Month: December 2008

More niggling on fiscal stimulus

Paul Krugman describes and writes:

Here’s how I see it: the opponents of a strong stimulus plan don’t
really have an alternative to offer. They don’t even have a really
coherent critique; as Brad DeLong points out,
if you believe that a surge in private spending would raise employment
– and even the critics agree on that – it’s very hard to explain why a
surge of public spending wouldn’t have the same effect.

The critics are instead mainly engaged in a series of minor complaints, aka niggles; FDR didn’t do so well, the statistical evidence ain’t so great, you can’t trust government, etc., etc..

My view is the disaggregated one that sometimes private spending can stimulate employment and sometimes it cannot. Private spending has the greatest chance of stimulating employment when a) market psychology is on its side, and b) the financial system is relatively well-functioning.  Neither is the case right now. 

Note that under standard theory neither monetary nor fiscal policy will set right the basic problems from negative real shocks and indeed the U.S. economy is undergoing a series of massive sectoral shifts.  That includes a move out of construction, a move out of finance, a move out of debt-financed consumption, a move out of luxury goods, the collapse of GM, and a move out of industries which cannot compete with the internet (newspapers, Borders, etc.)

I’ve never seen a stimulus proponent deny this point about real shocks but I don’t see them emphasizing it either.  It should be the starting point for any analysis of fiscal policy but so far it is being swept under the proverbial rug.

Maybe a big enough push to aggregate demand could stimulate useful, productive employment (as opposed to merely boosting measured gdp) right now, but since the
U.S. savings rate must rise sooner or later, that would only mean a
steeper decline for aggregate demand some time in the future
.  My discount rate isn’t that high.

The alternative to a huge fiscal stimulus is simple: enough pro-active fiscal policy to ensure that cuts in state and local spending do not bring additional contractionary pressure to bear on the economy.  Otherwise bear the costs of the ongoing sectoral shifts and allow consumption to decline as indeed it must sooner or later.  Aggregate demand macroeconomics really does matter, but it is easier to do badly from negative shocks than it is to engineer good results from expansionary shocks. 

Those looking for other policy alternatives might consider Robert Lucas’s recent suggestions for monetary policy or cuts in the payroll tax, although I am myself not quite (yet?) on either bandwagon (though I think they are better plans than massive fiscal stimulus).

By the way, FDR didn’t do so well, the statistical evidence ain’t so great, and you can’t trust government, etc.  But those are only my minor complaints.

The bottom line remains this: we are being asked to spend ???? hundreds of billion dollars when a) the evidence for fiscal policy is inconclusive, and b) when you consider how real shocks fit into aggregate demand analysis, the theory isn’t there either.

Addendum: Here is a post by Krugman on the "hangover theory."  The answer to Krugman’s #1 is a combination of (perceived) wealth effects, downward nominal and real rigidities, and, during the boom workers at least thought they knew what they should be doing but now they do not.  The coordination problem on the upswing is not symmetric with the coordination problem on the downswing.  In any case it is correct that real sectoral shift theories do not explain all facets of a recession or depression; it is incorrect to conclude that therefore, in light of sectoral shocks, fiscal policy will be effective.

Was bailing out Long-Term Capital Management a good idea?

Here is my latest NYT column.  It starts as follows:

The financial crisis is a result of many bad decisions, but one of them hasn’t received
enough attention: the 1998 bailout of the Long-Term Capital Management
hedge fund. If regulators had been less concerned with protecting the
fund’s creditors, our current problems might not be quite so bad.

Bear Stearns, Merrill Lynch, and Lehman Brothers were all major creditors of LTCM.  Given that regulation is inevitably imperfect, and cannot foresee or prevent every firestorm in advance, this was one chance to send a very stern message to those creditors.  Perhaps no LTCM bailout would have meant dire consequences at the time, but still:

…Fed inaction might have had graver economic consequences,
especially if a Buffett deal had fallen through. In that case, a rapid
financial deleveraging would have followed, and the economy would have
probably plunged into recession. That sounds bad, but it might have
been better to have experienced a milder version of a downturn in 1998
than the more severe version of 10 years later.  In 1998, there was no collapsed housing bubble, the government’s budget
was in surplus rather than deficit, bank leverage was much lower, and
derivatives markets were smaller and less far-reaching.

I’ve been reading much about LTCM in recent times, and in so many ways it was a micro- dress rehearsal for our later problems.  This column also criticizes the current now-standard practice of "regulation by deal."

Addendum: Matt Yglesias adds: " At the time I think everyone was clear on the idea that if
institutions such as LTCM were “too big to fail” that they had to be
brought into a regulatory umbrella. But as soon as it was clear that
disaster had been averted, a lot of people became complacent about
operationalizing this determination to expand the scope of regulation
and some of the key participants – especially Alan Greenspan – in the
bailout only redoubled their opposition to regulation."

The countercyclical asset, a continuing series

Cocoa futures hit a
23-year high, capping a successful year for the commodity.  Chocolate
has done rather well this year, and not simply because the world has
been fretting about recession and craving comfort food. Constrained
supply coupled with robust demand has helped London cocoa futures rise
by some 71.0% since the end of last year, making cocoa one of the
market’s best performing commodities.  On Wednesday, the day before
millions of people around the world offered boxes of the sweet stuff to
their relatives as Christmas gifts, cocoa futures for May 2009 delivery
hit a 23-year high of £1,820.0($2,545.90) per ton in London(…)

Here is the story and I thank John de Palma for the pointer.  Here are previous installments in the series.

Nazi privatization

This paper was news to me:

The Great Depression spurred State ownership in Western capitalist countries. Germany was no exception; the last governments of the Weimar Republic took over firms in diverse sectors. Later, the Nazi regime transferred public ownership and public services to the private sector. In doing so, they went against the mainstream trends in the Western capitalist countries, none of which systematically reprivatized firms during the 1930s. Privatization in Nazi Germany was also unique in transferring to private hands the delivery of public services previously provided by government. The firms and the services transferred to private ownership belonged to diverse sectors. Privatization was part of an intentional policy with multiple objectives and was not ideologically driven. As in many recent privatizations, particularly within the European Union, strong financial restrictions were a central motivation. In addition, privatization was used as a political tool to enhance support for the government and for the Nazi Party.

I thought this sentence (p.13, see the graph on p.14) was interesting:

Overall, the relative dimension of privatization proceeds in 1934-37 Germany is close to the ratio for the EU-15 in 1997-2000, at 1.79 per cent.

Here is some earlier discussion from Mark Thoma.  Again, history holds a lot of surprises. 


The wisdom of David Backus

He makes many good points.  Excerpt:

evidence is fuzzy, to be sure, but to me it suggests a multiplier
around one, maybe smaller. Even stimulus cheerleader Paul Krugman only
claims 1.1. If that’s the case, the impact of government spending (say
700b over two years) is barely enough to reverse the decline in GDP we
expect to see over the next two quarters.

Read the whole thing.

What I’ve Been Reading

1. The Uncrowned King: The Sensational Rise of William Randolph Hearst, by Kenneth Whyte.  A detailed revisionist account, arguing Hearst was a better progressive and better journalist than his reputation.

2. Tim Blanning, The Triumph of Music: The Rise of Composers, Musicians and Their Art.  An overview of the history of music, with many insights from an economic point of view.

3. Elsewhere, U.S.A., by Dalton Conley.  Everything by Conley is worth reading.  The subtitle to this one is: How We Got From the Company Man, Family Dinners, and the Affluent Society to the Home Office, Blackberry Moms, and Economic Anxiety.  The focus is on technology and markets.  Here are numerous earlier posts on Dalton Conley.

4. The Invention of Air: A Story of Science, Faith, Revolution, and the Birth of America (these subtitles are getting more and more all-encompassing!).  The author is Steven Johnson, another author always worth reading.  The topic is Joseph Priestley.  Here is Johnson’s blog.  Here is a good review.

5. East of Eden, by John Steinbeck.  I’ve long resisted Steinbeck, so we’ll see how far I get in this one.

My Christmas present

It’s the best book of the year and not just because it was my Christmas present.  It’s The Phaidon Atlas of 21st Century World Architecture (good photo excerpts at the link).  The book is 812 pp. and also several times larger than a normal book so it is like getting a 2000 pp. book or more.  (That’s why it costs $122!)  It is very heavy to carry around and it comes in its own plastic case.

The book offers photos and information about the splendid works of architecture that have opened since the beginning of the millennium.  It’s amazing how much there is (1037 structures, according to one review) and also you can compare one locale to another; why for instance has Medellin been so active in building innovative structures?

Unintentionally, the book is a paean to the now-passed global real estate bubble.  It is an amazing feeling to turn the pages and see how much effort and creativity mankind has put into building.  Homes were considered profitable investments and state and local governments had plenty of funds for public buildings.  Today, many projects are on-line as half-baked cakes but, overall, the next eight years won’t be anything like these.

Highly recommended.

Does paying for grades work?

C. Kirabo Jackson has a new study and his conclusion is a qualified yes:

…the incentives produce meaningful increases in participation in the AP program and improvements in other critical education outcomes. Establishment of APIP results in a 30 percent increase in the number of students scoring above 1100 on the SAT or above 24 on the ACT, and an 8 percent increase in the number of students at a high school who enroll in a college or university in Texas. My evidence suggests that these outcomes are likely the result of stronger encouragement from teachers and guidance counselors to enroll in AP courses, better information provided to students, and changes in teacher and peer norms. The program is not associated with improved high school graduation rates or increases in the number of students taking college entrance exams, suggesting that the APIP improves the outcomes of high-achieving students rather than those students who may not have graduated from high school or even applied to college. Nonetheless, APIP may be an exceptionally good investment. The average per-student cost of the program, between
$100 and $300, is very small relative to reasonable estimates of the lifetime benefits of attending and succeeding in college.

Here is a recent article on the topic.  My intuition is that this works best for unmotivated students, where there is no intrinsic motivation to undermine.

Brad DeLong on fiscal policy

Brad thinks I am too pessimistic about the prospects for a fiscal-led recovery:

But surely we believe that if the U.S. government were to follow the
Countrywide plan–to send its representatives out onto the streets to
have them walk up to people and say: "Here’s $500,000. You can have it
if you go buy a house"–then that would drive a recovery, right? I mean
it drove a recovery in 2003-2006, didn’t it?

Even the Austrians believe that spending–in their case, driven by
credit-expansion created by the malefactors of fractional-reserve
banking–works. So why can’t the government do what fractional-reserve
bankers can?

Here is the link.