we should reallocate money away from "stimulus" toward this problem.  Falling aggregate demand is a derivative problem in today's crisis but this is a fundamental problem.  There is a vague sense on the Democratic side that "we can do everything" but the reality is that of the budget constraint, not "guns and butter together."  Have you noticed that Obama is not presenting a consolidated recapitalization/stimulus bill?  That is no accident.

I should add that I am skeptical of tax cuts as a form of stimulus, so we should evaluate tax reforms on their own merits, which involves broader questions about the overall path of spending and taxes.  But if you wish to go this route, cutting the payroll tax is probably the most promising idea.

1 Bob Murphy January 24, 2009 at 9:29 am

1. Bigger

2. government

3. “solutions.”.

2 mickslam January 24, 2009 at 9:56 am

Nice catch Richard.

I am glad to see the payroll tax idea finally catching on big time in the mainstream. It is a great idea if done properly. It should be done at the paycheck level, not the tax return level.

We get to run a real world experiment on Keynesian thinking. We can disprove it once and for all by running a large stimulus package and having it not work. However, if it does work, some other theory will be disproven, which is part of the reason for the opposition from some economists to stimulus spending. Settling this argument is worth trillions, maybe 10’s of trillions.

If the spending ends up having a multiplier of more than 1, some people are going to be eating their hat.

#2. At zero short term interest rates, you can and probably should just print money. It is a simpler solution that having the government own private assets. It directly addresses the current problem of deflation. Plus, buying private debt implies selling it at some point or accepting repayment, which defeats the purpose of the fed buying it in the first place. And then, we’ve already purchased a good amount of private debt through some of the programs, and it does not seem to be helping. We are still at zero short term rates.

#3. The chart shown at Matt Y’s is a demonstration of leverage in the system. While recapitalizing the banks is critical, it will not renew their appetite for leverage.

3 Thomas January 24, 2009 at 10:07 am

I think the payroll tax cut should be permanent. I’d add the corporate income tax, too. I would also make a down payment on a carbon tax, although it should not be set at a level to raise much revenue until the economy is starting to inflate. The carbon tax is important because it will send a signal of what to invest in so that ex ante I will equal ex ante desire of households raise S to repair their balance sheets.

4 Bill January 24, 2009 at 11:26 am

Economists have long known the conditions when government can increase real wealth—providing public goods, mitigating negative externalities, etc. Macro models where generic government spending, or tax cuts, do the same don’t obviate all that and are, in some respects, little more than formalized wishful thinking regarding government’s ability to spin flax into gold. At a fundamental level, such models deny that market participants, given the costly information and uncertainties they face, are putting resources to their most profitable uses. (How else is it even possible for fiscal stimulus to expand real output?) Yet even a brief exposure to the realities of government decison processes makes it nearly impossible to believe that politicians and government bureaucrats have some kind of informational advantage over market participants. The likely outcome of all the stimulus spending currently being proposed will be increased government borrowing, monetized by the Fed, and all the attendant inflationary cost that entails. So to Yglesias’ question, Is the anti-stimulus idea to do nothing and hope for the best? my answer is yes so far as “stimulative” fiscal policy is concerned. Let government concentrate on not adding to economic uncertainty.

5 Alex January 24, 2009 at 1:03 pm

I don’t know how the logistics of getting to write a New York Times article work, but it would be worthwhile to spread such ideas for alternatives more widely.

6 Devin Finbarr January 24, 2009 at 1:55 pm

How can monetary policy ever run out of room? The Fed has a technology, called a printing press. And even if the problem is lower velocity of money, printing money actually reduces demand for money as people trade their dollars for non-diluting assets. Also, printing money and distributing it neutrally helps everyone repair their balance sheets, thus allowing velocity to return to normal.

The Fed should print money and mail every taxpayer a check for $500. Do this every two weeks until the deflation stops.

7 Tim January 24, 2009 at 5:35 pm

I second your question. It seems like a very common sense assertion that people putting money in banks helps the banks. Of course, we’d need a certifiably top notch super economic Nobel Prize winner like Paul Krugman to okay any such statement, otherwise it can’t be true.

8 Greg January 25, 2009 at 9:57 am

The administration(s) has (have) pulled the both the monetary policy lever and the stimulus lever. It will take time for these actions to flow through the system. The recession will reverse, employment will begin to increase and life will begin to return to something called normal when businesses resume innovation and expansion. This won’t happen as long as they are unsure about the rules under which they operate. At this point the most important thing that the Obama administration can do is not spend more of our money, but rather set down the rule set for business and stick to it. Telling the business community that the administration will revise the rule set every few months until things get better is a prescription for a continuing business paralysis that could become an economic death spiral. Believe it or not most business take their fiduciary responsibilities very seriously. They will not spend their investors’ money when they face large unknown and therefore unquantifiable risk. Nor should they.

9 Eric Rasmusen January 25, 2009 at 12:59 pm

Don’t forget that hardest of all government policies to recommend:

Do nothing.

That’s what we did when Congressmen were calling out desperately for something to reduce gasoline prices.

And it worked!

10 floccina January 25, 2009 at 9:20 pm

@Bill Woolsey

Thank you for explaining some banking basics.

11 mulp January 26, 2009 at 12:36 am

DanC wrote: “The worst recession before this was 1981. How did we get out of that? Tax simplification, rate cuts, decreased regulation.”

Is that myth, ideology, or history?

Reagan’s 1981 tax cut was passed and the 1981 recession began, according to NBER, and the 1982 tax hikes were passed with the recession ending there after. The 1982 tax hikes are called by conservatives the largest tax hikes in US history.

The expansion that followed those tax hikes was the longest since the mythical JFK tax cuts and the 1961 expansion. That expansion ended soon after the Nixon tax cuts in 1969.

As far as the decreased regulation of the Reagan era, that resulted in the biggest financial crisis since the 30s, and the massive nationalization of S&Ls and unprecedented government bailouts.

12 mk January 26, 2009 at 9:07 am

Bill W: Thank you *very* much for the thorough explanation. I was dimly aware there was a “double requirement” of capital and deposits at work, but I wasn’t able to find a straightforward explanation of how they work or which one is currently binding until you posted yours. Thanks again!

13 tower defense May 10, 2009 at 1:11 am

Even if the problem is lower velocity of money, printing money actually reduces demand for money as people trade their dollars for non-diluting assets. Printing money and distributing it neutrally helps everyone repair their balance sheets, thus allowing velocity to return to normal.

14 cheap christian louboutin April 7, 2010 at 9:16 pm

Even if the problem is lower velocity of money, printing money actually reduces demand for money as people trade their dollars for non-diluting assets. Printing money and distributing it neutrally helps everyone repair their balance sheets, thus allowing velocity to return

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