Category: Economics

I'm not sure I understand the proposal, but here is what the NYT says:

Like Arnold Kling, I wish to shift the economy out of housing, not into it again. I also believe that the supply of homes is relatively elastic right now.  The tax credit will subsidize the new buyers without propping up the price of homes.  Demand will go up, supply will go up, price will stay more or less on the same trajectory, and banks won't be any healthier.  The subsidy goes to new home buyers and why should we be helping them above all others?  Aren't they relatively wealthy on average?  (Not that there's anything wrong with that.)  Aren't some of them the dreaded "flippers" and speculators for that matter?  (Can we really enforce the primary residence requirement?)  Do we really want to push people into being less diversified and less geographically mobile in the labor market?  And here's Alex's post from earlier today.

There's a whole other debate you could have on whether we should be encouraging people to buy outputs which are already produced.

So far I say boo to the Republicans.  It could be I don't understand the proposal; if that is so please correct me in the comments.  Here are further discussions of what is going on.

Ed Olsen, one of the nation's foremost housing experts, points out that it's much harder to stimulate housing than many people think because you have to take into account the rental market.

The primary effect of many proposals directed at the housing market would be to decrease the demand for rental units by about the same amount as they would increase the demand for owner-occupied units. This would be the effect of the proposed tax credits or loans at below-market interest rates to new homebuyers.

 …The impact of preventing foreclosures on housing prices is overstated for the same reason. The overwhelming majority of families who default on their mortgages move to another unit that they do not share with others. Therefore, preventing foreclosures would have little effect on the total demand for dwelling units and hence little overall effect on market prices.

 …Subprime mortgages did induce some people to buy houses beyond their means, and foreclosures would decrease the demand for the types of houses bought by these people. This would decrease the prices of similar houses. However, when they default on their mortgages, the families involved move to more modest houses or apartments, thereby increasing the demand for other types of units in other locations and the prices of units of these types. Preventing foreclosures would lead to higher prices for some properties and lower prices for others.

Read the whole thing (doc).

I'm not sure further progress will be made on what to me seems like
a largely semantic debate.  Krugman is making perfectly sensible economic arguments but then making a
semantic leap to claim he has proven something about permanent vs.
temporary.  He hasn't, as I'll consider in a moment.  But don't worry, the more important substantive
issue is government spending vs. tax cuts and on that I agree with
Krugman that very often tax cuts don't get you much stimulus.

Now let's turn to the details of the exchange.

Krugman argues, correctly, that fiscal policy can create a "bonds are net wealth effect" and also a "new bridge is built effect," and his post stresses the latter.  But playing up the "bridge effect" does not shift the evaluative balance between permanent vs. temporary fiscal policy, as both can be used to build useful things and indeed that is one element of the analysis which I have been explicitly holding constant across the two alternatives.  (I've not been denying the potential productivity of bridges or how gdp is calculated.)

Krugman also calls forth a "size of expenditure" effect (which is not in my view a true permanent vs. temporary comparison, but still let's go ahead and say it is).  He writes:

The question then is how much of that direct increase in government demand is offset by a fall in private consumption because people expect their future taxes to be higher; obviously that offset is smaller if they think the bridge is a one-time expense than if they think there will be a bridge built every year. That’s why temporary government spending has a bigger effect.

Even there I am not convinced, and that is because of the very last sentence of the paragraph.  If the government builds more bridges rather than fewer bridges, yes private consumption goes down more in the former case.  But if each bridge is valuable, the net stimulus (which is what matters) doesn't have to go down.  In this setting, with varying expenditure across the two cases, the permanent fiscal policy easily can have both more crowding out and more net stimulus.  Krugman is citing the higher crowding out but there is no demonstration (or even argument) of a smaller net stimulus from the permanent fiscal policy.  It still can go either way and no, figuring out the net effect isn't simple. 

Oddly, my position in this debate is that, within a Keynesian framework, "doing more over time" can in the theoretical sense work out in favor of stimulus.  It is thus instructive to see MR and Krugman commentators attacking my "right wing" position or Krugman's "left wing" position; it's a sign they don't understand what is being debated.  Krugman himself already mentioned that he was arguing under the rubric of Milton Friedman so I'll claim Keynes.  Keynes himself was a bigger fan of permanent than temporary fiscal policy and he thought it could provide ongoing stimulus by providing ongoing value for the dollar.  In this sense I am arguing for the theoretical coherence of the truly Keynesian view, even though when it comes to practice I am skeptical on public choice and Hayekian grounds. 

Addendum: Here is Megan McArdle's response.

From Chris Blattman.  By my calculations (here and here) road traffic accidents account for about 1.68% of deaths in the United States so there is certainly room for improvement in low-income countries although it would be important to know whether it is the driving, the roads, or the health care most amenable to such improvement.

Let's say government can spend $100 billion today or spend the present expected value of $100 billion, stretched out over time so it is a commitment in perpetuity.  Both spending programs are financed by bonds.  So that's the same net present value of spending and the same method of finance.

The Keynesian boost to aggregate demand arises because people consider the resulting bonds to be "net wealth" even when they are not, in the sense outlined by Robert Barro (1974).  People are tricked by the government's fiscal policy, but of course the extent, timing, and nature of the trickery is hard to predict.

Is it easier to trick people "a lot all at once" or "a little bit by bit over time"?  It depends.  If you try to trick them slowly over time, temporal learning and adaptive expectations may work against the policymaker.  But if you try to trick people a lot all at once, the trick may rise over their threshold of attention, perhaps because of media coverage.  We don't know which "trick" to aggregate demand will be greater, the temporary boost to spending or the permanent boost.

One way to get a clear answer — in favor of Krugman's hypothesis that the temporary spending is more potent — is to assume that bonds as net wealth fails for a policy rule but not for a single period policy surprise (the temporary boost in spending).  In contrast, the traditional Keynesian view is to think that bonds are also net wealth in the medium run and perhaps the long run too and then we are back to not knowing whether the permanent or temporary spending boost does more for aggregate demand.  Or you might think, as I have suggested, that whether bonds are viewed as net wealth in the short run will depend on the size of the spending boost.  Many different assumptions are possible and thus many different results are possible.

Alternatively, you might compare $100 billion today (and no more) to $100 billion each year, every year.  You could call that "temporary" vs. "permanent" although I suspect the dominant effects will fall out of "small" vs. "large."

The latter, permanent boost to spending will give a bigger boost to aggregate demand overall (unless again you neuter it by applying Ricardian Equivalence to the rule but not the single period policy).  It also will lead to more crowding out.  Do note that in the early periods of this policy taxes need not rise by $100 billion for each year but rather the early installments can be paid off over time.

It is less clear whether the permanent spending boost leads to a bigger AD shift only for today.  It will if you apply the same degree of bonds as net wealth to the rule and single period policy, and if you think that the later periods of government spending will add net value, thus creating positive feedback through the long-run wealth effect.

It is also unclear if the larger, permanent spending boost creates more "stimulus per dollar" (as opposed to more stimulus in the aggregate or more stimulus for the single period).  That will depend on whether we are in the range where the stimulus has increasing returns to scale (maybe a certain critical mass is needed, as I believe Mark Thoma has suggested), constant returns to scale, or diminishing or even negative returns to scale, because of eventual crowding out. 

Overall the Keynesian effects can mean either the permanent or the temporary spending boost has a bigger effect and there are also a number of ways of defining what a "bigger effect" might mean.  This analysis has more variations than does the Poisoned Pawn Sicilian.

Perhaps Krugman is drawing from Barro's 1981 JPE paper on government purchases, which does indeed derive the stated result, but that is no longer the dominant approach. Circa 1990, Aiyagari, Christiano, and Eichenbaum note:

On pp.4-5 they explain why Barro is incomplete. 

Overall I find these debates confusing.  I wonder for instance if Krugman's blog example is actually comparing tax finance to debt finance, rather than temporary vs. permanent spending shocks.  (Note also that Krugman is making a claim about demand or effective "stimulus" rather than output and employment, although I am taking the latter as what matter.)

Those of you with lots of time on your hands can ponder whether the "permanent vs. temporary" debates compare "$100 billion this year vs. $100 billion for each year to come" and/or "$100 billion this year vs. the present value of $100 billion spread out over time, in perpetuity," and whether all cited articles and blog posts are making exactly the same comparisons.

Results in this area usually can be modified by further assumptions.  I think of this as the central paper, published in the JME 1999.  Admittedly it is for a small open economy but the key result is:

Moreover, permanent increases in government expenditures have larger
positive labor supply and output effects than temporary fiscal policies.

Again, I don't have faith in these models and I believe agnosticism is the correct stance.  The point is not about who is wrong and who is right but rather how treacherous these analytical waters can be.  Beware! 

In any case there is hardly an overwhelming brief in favor of the stimulative powers of the temporary spending increase.  The best case for the temporary boost is I think the public choice argument that it is better to get it over with more quickly, so as to limit corruption of the government.

Addendum: Megan McArdle adds comments on her contribution to the debate.

Second addendum: You'll find a response from Paul Krugman here.  I'll note it is he that introduced the framework of Milton Friedman and the permanent income hypothesis, not I.  If you look at the literature as a whole, it can go either way whether the permanent or temporary increase in government spending is more potent.  Krugman's own example doesn't demonstrate his point that the temporary increase is stronger, as it compared debt-based to tax-based finance rather than permanent vs. temporary.

Here is my column on the social changes occasioned by recessions.  Of course recessions are mostly bad and this one is no exception.  Still, one underappreciated fact is that health outcomes appear to improve in recessions, not get worse (even though health care access and coverage decline):

Sure, it's stressful to miss a paycheck, but eliminating the stresses of a job may have some beneficial effects. Perhaps more
important, people may take fewer car trips, thus lowering the risk of
accidents, and spend less on alcohol and tobacco. They also have more
time for exercise and sleep, and tend to choose home cooking over fast
food.  In a 2003 paper, “Healthy Living in Hard Times,” Christopher J. Ruhm, an economist at the University of North Carolina
at Greensboro, found that the death rate falls as unemployment rises.
In the United States, he found, a 1 percent increase in the
unemployment rate, on average, decreases the death rate by 0.5 percent.

In this recession the consumption of the wealthy is taking a bigger hit than is usually the case in a downturn:

In any recession, the poor suffer the most pain. But in cultural
influence, it may well be the rich who lose the most in the current
crisis. This downturn is bringing a larger-than-usual decline in
consumption by the wealthy.

The shift has been documented by Jonathan A. Parker and Annette Vissing-Jorgenson, finance professors at Northwestern University, in their recent paper,
“Who Bears Aggregate Fluctuations and How? Estimates and Implications
for Consumption Inequality.” Of course, people who held much wealth in
real estate or stocks
have taken heavy losses. But most important, the paper says, the labor
incomes of high earners have declined more than in past recessions, as
seen in the financial sector.

Popular culture’s catering to the
wealthy may also decline in this downturn. We can expect a shift away
from the lionizing of fancy restaurants, for example, and toward more
use of public libraries. Such changes tend to occur in downturns, but
this time they may be especially pronounced.

This paper integrates theories of political budget cycles with theories of tactical electoral redistribution to test for political capture in a novel way. Studying banks in India, I find that government-owned bank lending tracks the electoral cycle, with agricultural credit increasing by 5-10 percentage points in an election year. There is significant cross-sectional targeting, with large increases in districts in which the election is particularly close. This targeting does not occur in non-election years, or in private bank lending. I show capture is costly: elections affect loan repayment, and election year credit booms do not measurably affect agricultural output.

I was invited to contribute to an Economist symposium on Olivier Blanchard's guest essay.  My piece is here and here is my bottom line:

Here is the complete set of essays, featuring Shiller, Caballero, Alesina, Thoma, and others.  Here is Bryan Caplan making a similar point about placebos.

I'm sure you've reading or hearing reports of the $4 trillion bailout.  I still don't know what this figure is supposed to mean, but it is incorrect to respond with something like the following: "that's really expensive, I guess we do need to nationalize the banks."  As one commentator on CR responded (approximately): "If Uncle Sam bails out the banks, who will bail out Uncle Sam?"

Bank nationalization is (possibly) cheaper when the banks have upside profit potential, which is then captured in whole or in part by the government.  But say that banks are in the red by $2 trillion for ever and all eternity.  Taking over the banks simply means that the government picks up these losses as owner.  Government ownership makes it less likely, not more likely, that bank creditors will "take a haircut."

Nationalization isn't going to solve this kind of cost problem. 

New appointee Jeremy Stein says yes:

Simply put, the government should force the banks to suspend all dividend payments," he told The Wall Street Journal in October.  "It makes absolutely no sense for the government to put money into the banks, only to see a significant fraction of it flow out again as dividends to shareholders, and in many cases, bank executives with large equity stakes."

I haven't seen much discussion of this issue.  Dividends are in general poorly understood by economists, in part because they continue to be paid when they face a significant tax disadvantage.  Surely there are cheaper ways to signal the quality of the firm.  One way of thinking about dividends is as a way to take advantage of bondholders.  Start a new firm, borrow $50, issue $50 in equity, and on day one pay $100 in dividends and by 4 p.m. declare bankruptcy.  Not a bad business model but of course neither the government nor the bondholders will let you.  This same strategy is also a way to take advantage of government subsidies and recapitalizations, even if you can't get the dividend up to one hundred percent.  So yes, I do see a case for following Stein's suggestion, at least for banks receiving government assistance above some threshold measure.

Stein, by the way, also favors this:

He advocated aggressive government audits of banks, aimed at separating
solvent ones from insolvent ones. Once that was done, insolvent banks
would be forced into closure or sale while solvent ones would be pushed
to raise more private capital. In addition to dealing with the bad bank
problem, putting the plan in place would remove much of the uncertainty
in financial markets that the government’s ad hoc approach to banks
thus far has helped instill.

A few of them are cute.

But they are starting to be asked more and more often:

Moreover, will we have the guts to impose similarly large percentage
reductions in budgets when the stimulus is supposed to end in two
years? Or will we simply add to a long-term budget problem that is
already horrendous?

Here is more.

The Fed is ready to do more, namely:

Two points are worth making.  First, defenders of large-scale stimulus point out that such measures may well not work.  That is true, but what are the conditions under which unorthodox monetary policy maybe will not work?  Low confidence and zombie banks, which are more or less the same conditions under which fiscal policy may not work either.  In that sense unorthodox monetary policy doesn't face a separate problem.

Second, cash and T-Bills have a broadly similar risk profile but cash and these other assets do not.  At some point monetary policy becomes fiscal policy too, as a quick look at the Fed's balance sheet will indicate.  So it's fiscal policy based on Treasury borrowing vs. fiscal policy based on Bernanke and money creation.  In a time of deflationary pressures, and a bad fiscal future, usually I would prefer Fed-led fiscal policy.  I do recognize that we are placing more weight on the Fed than it can bear, but of course at this point there are no good options.