Summary: This post gives a brief description of government stimulus programs, based on theory and past experience. Although there is a strong and broad consensus among economists on these things, it is not unanimous. And there is debate on about many aspects — esp how to balance short-term needs and long-term costs.
This is a follow-up to A situation report about the global economy, as the flames break thru the firewalls.
Contents
- Fiscal stimulus is a palliative, not a cure
- Long term vs. Short term stimulus
- Which stimulus programs work best?
- What stimulus measures give the most “bang for the buck”?
- What types of tax cuts and transfer payments have powerful short-term effects?
- Who can we trust? Who has the best economic research?
- Sources, where to go for more information
- Afterword and other posts about this on the FM website
Before you begin, please say a prayer for Obama — elected as the economy slides off a cliff. FDR took office in March 1933, at the worst point of the Great Depression. He would not look so good to us if elected in March 1931.
1. Fiscal stimulus is a pallitative, not a cure
Government stimulus provides support to the economy during hard times and minimizes suffering. No cures, no sparks to make the dead walk. From the abstract of “What Ends Recessions?“, Christina D. Romer and David H. Romer, NBER, June 1994:
This paper analyzes the contributions of monetary and fiscal policy to postwar economic recoveries. We find that the Federal Reserve typically responds to downturns with prompt and large reductions in interest rates. Discretionary fiscal policy, in contrast, rarely reacts before the trough in economic activity, and even then the responses are usually small. Simulations using multipliers from both simple regressions and a large macroeconomic model show that the interest rate falls account for nearly all of the above-average growth that occurs early in recoveries.
2. Long term vs. Short term stimulus
Supply-side measures, such as permanent tax cuts, have powerful long-term effects — but do little during a recession. Demand-side measures for a recession have different requirements. From “Economic Stimulus: Evaluating Proposed Changes in Tax Policy“, CBO, January 2002:
Supply-side incentives (that is, those that increase people’s willingness to save or work) are essential for economic growth in the long run, but they do not directly address the current problem of the economy’s short-term inability to use its existing capacity to produce goods and services. Consequently, the standard for judging the likely success of tax policy for countercyclical purposes is different from the standard for evaluating the policy’s contribution to long-term growth.
The effectiveness of tax cuts in stimulating an economy with slack capacity is largely determined by their ability to boost demand rather than supply. Tax cuts to stimulate economic activity in a recession do so by spurring additional demand. A tax cut is an effective fiscal stimulus if it creates sufficient demand to engage more of the economy’s existing productive capacity. A number of tax policies that are potentially desirable over the long term would generate little short-term stimulus.
A tax cut provides short-term fiscal stimulus when it increases consumption or investment demand. Consumption by households is generally stimulated when either after-tax income or lifetime wealth rises because of a reduction in taxes. Investment by businesses is typically stimulated when a tax cut boosts the aftertax return on capital sufficiently to make it profitable to invest more. In general, tax cuts designed to encourage more consumption are effective if they leave consumers with additional spending power. The bigger the chunk of their income that consumers are willing to spend instead of save, the more stimulus there will be from a particular tax reduction.
Tax cuts are a powerful tool for long-term economic vitality. Of course, cutting taxes to increase the deficit is certain suicide — eventually. With a total liability of $65 trillion (approaching 5 times GDP), America is accelerating towards a cliff (see the 2008 Financial Report of the United States Government for the ugly details).
3. Which stimulus programs work best?
Experts recommend a cocktail of programs, as each has advantages and disadvantages.
Tax cuts or “rebates” work fast but with astonishingly low level of effectiveness, as they will mostly be used to pay down debt or increase savings. Only 17% of the $177 billion 2008 rebates was spent, slightly less than that of the 2001 rebate.
Direct payments — food stamps, welfare, unemployment insurance — work fast with a high level of effectiveness. They support consumption (aggregate demand), mitigate suffering — but have no long-term benefit.
Building infrastructure creates jobs — but for a relatively small number of skilled tradesmen and a million immigrants from Mexico (attracting back many who left following the crash in housing construction). And its slow. Jack Wells, Chief Economist for the Dept of Transportation, said:
“Finally, it takes a long time for these jobs to be created. Infrastructure construction requires a long series of steps to plan, design, get environmental clearance on, and construct infrastructure projects. Only about 27% the funds, on the average, are actually spent (“outlayed”) in the first year, while another 41% are spent in the second year.”
Eventually, if the downturn persists, we will resort to New Deal programs like the Public Works Administration, the Civil Works Administration, and the Works Projects Administration. See this article in Slate by Charles Peters and Timothy Noah for more information.
4. What stimulus measures give the most “bang for the buck”?
Just what you would expect from the previous report. Poor people spend their money, esp during recessions — giving aid them a relatively high level of impact. From “The Economic Outlook and Stimulus Options”, Mark Zandi ( Chief Economist of Moody’s Economy.com), Senate Budget Committee, 19 November 2008 — Table #1 on page 10.
5. What types of tax cuts and transfer payments have powerful short-term effects?
Temporary Increase in Food Stamps 1.73 Extending Unemployment Insurance Benefits 1.63 Increased Infrastructure Spending 1.59 General Aid to State Governments 1.38 Payroll Tax Holiday 1.28 Refundable Lump-Sum Tax Rebate 1.22 Across the Board Tax Cut 1.03 Non-refundable Lump-Sum Tax Rebate 1.01 Extend Alternative Minimum Tax Patch 0.49 Make Dividend and Capital Gains Tax Cuts Permanent 0.38 Make Bush Income Tax Cuts Permanent 0.31 Cut in Corporate Tax Rate 0.30 Accelerated Depreciation 0.25
Government money to the poor both helps those most affected by a recession and has the greatest cost-effectiveness. From “Options for Responding to Short-Term Economic Weakness“, CBO, January 2008 (Color italic emphasis added), pages 6-7:
Cost-Effectiveness. In general, stimulus may be generated through policies that affect the spending of households, businesses, or government. The cost-effectiveness of stimulus varies within those categories of policies as well as across them. The same dollar amount of spending increases or tax reductions can have significantly different effects on overall demand, depending on how it is provided and to whom.
Households. In general, tax cuts or increases in transfer payments from the government to people (such as Food Stamps or unemployment insurance benefits) increase household demand by providing consumers with additional spending power. The bigger the chunk of that additional income that consumers are willing to spend instead of save, the more stimulus there will be from a particular tax reduction or increase in government transfer payments. But households do not predictably spend a fixed proportion of the extra income left in their hands when taxes are reduced or transfers are increased. Rather, a household’s propensity to consume appears to vary with its income and depends on expectations of the household of what will happen to that income over the longer term. A household’s consumption also varies for other reasons that are little understood.
Households are particularly likely to spend a greater share of a temporary reduction in taxes or additional transfer payments if they are credit constrained (that is, they have borrowed as much money as creditors will lend them). Given that these households would probably borrow additional money if given the opportunity, they are unlikely to save additional income. They are therefore likely to spend a greater proportion of a tax reduction or a transfer increase than other people who have access to credit. Lower-income households are more likely to be credit constrained and more likely to be among those with the highest propensity to spend. Therefore, policies aimed at lower-income households tend to have greater stimulative effects.
The cost effectiveness of tax cuts is low unless tightly focused. Only 17% (roughly) of the 2008 tax rebates were spent, slightly less than the 2001 rebates. Poorly targeted for effectiveness, all we have to show for it was a brief bounce in the economy and another $177 billion in government debt. As shown in this study: “What Ends Recessions?“, Christina D. Romer and David H. Romer, NBER, June 1994
Only 1/5 of survey respondents said that the 2008 tax rebates would lead them to mostly increase spending. … The survey estimates imply that the marginal propensity to spend from the rebate was about one-third and that there would not be substantially more spending as a lagged effect of the rebates. … Because of the low spending propensity, the rebates in 2008 provided little “bang for the buck” as economic stimulus.
As economist David Rosenberg wrote about the new stimulus plan on 20 January 2008:
“Of the tax cuts, the bulk is in credits, once again to low-and middle-income households. Since this had virutally no effect on consumer spending in last year’s 2nd quarter, we would not expect much of a response to this type of stimulus this time around, esp. with the credit contraction, economic recession, and asset deflation backdrop much more deeply entrenched.”
6. Who can we trust? Who has the best economic research?
It’s 21st century America, and the only illegal whores are those on the Streets. Doctors and lawyers lie in the courts. Scientists shade the truth for grants. As for economics — with the government the largest source of wealth, power centers (left, right, business, labor, greens) hire economists to say whatever is needed to get their share of the swag.
The academic literature is largely incomprehensible to laypeople — so still relatively reliable (why buy a product few understand). Even more useful is the work of the Congressional Budget Office. With Congress so evenly balanced for so long, they have been able to maintain objectivity. Their reports are based on academic literature (properly cited for reference), but written in a rigorous clear manner understandable by laypeople.
7. For more information
Codes:
- CBO = Congressional Budget Office
- NBER = National Bureau of Economic Research
Research about government stimulus programs:
Note: Christina Romer is the new Chairwomen of the Council of Econmoic Advisers.
- “Economic Stimulus: Evaluating Proposed Changes in Tax Policy“, CBO, January 2002
- “The Macroeconomic Effects of Tax Changes: Estimates based on a new measure of fiscal shocks“, Christina D. Romer and David H. Romer, UC Berkeley, March 2007 (68 pg)– Largely bout tax increases.
- “The Economic Outlook and Stimulus Options”, Mark Zandi ( Chief Economist of Moody’s Economy.com), Senate Budget Committee, 19 November 2008 — See Table #1 on page 10.
- “The Job Impact of the American Recovery and Reinvestment Plan“, Christina Romer and Jared Bernstein, 9 January 2009
- “Options for Responding to Short-Term Economic Weakness“, CBO, January 2008
- “The Job Impact of the American Recovery and Reinvestment, Plan“, Christina Romer and Jared Bernstein, The Presidential Transition Project, 10 January 2009 (14 pg)
- “H.R. 1, American Recovery and Reinvestment Act of 2009“, CBO, 26 January 2009
- “The State of the Economy and Issues in Developing an Effective Policy Response“, Douglas W. Elmendorf (Director, CBO), 27 January 2009 (30 pg)
- “Painful Medicine“, Laurence Ball, Daniel Leigh, and Prakash Loungani, Finance & Development, September 2011 — “Although advanced economies need medium-run fiscal consolidation, slamming on the brakes too quickly will hurt incomes and job prospects”
A selection from the vast research about infrastrcure spending:
- “Contribution of Highway Capital to Industry and National Productivity Growth“, M. Ishaq Nadiria and Theofanis P. Mamuneasc, prepared for the Federal Highway Administration, September 1996 (130 pages) — They found the contribution is positive, but far smaller than previously estimated — and has been falling over time.
- “Contribution of Highway Capital to Output and Productivity Growth in the US Economy and Industries“, M. Ishaq Nadiria and Theofanis P. Mamuneasc, August 1998 — Updating and expanding their 1996 study.
- “Trends in Public Spending on Infrastructure“, Joseph Kile (CBO Assistant Director for Microeconomic Studies), 5 February 2008 (PDF, 13 slides)
- “Issues and Options in Infrastructure Investment“, CBO, May 2008 (52 pages)
- “Issues in Infrastructure Investment“, Joseph Kile (CBO Assistant Director for Microeconomic Studies), National Tax Association Conference, 26 September 2008 (PDF of 10 slides)
8a. Afterword
Please share your comments by posting below. Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For information about this site see the About page, at the top of the right-side menu bar.
8b. For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest these days:
- About the Financial crisis – what’s happening? how will this end?.
- Good news about America, a collection of articles!
Other posts about solutions to the economic crisis:
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
- Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
- How should we respond to the crisis?, 24 September 2008
- A solution to our financial crisis, 25 September 2008
- A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
- The Paulson Plan will buy assets cheap, just as all good cons offer easy money to the marks, 30 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008
- Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
- Dr. Bush, stabilize the economy – stat!, 7 October 2008
- The new President will need new solutions for the economic crisis, 9 October 2008
- New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
- A look ahead to the end of this financial crisis, 30 October 2008
Well… this thing is just plain big. Half a tril, give or take a few bil’ is about the size of the US military budget. Wikipedia gives the US Navy/Marine combined budget as 127B, so this money could fund the Navy for maybe 6 years or so? That’s real.
If we’re not worried about inflation at all, and now that we’re decoupled from tax revenue, what’s it matter what is the most bang for the buck. Dollars, they can always print more, why not just throw caution to the wind. Really, mostly, they don’t even need to print, it’s just some numbers on a screen somewhere. Blip, blip.
In any case, what is spent here will be the USA of the future. If this bill hires a lot of unionized government employees, then that’s what the USA will become. It’s already settled at this point, so it’s most useful to try to work out what is really in this thing. Who is getting hired, what are they going to do, and how long we can keep this all going. I presume the details should be dribbling out over the next few weeks. I’d like to find out what kind of economy we’re going to have so I can start scheming to get a piece of the action.
Nice work, Comrade Maximus… slices the rickety legs out from under the congressional GOP and has excellent quantitative backing for a Marxist Christian approach to the recession. All the stimuli listed with a ratio of one or more in the bang-for-buck column are traditional liberal Democratic approaches, and all of Bushonomics as still promulgated by the Confederate remnant values out at .5 or less.
I do think, though, that everyone should realize that the energy-related portions are essential in light of the fact that it was an energy price rise that hastened the deflation of the housing and securities bubble. Unless efficiency in the use of dwindling petroleum resources is combined with diversification and reengineering, every little recovery that does ensue will hit the energy ceiling and bounce down again. It may regardless, but it is worth trying to prevent or reduce that effect. In which case we all, as capitalists in a a free market economy of rugged individualism, can join with Cathryn in plotting for our slice of the pie;-).
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Fabius Maximus replies: “‘Marxist Christian’ approach to the recession”, I like that. What an interesting fusion of divergent views, nicely capturing the weirdness of economics.
I strongly agree that we should make full use of this opportunity to upgrade our energy infrastructure. For more on the relationship between the rising energy prices of 2002-2008 and our current debt deflation, see “The geopolitics of inflation, an introduction” (17 June 2008).
greg: Unfortunatly, its due to “the truth has a notorious liberal bias.”
If you give a tax cut, or one-time payment, to someone in my position it goes straight into savings. ESPECIALLY one-time payments. If you tax the hyper-rich (top 400) at 17% (extend the bush tax cuts/capital gains cuts), they are just going to save it. How much, percentage wise, does Warren Buffet spend of his yearly income? How much do you?
But if you give an extra $100 in food stamps to 10M working poor, that $1B will be spent at the grocery stores, which goes to the whosalers, which goes to the suppliers, and along the way helps pay for the grocery employees, the whosaler’s employees, the farmworkers, etc…
The key for short-term stimulus is it needs to inject money into “high velocity” flows: where the money will not just be spent, but repeatedly spent, through a large chain of activity.
The key for LONG-term is efficient allocation of assets, using the tax code to ensure that the economy avoids imbalances but generally grows well. This is the theory behind capital gains cuts (it doesn’t work that way in practice, it just ends up being a way for hedge-fund managers to convert income into 1-year capital gains), and why I’d make the social security tax lower and make the money back up on an oil tax.
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Fabius Maximus replies: All great points! This difference in short- and long-term effects is often lost in the mainstream media, making discussions of these things a “tower of babble”.
Greg:
All items on the list with a 1.0 and above “bang for the buck” rating go right to those most willing or by necessity need to spend now, while everything below 1.0 would go to those who would probably save and invest…i.e the taxpayers and producers. It pretty much splits out per the information provided by Fabius….above 1.0 good for short term stimulus to counteract affects of recession hardship, below 1.0 good for long term growth and health of economy. Unfortunately both parties want it all their way all the time. The Dems love to use those measures above 1.0 no matter where we are in the economic cycle to pay off their special interest groups and vice versa for the Repubs. The trick is to get the balance and timing right which both factions don’t seem to care much about.
Re #3: yup. I remain convinced that targeting velocity is the key as the numerous stamp script currencies in the 30’s proved in the laboratory of Reality.
One big concern that dwarfs all others for me right now is the conviction – even though I confess to not understanding all this stuff (like Greenspan as it turns out!) – that this logic of bailing out the major (centralised) players in the finance sector because they are ‘too big to fail’ is ‘stinkin’ thinking’. In fact they are too big to save and by saving them we forgo real stimulation by boosting lower class incomes with extended Food Stamps, UI etc. such that the real economy weakens further and these same banks are the ones left to pick up the pieces and take over everything after the economic dust (bowl) settles. If we let them go without setting up a ‘bad bank’ to relieve them of their losses (aka ‘toxic assets’) then the regional – or real – banks might move to the fore delivering credit to local and regional enterprise without all these high-falutin’ shenanigans dragging everything down with them.
Even worse: those big banks could still ‘fail’ and one monster bank, internationally networked, takes over the whole thing turning current Federal Governments of nation states into ipso facto State governments subservient to a larger, One-World entity. Centralisation to the max.
We have too many people for the amount of stuff that we need to make. Stimulate that.
No amount of stimulus will solve that problem. We are paying now, for a problem that should have been addressed in the seventies. As Chuchill said, we will pay much more now than we would have back then.
Using economic tools, to solve a social problem, will prove inefffective at best. We must define the real problem, to come up with a real solution.
A few ideas: cut the work week to thirty hours (with a cut in pay), punish overtime, both in hourly and salaried people, with jail time, establish a minumium level of income for each citizen. It’s no ones fault they cannot find work. Eliminate barriers to hiring new employees. Secure the borders-if we have a minimum income, citizenship will actually mean something again.
The issue of work becoming a scarce good, is not some hazy, far away thing to deal with later on. It’s here, it’s now.
Johnny: The low items on the list aren’t necessarily good long run however, its just they aren’t good in the short run. The ability for a policy shift to be good in the long run is actually orthoginal to the short run.
Lets take the Bush capital gains tax cuts. Treating capital gains much better than ordinary income is why the hyper-rich pay 17% federal tax, while the upper middle class may pay 30%+ (and why Warren Buffet pays a far lower percentage of tax than his secretary does).
The theory is compelling, but in practice what happens is the very rich use it as a way of shifting ordinary income into capital gains, but everyone else is unable to do that and benefits little.
Yet it actually has a huge short-term GAIN on revenues, as people who are very wealthy realized this was a short time window, so deliberately captured a large amount of capital gains now. So long-term it is revenue-bad, but short term revenue-good. And long-term economic health far less effective than casual theory would predict.
Rather, the proper solution for capital gains is “Treat as ordinary income, but only tax the REAL gains.” With modern computers for taxes, it would be trivial to have capital gains be only on the post-inflation gains. A capital gains tax thats at the same ordinary-income rate would be a disaster if inflation returns, and those planning 10+ years out really do worry about inflation
Likewise, tax shifts can have profound effects on how things operate. EG, what would happen if you cut the employee fraction of social security from 7% to 3%, but made up the revenue on a tax on imported oil? It would help the car-less working poor, it would hurt the car-based working poor and lower middle class, it would help the upper middle class (I may commute 40 miles each way, but I pay a fortune in social security tax…), and it would help shift the economy away from its dependence on oil
One of the root problems, however, is the complexities of the debates get muddled by the press and those shaping the press and those lobbying. EG, do you think the estate tax repeal would have gone through if the democrats had the sense to spin it as the “Paris Hilton Tax”? Or the (in retrospect disastrous) california repeal of the vehicle liscence fee if it was spun as the “Mercedes tax”?
And we are seeing the same thing happening all over again with this stimulus debate.
Erasmus: The problem is on the banks is that there are several that really ARE insolvent (BofA, Citigroup) if you actually went through their books, and they really are a major vulnerability in the system.
Something DOES need to be done about them, but the least repugnant option is nationalization, as everything else is even more rife with moral hazard.
The problem is the Paulsons, Greenspans, etc see themselves as servants of Wall Street, not the people. Nationalization may be the best thing for the people and the system as a whole, but would mean a complete wipe-out of stockholders, an end to the bonus culture, and a huge pullback from reckless financial engineering.
EG, Fannie and Freddie, as recently as two years ago, were complaining that they were too restricted by their charter from doing all the cool subprime crap that was taking market share from them.
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Fabius Maximus replies: Paul Krugman expressed the situation perfectly in his 29 January blognote.
The original version of this joke: “Capitalism is the exploitation of man by man. Socialism is the reverse.”
I used to hate the fact that Theodore Rosevelt busted the trusts. I figured it was a government taking of property that despoiled the honorable intentions of the 5th Amendment. If I hear one more stupidly run business referred to as “too big to fail”, I’ll conduct my own seance to bring back TR. (Image what a “bully little war” he could have himself in Iran.)
Seriously, our government, our major corporate conglomerates, our institutions, are all way too big. Put too many eggs in one basket and two things happen.
1) Invariably, the moral hazard overwhelms the sense of business and governmental ethics that our society tries to develop as a safeguard to protect us when the law comes up short.
2) Some idiot like Dick Fuld or perhaps Alan Greenspan sits on the basket.
Xaoding: Such policies have been tried in europe. They don’t work. France, in particular, is a country to be avoided when you are starting a business, because of such regulations and restrictions. It was also tried by the Hoover administration.
Artifically limiting the ability of people to work is not an effective strategy, and relates to the “Lump of Labor” fallicy.
Just beyond the probable lack of reduction in employment, how well would you do with a 25% pay cut? A 30+% pay cut? You aren’t going to be paid the same to produce 25% less.
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Fabius Maximus replies: It’s not clear to me that France’s policy mix, broadly defined, works less well than ours. Their productivity is similar to ours, but accomplished in far fewer hours of work. Their economy provides a different set of social trade-offs, but saying “they don’t work” seems too strong. A long, severe downturn will test both our systems; the results will be interesting to see.
Excellent. We will subsidize cheap beer and run producers, and keep crack houses in business! Support above 50% illegitimacy, cigarettes, junkfood, and crack houses. I love these ideas! Perpetuate low achievement by shunting society’s resources to the bottom rungs. That is long term thinking at its best.
What kind of stimulus will work is an interesting but pedantic question, in light of the many times greater giveaway to banks which has already taken place (the Bush/Paulsen phase at least $2 trillion; Obama’s “bad bank” plan another $2-4 trillion). I think Cathryn is making the point that the ultimate picture has already been decided. It’s one where wealth and power is even further concentrated at the top, and ordinary folks will pick up the scraps.
In this respect, the stimulus plan is more of a band-aid than a serious program, and the social question is more important than the economic — how long will ordinary folks put up with it?
(145 words left. . .)
The very large mall near me is beginning to show For Lease signs. Behind each For Lease sign is a lender whose balance sheet is looking shaky; behind a bunch of those lenders may be a large national bank. Workers in those stores are now unemployed. The customers who stopped coming have used up their credit. The whole thing was built on a bubble of credit that started with low interest rates and lax regulation at the national level. So far, including the so-called stimulus plan, the government is simply trying to re-inflate that bubble. The ultimate beneficiaries will again be the lenders, who make money whether the loans are repaid or not. Shouldn’t we be thinking about a different approach — an economy that works for people?
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Fabius Maximus replies: Your attached email address does not work. I will resend my message if you provide another one.
“Excellent. We will subsidize cheap beer and run producers, and keep crack houses in business! Support above 50% illegitimacy, cigarettes, junkfood, and crack houses. I love these ideas! Perpetuate low achievement by shunting society’s resources to the bottom rungs. That is long term thinking at its best.”
I appreciate that you recognize the social issues. They are not economic problems.
Over the past twenty years, we have supported vast over-investment in cheap, shoddy housing and crappy malls and office parks. This led to vast hordes of people engaging in construction careers that were nothing more than makework for the stupid, and crimminally inclined. I see problems all over. :)
NW: thnx for the link, I’ll check it out. Off the top of my head, I don’t think of Europe when I think of the future. :) So, it’s been tried before, and failed? Space exploration has the same problem too!
Yes, I accept the pay cut. It will make many uncomfortable. This is all for the good.
Here’s a question (rhetorical of course). If increased infrastructure spending has such a great multiplier effect, why do people gripe so much about the infamous “bridge to Nowhere”? I mean, come on. It’s stimulus, not pork!
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Fabius Maximus replies: Just because digging holes and filling them in is stimulus — helping people keep food on the table — does not mean that we cannot do better with the money. Why build bridges to nowhere when we need real repairs to our infrastructure?
It is of the utmost importance to remember that we are borrowing this money! The twin goals should be IMO:
(1) Spending it on things that generate a future economic return, or
(2) Spending it on things that mimimize pain and suffering today.
Nicholas Weave:”The key for short-term stimulus is it needs to inject money into “high velocity” flows: where the money will not just be spent, but repeatedly spent, through a large chain of activity.”
I’ve been thinking… (which is always dangerous.)
Avoiding inflation should be our goal, not spending efficiently. I agree that we’re in a pretty deep hole as far as deflation, but inflation should be our ultimate gate keeper. Since the money is fiat currency we can always make more. There’s no real practical limit here, so being thrifty doesn’t apply any more. Our goal should be putting money into the economy, as much as we can, but while still being mindful of inflation.
If money goes into personal savings, nothing bad happens. If all that money goes into savings, all that happens is that people have more savings. Savings does not cause inflation, all savings will do is is end the depression more quickly as people climb out of debt It’s not a bad thing.
But the guys warning about inflation are not just raving crackpots. Don’t ridicule the risk of inflation, it’s not a joke. Inflation will occur if all this money tries to buy one single commodity, like oil, and that might happen if the money all goes into high velocity flows. So here’s the signal, when we start to see oil prices and natural gas places climb again, that’s the sign that the stimulus is beginning to feed into tangible goods. This will accelerate. If we have a lot of M0 out there, and oil is going up, well, why not invest in oil? We have to have the discipline to stop the tap when this starts to happen. That’s what’s missing from all this.
So, the key is we need stimulus with an off switch. We need to stimulate the economy but we need to turn it off instantly when inflation begins to occur. If we create massive fiscal projects that stimulate spending the problem is these projects create momentum that cannot be stopped when inflation begins to occur. If we have large construction projects, they’ll want to be finished. If we have large unionized government employee expansion, they can’t be fired so easy. That’s another reason why fiscal stimulus is awkward. It’s impossible to stop.
That’s why a tax cut would be better because we can turn it off when inflation begins to occur.
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Fabius Maximus replies: IMO this shows that you do not understand the nature of the problem. I suggest reading “Debt – the core problem of this financial crisis, which also explains how we got in this mess“. We are suffering from debt deflation. Worries about inflation during debt deflation was a major cause of the Great Depression and a major reason Bernanke’s response to this crisis was so slow and incremental.
Worries about inflation come during the recovery. Worry about inflation could easily make that a problem for our children — a generation from now. Look at Japan, going down again in their 20 year battle against deflation.
Cathryn: “Avoiding inflation” might not actually be the right thing. We want some inflation (not too much mind you, but some). With 0% or deflation, you get vicious cycles where people postpone speanding, which greatly reduces the velocity of money. Inflation (to at least some degree) increases the velocity.
EG, say the car you want this year would be $20K. But you know that, next year, you might be able to get it for $19K. You are far more likely to wait a year if you can, compared with you knowing that next year it will be $21K. Since much of the short-term goals is to increase the velocity of money, we need to worry more about deflation in the short run than inflation.
Its a tradeoff. Deflation and high inflation (>4%+ by my non-economist-think) are both really bad. But right now, its going the wrong way.
And putting more into savings actually doesn’t end the recession more quickly, it does the opposite in fact (the “Paradox of thrift” ). With the aggregate US savings rate so abysmally low, we do need to save a lot more than we do, and for the LONG term health, we need to greatly increase our savings rate.
But people shifting from spending to savings will, in the SHORT TERM, make the recession worse, as this reduces the velocity of money.
FM: I was a bit glib on the “tried in France” bit, but generally speaking, I don’t believe restricted work-weeks and significant restrictions on firing have proven effective at reducing unemployment (France has been at it for quite a while now), especially compared with the costs.
How much of the french economy is really “global competitive” items like manufacturing, vs local service sector and specialized agriculture? The only “global competitive” items that I can think of are aircraft, which are explicitly subsidized by the European government (Airbus).
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Fabius Maximus replies: You are too kind IMO in your response to the concerns about inflation. It’s like worry about floods during a fire, grossly counter-productive.
As for France, you were quite clear — and IMO accurate about the economic effects. I was just noting that money is not everything. Social harmony and leisure time are also important things.
The present stimulus bill is big payback to supporters of the current administration and dominant party in US congress. It is not stimulus or infrastructure bill except to be flushing wealth down to black hole. What is coloring of your parachutes?
I’m a little surprised that not one of the respondents in this forum — let alone Fabius — asks whether it might be appropriate for the government to do nothing. Instead, the only disagreements seem to be about where and how the government should spend its money.
If it’s truly possible for the state to run a prosperous planned economy–and that is what we are talking about here–then all will indeed be well. (Assuming our planners are good enough to come up with a 5 Year Plan that actually works.) I find it a little bit strange that a few years ago, it would have been difficult to find so many believers in the principle of state-planned economy, yet now this belief seems to be the accepted norm. Quae mutatio rerum!
As usual, I find myself puzzled and out of step with everyone else. I suppose I’ll do what I must–wait and see. If my paternalistic state plans so well, then I suppose I’ll never again hear any of that silly talk that there’s not enough money to pay my social security (yes, retirement looms in my life). After all, the state can just “plan” for it by printing me some money.
On the other hand, you may all be rudely disillusioned, and I’ll be dumpster diving–comforted by the thought that my life-long pessimism has, at last, been definitively vindicated.
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Fabius Maximus replies: This must be Andrew Mellon, speaking to us from the hearafter. I don’t blame you for using a pseudonym, considering the disaster your policies created. But you could not know in advance. Contemporary economic theory was inadequate for the crisis, and leaders had to use their instincts. Yours were quite poor (as it turned out), and so the US (and UK) suffered more than most other developed nations.
What is so sad is that after that experience people still advocate “doing nothing.” Fortunately your efforts left a legacy of knowledge that most Americans remember, so I am confident that your mistakes will not be repeated today.
Update: the pretense that this comment was written by Mellon from Heaven is a joke, of course. Reynardine describes what Matthew Yglesias calls “neo-Hooverism.” Hoover’s policies in the first few years of the Great Depression were reasonable by the standard economic and financial theories at that time, but hard experience proved them to be disasterous. Many policies of the last two years of Hoover’s Administation were similar to FDR’s, although smaller in scale.
NIcholas Weaver:”Avoiding inflation” might not actually be the right thing. We want some inflation (not too much mind you, but some). With 0% or deflation, you get vicious cycles where people postpone speanding, which greatly reduces the velocity of money. Inflation (to at least some degree) increases the velocity.”
The risk of funding the public good from monetary expansion is hyper-inflation. The way to prevent hyper-inflation is to stop the monetary expansion when inflation begins to occur. Inflation could come quickly, so we’ll need a stimulus that we can turn on and off rapidly. If our fiscal stimulus is funding projects for the public good, this is not so easy — those needs will still be valid after inflation begins. This bill will create a political constituency dependent on this money.
We need to build in the brake pedal to this spending now, so that it can turn off at the correct time. Because we won’t have the discipline to shut it off when we need to.
Nicholas Weaver:”And putting more into savings actually doesn’t end the recession more quickly…”
Sorry, I wasn’t clear here. The context I have in mind, is that if people are given tax cuts from monetary expansion that they’ll save the money. Since that money is new money into the system, it won’t cause recession. It’ll just cause people to have more money in bank accounts. Eventually they’ll spend more due to the wealth effect. The effect you’re referring to has to do with when they take their existing income they had been spending and then apply it to savings, but new savings from monetary expansion isn’t taken from existing income. It just adds to savings only.
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Fabius Maximus replies: This really misses the point. The essence of debt deflation is a decline in asset prices. It’s a negative wealth effect. Any government actions can only offset or mitigate this process.
Also, tax cuts generate income. How much of this is spent depends on people’s propensity to save. It does not generate wealth in any meaningful sense, esp when the government borrows to fund the cuts.
Spending due to “wealth effect” is not going to happen, because anyone subject to the wealth effect just lost a huge amount between their stock market losses and real estate losses.
To cause me to spend more at all due to wealth effect, you’d have to provide a HUGE influx of additional money.
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Fabius Maximus replies: Too kind a response! The idea that the government can borrow and distribute funds — by any means — to generate a net increase in wealth is absurd. More than absurd. Doing so can help keep the wheels turning — sustain the economy and mitigate suffering — but not generate net wealth for the nation.
Nicholas Weaver:”To cause me to spend more at all due to wealth effect, you’d have to provide a HUGE influx of additional money.”
Maybe not you, but someone else more needy would spend the money. And the money that you save wouldn’t hurt anything provided that money doesn’t cause inflation.
I do think it makes sense to target the middle-class and poorer, because they would spend more of it. Too much to the rich might trigger another price bubble somewhere else in the system, and that’s dangerous also. Though for now, likely the rich would just take additional cash and stuff it in government bonds.
There’s a vast hole to fill. We can put a huge influx of new money into the economy as long as we have the ability stop quickly when inflation starts. That’s what this stimulus bill is doing — it is adding huge influx of new money. The problem is as prices begin rising, we’ll need yet another debate about what needs to be to cut, that will take time, and then, well, we’ll see…
In my amateur opinion the problem in the UK was largely preventable , and any gov worthy to hold office should have , a few years back :
-Stopped the personal credit crisis by outlawing credit cards .Debit only allowed .
– Not taxed pension fund dividends .
-Stopped corporations investing in dwelling houses ( DH ) .
-Limited private investment in DH to 2 per adult , or removed the tax advantages of buy to let mortgages .
-Controlled immigration . Even if this meant redefining our relationship with the EU .
These measures would have limited the housing and credit bubbles .
-Recognised that a jump in oil price and world droughts , would push inflation to 10 % . Admit inflation had escaped the set maximum ( 4 % ) and allow wages to catch up . Slash bureocracy and uneccessary spending , start glorifying manual labour and wipe out tax for the low paid .
In the present situation , bank bailout money should have been used to transfer ‘junk’ loans into longer term loans with lower monthly repayments , (loans even ‘ beyond death’) .
Our gov seems to have acted on a level with that Iraqui minister , who with US tanks in the camera frame , told us so sincerely there were no foreign troops in Baghdad.
From now , all persons in power should be subject to random drug testing for recreational chemicals and prozac , so they have a better chance of telling the blue decks from the red .
I feel very angry about this situation because I may be facing having to reduce hours for my totally brilliant hard working staff , through no fault of their own , with frightening consequences for their mortgages .
Re #18 re ‘doing nothing’.
Well, there is government that is hands-on dirigiste of whatever stripe (dictatorship, communist, corporate-fascist etc.).
But even a powerful, successful State enjoying laissez-faire Govt owes that to Govt because Govt in all cases is not just managing things to one degree or none, but providing the rules of the road via legislation, oversight etc. A large population has to have some form of shared procedures.
So in this case even if the USG did ‘nothing’ it would still be doing a lot by allowing the same legislative and regulatory situation, which has much to do with how things unfold, to continue.
Personally, I think they should have overseen the defaults of the major banks, put in plunge protection for mortgage defaults for a year or three by taking over via Fanny and Freddie any mortages ‘liberated’ from bank closures. Another HUGE way of doing nothing would be to dismantle the Fed and return it to the void from whence it came! And yet another way of doing nothing would be to dismantle the vast US military empire abroad (i.e. doing nothing could also mean to stop doing alot of the terrible, expensive things they are doing.)
But one way or another they are doing a lot all the time. The real question is what are they doing and more importantly, why; and where is the country headed generally, i.e. the vision and mission need to be rethunk.
anna nicholas:”These measures would have limited the housing and credit bubbles .”
That housing bubble was pretty tricky to spot. I wasn’t sure myself. I saw houses going up to $US500K and $US800K around here, and yeah, who could buy that, but somehow people managed. I think it was a little like that Madoff scandal. All these houses eeked up in value just enough to satisfy our greed, but it wasn’t so much that we panicked. We just got use to it. It seemed normal. I don’t think we can completely make these bubbles go away, but we can have a world economy that is better able to deal with them.
The problem is that the banking system was way, way, way over-leveraged, and just a bit of default, cascaded into a massive collapse of the planetary economy. Institutions need to be built for resiliency as well as profit. Bad loans to borrowers with insufficient income were masked by financial innovations that in the end only helped obfuscate the real risks involved.
Billions of dollars continues to be looted from the world economy by these idiots as their stupidity is rewarded with more and more bailouts. Citigroup/BofA have already gotten $90B. There’s a $300B guarantee to Citigroup alone, how much of that is going to turn into real payments? Let me see, for $125.2B we could pay all service members in the entire US military for a year. What a bargain!
Ack, I’m ranting. Sorry. I don’t blame those French unions for going nuts. The whole thing is crazy.
FM: “Only 17% (roughly) of the 2008 tax rebates were spent, slightly less than the 2001 rebates. Poorly targeted for effectiveness, all we have to show for it was a brief bounce in the economy and another $177 billion in government debt.”
This silly argument, without a specific link, has been made many times. (A couple times in just this post!) Certainly not all would be ‘spent’, but my guess is that more than $30 bil. was spent in 2008. But even if it was only $30 bil., the other $147 bil. was used to reduce US taxpayer personal debt.
A huge part of the mid- and long-term problems of the coming depression are caused by what? Too Much Debt. As FM so frequently has cited in the end of the post WW II debt crisis.
The FM-denigrated tax rebate was acting in a positive way on reducing the underlying Too Much Household Debt problem. To complain in many posts about Too Much Debt, but then to complain about a non-preferred stimulus policy that reduces the debt problem is silly.
177 is less than 1/4 of the $860 pork stimulus Obama alternative. The tax rebate was only used once in 2008, instead of every quarter. Four quarters of that treatment might well have insured only a recession, and not the depression we’re now looking at — AND would have included a huge reduction on personal debt.
Best short, mid, long term policy now — month by month tax holiday until inflation starts up again, then collect taxes as usual. Compare the mid term of this with the extended unemployment benefits or more Food Stamps — which in the mid term encourage and reward bad work habits and live style choices.
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Fabius Maximus replies: You are confusing two very different goals, which I explictily warn against in this post. One, short-term stimulus — first aid to support aggregate demand and minimize suffering. Two, a cure for the underlying problem (long-term).
You seem to imagine that government action provides a cure, a belief which has little support in the economic literature. Both Ben Bernanke (Chairman, Fed) and Christina Romer (head of CEA) have written extensively about this misconception.
If “government borrowing money and passing it out” is the cure for deleveraging, why not just borrow the entire 5 trillion or whatever and just do it now? Absurd.
As for the rebate, the reason it has been said many times is that much research has shown it to be true. Here are two references.
(1) Economist David Rosenberg’s comment on 20 January 2008:
(2) Conclusions from “Did the 2008 Tax Rebates Stimulate Spending?“, Matthew D. Shapiro and Joel Slemrod, U Michigan and NBER, 27 December 2008:
Yes, Erasmus, you are quite right: the government should be urged to do nothing more creatively than hitherto. I had not meant to say that nothing should change; I did mean to say that the changes being urged are senseless. I agree that we need rules: I plan to continue to drive on the right side of the road. And yes, ending our involvement in pointless wars would be a Good Thing, as would chucking the Fed. We should also examine some pretty fundamental questions, such as “what is the proper role of the state vis a vis money? Does it even have one?”
Cathryn Mataga: “That housing bubble was pretty tricky to spot.”
You must be young. I’ve been watching housing prices on both coasts–and particularly in California–do nothing but rise since the late 70s, and I’ve known it was a bubble at least since 1988. At that time, I had a chance to go work in California or Texas. I owned a house in the Chicago area. From what it would bring, I could buy a hovel in California that was over an hour’s drive away from my job. Or I could buy a (comparatively) palatial residence in the Dallas suburbs 10 minutes from a job there. I chose Texas.
Since then, I have watched housing prices zoom ever upward in other regions with continual amazement. How could people be so stupid? Did they really think cracker box houses were worth $750,000 because some bank would loan them the money? Did the banks think they were worth it? (It turns out the answer was really “no”–the banks decided they could protect themselves by disguising these poorly collateralized loans and selling the resultant paper to other banks. Unfortunately, they all were also buying the same stuff. This is called “sharing the risk”. Or is it mass stupidity?)
And yes, I saw the dot com bust coming too. Now that one was really dumb!
I dont think it wasnt greed that made ‘ordinary’ people in UK pay ridiculous prices for houses . It was that they wanted a home of their own – dont we all ?- and rents were as high as mortgage repayments . So there was a Rent Bubble as well .
Many of us saw this coming , and tried to cut our cloth accordingly ,except, it seems , all the people in power .
The other poison worldwide is the Hot Air Jobs / Slave labour Jobs Bubble .This should have been , and needs to be , addressed .
FM:”Fabius Maximus replies: This really misses the point. The essence of debt deflation is a decline in asset prices. It’s a negative wealth effect. Any government actions can only offset or mitigate this process”
Yes, I agree with this. The decline in wealth is vast. We could throw the entire US tax base at this problem, and it would be small in comparison. The USA is not all powerful. It’s just one of the biggest players.
FM:”Also, tax cuts generate income. How much of this is spent depends on people’s propensity to save.”
Yes, I also agree with this.
FM:”It does not generate wealth in any meaningful sense, esp when the government borrows to fund the cuts.”
This is true, but I see it differently. I know this sounds paradoxical, but right now, not generating wealth is a good thing. The problem with the current economy is that we have vast overproduction — a lot of Chinese goods and cars are sitting around, but nobody is buying. We don’t need to generate new wealth so much. In fact, generating more wealth will just accelerate deflation as those extra goods compete for the scarce dollars being spent. What we need to do to save existing businesses is to stimulate consumption to clear out existing inventory. Normally ‘handing out free money’ would cause inflation, but now because we’re in a deflationary spiral, we can get away with it. It’s okay as long as we know when to stop.
As far as the borrowing, well,if we borrow money from the Fed, that money appears out of thin air. We can do this as long as there’s no inflation or other price bubbles. If we’re spending to clear Chinese products out of the retail pipeline, the Chinese will lend us the money. We’re paying near 0% interest anyway.
We are not 30’s America; we are not 90’s Japan. We aren’t Weimar Germany or Zimbabwe either. We are a new thing. We need to keep an eye on the inflation gauge right now, because what we’re doing, that is passing massive fiscal stimulus and expanding the money supply by the fed are all potentially inflationary actions. Picking our favorite historical analogy is not going to shield us from this. Yes, there’s a massive collapse in wealth on the other side of the scale, so maybe inflation doesn’t come. I don’t know myself, there’s a lot of variables here.
Seems to me, the prudent thing is to worry about future inflation now, while we are passing laws and creating economies that future humans will have to live with. Yes, we need to stimulate, but my view is that if in the process we create an economy and a constituency that requires endless monetary expansion to keep going, we could create future hyperinflation. There’s plenty of recent and historical examples of this — though none of them are at the scale we’re dealing with now.
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Fabius Maximus replies: We are not “a new thing.” Basic economics remains for all societies, and in most important respects today’s America is like America 1930 or Japan in the 1990’s. There is a large body of literature about these things. Trying to refute this with little knowledge of economic history or theory is like attempting to build a nuke with legos. Self-confidence is not sufficient.
From the BEA’s report today about US 4th auarter GDP: “the personal consumption expenditures implicit price deflator (IPD) that is used to deflate DPI decreased 5.5% in the fourth quarter.” One of its components, the deflator for non-durable goods, dropped a stunning 18.8%. Those are seasonally adjusted annual rates. That’s deflation, lethal to a high-debt economy like our unless stopped.
FM:”Trying to refute this with little knowledge of economic history or theory is like attempting to build a nuke with legos. Self-confidence is not sufficient.”
You work for the government, don’t you?
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Fabius Maximus replies: Sorry, no personal information available. I don’t ask about you, and don’t tell you about me.
I have had dialogs like this many many times when answering the 7,000 comments on this site. They only can go so far, unless you have some background knowledge. These things, as usual in the social and physical sciences, are complex beyond my ability to imagine. The explanations on this site just float over the surface of its deep foundations of theory and data. Economics is not physics, but far from alchemy.
To discuss economics in more detail you might go to an economics-focused site. Such as that of Prof Brad Delong at Berkeley. As a start, consider the following medium-technical discussions of the stimulus plan there. (These sorts of things zoom over my head quickly)
“Time to Bang My Head Against the Wall Some More (Pre-Elementary Monetary Economics Department)
Oh boy. John Cochrane does not know something that David Hume did–that the velocity of monetary circulation is an economic variable rather than a technological constant.” (26 January 2009) — Link.
Or this series:
* Fama’s Fallacy, Take I: Eugene Fama Rederives the “Treasury View”
* “Fama’s Fallacy II: Predecessors”
* “Fama’s Fallacy, Take III”
* “Fama’s Fallacy IV: The Decline of Chicago”
* “Fama’s Fallacy V: Are There Ever Any Wrong Answers in Economics?“
Re Cathryn’s ‘The problem with the current economy is that we have vast overproduction’. Yes, because forward momentum has – for now at least – stalled so people can’t keep borrowing in order to consume stuff that in most cases they don’t really need and certainly not at the prices that easy credit had allowed to mushroom into la-la land levels.
That great little piece by Brad Delong linked above (the ‘link’ one) does a good job of explaining velocity with an example that shows how, if people are productive, the economy expands even though no extra money is supplied. It just circulates more, aka velocity.
So to counter your statement above, one could ALSO say that ‘the problem with the current economy is that we have vast under-productivity’. For a host of reasons (including technological efficiencies, over-regulation, international wage arbitrage etc.) far too little work goes into building and making things, and far too little income from work goes into circulation amongst workers/citizens, with far too much ending in computer terminals as electronic blips in ivory towers.
Take a house for example: with reduced wage arbitrage, corporate centralisation, unnecessary industry-biased regulations (health and safety regarding building codes for example), and wage arbitrage that results in basic stuff being supplied from elsewhere that we could put together at home ourselves, building houses could be a far greater source of employment, personal and collective productivity, and thus velocity, which might be increased tenfold were we to change the way it gets ‘built’. Of course this is over-simplifying but still…
Erasmus:”So to counter your statement above, one could ALSO say that ‘the problem with the current economy is that we have vast under-productivity’”
Eventually we want more productivity, but right now we have deflation. Stores are filled with items that are not being bought. Deflation is created by high supply and low demand. Increasing productivity will increase supply and make deflation even worse.
Right now, we need to fix the demand side. Only after demand is restored can inventories clear out and people go back to being productive.
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Fabius Maximus replies: I believe we can state the situation more precisely. For a first cut: “Deflation: Making Sure ‘It’ Doesn’t Happen Here“, Ben S. Bernanke, speech bBefore the National Economists Club, 21 November 2002:
Going one step back, the primary cause of the collapse in spending is too much debt. Here are come posts disucssing this in more detail.
* The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
* We have been warned. Death of the post-WWII geopolitical regime, Chapter II, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions.
* Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
* A picture of the post-WWII debt supercycle, 26 September 2008 — One picture tells the tale.
* Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008 — About debt deflation.
* Causes of the financial crisis (no, its not the usual list), 29 October 2008
It would help us ADAPT if our gov Intent was in any way clear. Then we would have a better idea whether to persevere with the pig farm, take over a car dealership, set up a car mending workshop, study accountancy or learn Swahili. For example,
* if Intent was “to continue cheap imports for consumers, and continue export financial products”, you would want good interest rates (but been slaughtered) and bank bailouts.
* If Intent was “British Jobs for British Workers” you would want to suspend lots of British employment law, pronto.
* If Intent was “Globalisation and the Free Market must continue” you would leave the economy to sink or swim without interference.
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Fabius Maximus replies: Fortunately or unfortunately, depending on your point of view, the US government does not determine “intents” for its citizens. Hence America lacks clear public policy direction for such things. Personally I am glad of that.
Bernanke: “{read} about Japan, where what seems to be a relatively moderate deflation — a decline in consumer prices of about 1% per year — has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors. … ”
This is kind of an aside, but I was just in Japan a few weeks back, and I was thinking Japan could use a bit more deflation. In Japan, it’s pretty easy to throw around 5,000 yen bills like they are $20’s, and it takes only a little math to realize these things are like $55US. For all the deflation, the place is makes you feel poor if you’re paid in dollars.
Japan has run trade surpluses, and this has pushed the currency higher in value. Imports are always getting cheaper because the currency is rising higher, and this contributes to deflation. Right now, the Yen has risen even further, but just walking the streets I can tell the price difference hasn’t made it to the stores over there, so I’m pretty sure there’s even more pressure for decreased prices.
If they want to achieve inflation of prices in Japan, in Yen terms, they’d need to let the currency decrease in value. But this causes political problems with Japan’s trading partners. It’s hard to imagine fiscal/monetary policy alone raising Japanese inflation higher without a currency value change.
I’m not sure how valid of a analogy this is for the current US economy.
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Fabius Maximus replies: It is not a valid analogy for Japan, let alone the US.
The Bank of Japan struggles to keep the value of the Yen low, as its rise hurts the exports on which Japan’s absolutely depends for prosperity. Japan has fought deflation and accompanying recession for 20 years. Another round has begun, with the outcome unknown. Suggesting deflation for Japan is like suggesting cancer for your neighbor as a way to lose weight.
For a high-debt nation like the US deflation is potentially lethal.
Also, the relation between domestic inflation and one’s currency is much more complex than you suggest (and too complex to discuss here). In brief, higher inflation (relative to one’s trading partners) and currency appreciation (vs. one’s trading partners) are roughly similar in effect on a nation’s domestic price level. See this Brookings article for an explanation of this dynamic for China. Also, I discussed it in “The geopolitics of inflation, an introduction“, both in the post and the comments — and will not repeat the experience.
FM:”Suggesting deflation for Japan is like suggesting cancer for your neighbor as a way to lose weight.”
I don’t really suggest deflation for Japan as public policy. In this statement I’m only considering my selfish desire buy stuff in Japan at a slightly cheaper price.
FM:” In brief, higher inflation (relative to one’s trading partners) and currency appreciation (vs. one’s trading partners) are roughly similar in effect on a nation’s domestic price level.”
If you have higher inflation, relative to trading partners or not, then your domestic price levels are higher. That’s just the definition of inflation. Do you mean to say that higher relative inflation and currency appreciation, have the same effect on the relative prices of imports compared to domestic goods? Something like this?
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Fabius Maximus replies: OK then, suggesting deflation for Japan is like suggesting cancer for your neighbor in order to pick up stuff cheap at the Estate Sale. As for your 2nd point, the links I gave provide a detailed explanation. It is too complex for discussion in comments (or even on this site).
FM: “As for your 2nd point, the links I gave provide a detailed explanation. It is too complex for discussion in comments (or even on this site).”
Wait, sorry, I see what he’s saying. Not complex, just a little confusing. He’s talking about domestic inflation and its effect on price levels relative to other currencies. He says it right here, and I agree, if Japan’s currency hadn’t gone so high, Japan might have had inflation and not deflation. You can see this if you just go there and imagine selling the US purchased stuff in your suitcase.
FM:”Basic economics remains for all societies, and in most important respects today’s America is like America 1930 or Japan in the 1990’s. There is a large body of literature about these things. ”
Me, I’d like to respectfully pick away at this a little bit. The root causes of the deflation in Japan and the USA are very similar, but Japan had an external force, the rising Yen due to trade surpluses and the pressure to raise the value of its currency that forced the deflation to last as long as it did. Whether they could have offset deflation caused by the rising Yen with even more massive fiscal stimulation, I don’t know.
Geng Xiao (source):”The strength of the financial sector in the U.S. contrasts sharply with the weakness of that of China.”
I can’t resist. This is kind of a laugh line; he must have written this article last year. I don’t think ‘strength’ is the first word that comes into mind when discussing the US Financial Sector.
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Fabius Maximus replies: We feel smart when reading Geng Xiao’s words because they were written in July 2007. At that time this was the conventional wisdom — for example, a standard line in speeches by senior Fed officials and Wall Street research. The future makes us all wise when looking backwards. Being wise about the future is more difficult.
The posts on this site contain many forecasts. You can look at those of the past two years (very extreme outliers vs. mainsteam opinion) to see how well I have done. It will be interesting to see how the recent ones (still extreme outliers) withstand the test of time.
Economies improve when people make things out of raw materials. This is the only way to actually add to value to an economy, everything else just being shuffling paper. As raw materials move up the ladder they have a multiplyer effect. Raw materials multiply-five-to-one. But, agricultural raw materials multiply seven-to-one.
Eddie Albert laid it out at the 81st Annual Convention of the National Farmers Union. It’s been reprinted in full here. This idea is further expanded here. Also, the writings of Cornell University Professor George F. Warren, an important adviser to Franklin D. Roosevelt on rural development policy, explores this in great depth.
A good deal of these comments seem to address the problem and how to keep the problematic institutions viable instead of looking at known solutions.
“Now all of political economy from prehistory on to 1932 has been intent upon one thing only—how to take the wealth from the producer, how to take the food from the person who cultivated it and harvested it and give him very little in return. But when you take too much, you can kill the goose that lays the golden egg.” – Charles Walters
Read the rest of it here.
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Fabius Maximus replies: I do not understant this theory. What about ideas? Steam engines, internal combusion, atomics, fusion, zero point energy — ideas have been among the most powerful divers of our economic progress.
FM Note: comment deleted per author’s request.
With The Doorbell Program for Laurel MS, and The Dog Walk for Chula Vista, Ca, and The Sports and Business Center for Camuy, PR, I’m sure happy days wuill soon be here again!
To find out some of the details as to what is actually in the bill, check out Stimulus Watch.