Tag Archives: Fiscal policy

Inflation decreases, and we are screwed

Many on the right claim that additional fiscal stimulus is not required and in fact will lead to staggering levels of inflation. But inflation is actually falling in the United States, more than four years after the beginning of our current economic crisis.

The Commerce Department’s price index for personal consumption expenditures, which is the Fed’s favored measure of consumer price inflation, was up 1.5% in June from a year earlier. That’s below the Fed’s 2% goal and also much lower than last year, when inflation measures neared 3% because of surging gasoline prices.

Falling inflation means one thing: lack of sufficient demand. It is what happened in the 1930s in this country, and in Japan in the 1990s. The result in both cases was suffering for the weakest among us.  And it is happening today around the world on a huge scale.

The only reason that we have not had sufficient stimulus (i.e., government spending to plug the hole in demand and return our citizens to work) so as to help address the ruinously high levels of real pain is the intransigence of republicans in the House.

When an economy collapses, particularly when the cause of the collapse is a lack of demand, the only solution is fiscal stimulus, which is the antithesis of austerity.

Many economists argue that a stimulus would be the surefire way to ensure that the economy would regain its footing. Paul Krugman was an early and prominent advocate for a stimulus. He forcefully argued for a big stimulus. Other economists, particularly those of the conservative persuasion, criticized the idea of a big stimulus because they said that it would lead to inflation, hinder rather than facilitate economic recovery, and would spook the bond market, thereby making it more expensive for the U.S. to borrow money. They favored austerity as the best remedy for the ailing economy. Three years later, the verdict is in: Krugman, the Nobel Prize-winning economist, has been vindicated and the critics of the stimulus have been wronged, as none of their predictions had come to fruition

My undergraduate major was economics (albeit 40 years ago) and it was considered “black letter” policy that a demand shortfall was most effectively attacked via government spending to fill the hole of falling demand for goods and services. Despite the rush to so-called conservative values in this country, I continue to believe such is the case.

Hell, even Milton Friedman, the apogee of anti-stimulus, anti-inflation hawk, would have likely favored such action in our current situation.

… Friedman also considered variables other than prices. A characteristic of both the contraction of the 1930s and the Japanese stagnation of the 1990s, he noted, was the drag of tight money on nominal GDP. Reversing this would “have the same effect as always,” he said: “output will grow, and after another delay, inflation will increase moderately.” He grew flexible, as well, concerning money-supply rules. In 1984 he wrote that slow, steady monetary growth was “not a necessary implication of monetarist theory”. And when an economic crash in 1990s Japan gave way to a feeble recovery and deflation, Friedman recommended a monetary “kiss of life” in the form of QE.

Ignoring decades of economic thought and numerous examples around the world, and in the absence of Congressional action, we are left only to the Federal Reserve’s preparation to do what they can. The most effective approach requires Congressional action in the form of increases in government spending over the short term. Here is a cogent explanation of what should happen, from The Economist in June of this year:

I’d LIKE to say a bit more about the policy side of things given the state of the world economy. There is a great deal of attention paid to fiscal issues, and certainly fiscal issues deserve scrutiny. Greece, Ireland, and Portugal have little choice but to embrace swingeing short-term austerity, but massive short-term cuts in places like Spain and Italy are foolish and counterproductive. Maybe Germany and France can’t be talked into substantial fiscal stimulus but, again, focusing fiscal consolidation efforts on the long-term and practicing a sort of benign deficit neglect at this moment of crisis seem the smart options. In America, the fiscal situation is extraordinarily frustrating. Each day, Treasury yields touch unbelievable new lows. It would certainly seem a very good opportunity to undertake, in scale, any capital investments the government has been putting off, and there are many. Congress isn’t doing that, obviously. Instead, paralysis reigns and may produce a massive fiscal contraction at year’s end, on top of which may come a disastrous debt-ceiling battle.

Despite the claims of the so-called deficit hawks, who have been sending up distress signals of impending rampant inflation, borrowing costs of reasonably stable economies like the US and Germany, are at record lows. Stated simply, money is cheap, whether over the short term or the long term. US 10-year Treasury bonds have hit new low yield records several times in the past two weeks.  It is a perfect occasion to borrow money to grow economies over the long term.

But no such stimulus will occur in the United States prior to the election. And this will occur for purely partisan reasons.  The House republicans can, have and will block such action solely to increase the likelihood that Romney will be elected in November as a result of continuing weakness in US employment.

Yet millions of unemployed Americans suffer every day, desperately searching to land a job and support their families, and hundreds of millions around the world suffer as well. Needless suffering is the result.

Shameful.

The truth revealed

I know I have been heavy on the quotes lately, but this one is too insightful to bypass. In the short term, our problem is lack of demand in the economy.

Read the full version via the link below.

The crisis has, however, been clarifying in several respects. We can now say with some confidence that Washington will be doing nothing more to help the ailing economy. President Barack Obama is trying to push an employment agenda. But for the federal government to spur growth or create jobs, it has to spend additional money. The antediluvian Republicans who control Congress do not think that demand can be expanded in this way. They believe that the 2009 stimulus bill, which prevented an even worse economy over the past two years, is responsible for the current weakness. Their approach of depression economics – embedded in the debt ceiling compromise – demands that we address the risk of a double-dip recession by cutting public expenditure immediately.

* * *

We now also understand that the US is not going to make meaningful investments in its economic future. The conservative position that all spending is evil obliterates any distinction between investment and consumption, between the long term and the short term. The US suffers with an increasingly third-world level of infrastructure, third-tier education system and enormous gaps in the preparedness of its workforce. The debate has now ended; money to upgrade those faltering systems will not be forthcoming. And by the way, the US is not going to take on any other major problems either – immigration, tax reform or climate change, for example. It is not going to do so for the same reason it has failed at sensible economic management: because the Tea Party has a veto.

Jacob Weisberg writing in The Financial Times

Political quote of the day

Given President Obama’s endorsement of large budget cuts, the only question now appears to be how much fiscal policy will tighten and how fast. If it is back-loaded and mainly involves cuts in transfer programs, the impact on growth may be modest. But if – as I suspect Republicans will demand – the spending cuts are front-loaded and involve reductions in government consumption and investment spending, the impact could be severe.

Bruce Bartlett, who held senior policy roles in both the Reagan and George H.W. Bush administrations, warning of the risks to the current economy of substantial spending cuts and tax increases.

Econ 101

James Fallows studied economics in the seventies, as did I. His take on our current situation:

Those days of the 1970s are now nearly 40 years in the past. And this morning’s jobs report makes me wonder whether, as a political system, we ever learn anything. Even this basic thing: That when tens of millions of people cannot find work because of an overall “failure of demand” — not enough paychecks going to not enough people who can not make enough payments to create jobs for enough other people — the main problem facing the nation is not “runaway government spending.” Any more than it was when Herbert Hoover tightened up on spending as markets crashed, in the wave of folly that Keynes and Ahamed in their different ways chronicled. A lot has changed since the 1930s, and the 1970s. But not this basic principle.

The only way out is through (updated)

Unemployment in the US is now at 9.2%.  If you include people who want to work, but are working only part time or have given up looking for now, the rate is 16.2%, or about 1 in 6 of all American adults.

Given these grim numbers, three years after the largest collapse of a financial bubble since the Great Depression, there should be calls for a sensible economic response. Such a response would include short-term tax reductions and Federal spending increases, married to long-term debt reduction.  In times of economic collapse, while citizens and business need to retrench and rebuild their balance sheets, the Federal government should increase outlays over the short- and medum-term in order to offset, to the extent possible, the collapse of demand and spending in the private economy.  Deficit reduction could be triggered when unemployment reaches a reasonable (but not perfect level), say, 7.5%.

The stimulus bill early in 2009 was enacted for this purpose and, while the GOP clamors that it “failed,” the fact is that it did preserve and create some jobs, and the current economy is better that would be without that action. If there was a failure, it was that the stimulus was too small.

Paul Krugman in January, 2009:

Even the C.B.O. says, however, that “economic output over the next two years will average 6.8 percent below its potential.” This translates into $2.1 trillion of lost production. “Our economy could fall $1 trillion short of its full capacity,” declared Mr. Obama on Thursday. Well, he was actually understating things.

To close a gap of more than $2 trillion — possibly a lot more, if the budget office projections turn out to be too optimistic — Mr. Obama offers a $775 billion plan. And that’s not enough.

Now, fiscal stimulus can sometimes have a “multiplier” effect: In addition to the direct effects of, say, investment in infrastructure on demand, there can be a further indirect effect as higher incomes lead to higher consumer spending. Standard estimates suggest that a dollar of public spending raises G.D.P. by around $1.50.

But only about 60 percent of the Obama plan consists of public spending. The rest consists of tax cuts — and many economists are skeptical about how much these tax cuts, especially the tax breaks for business, will actually do to boost spending. (A number of Senate Democrats apparently share these doubts.) Howard Gleckman of the nonpartisan Tax Policy Center summed it up in the title of a recent blog posting: “lots of buck, not much bang.”

The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job.

The approach outlined above is Economics 101 and the basic teaching of John Maynard Keynes. [As a side note, it is unfortunate that the overwhelming expenditure of Federal dollars at the time of the collapse went Wall Street and other financial entities who themselves were the fundamental source of the bubble, rather than to truly stimulative spending.]

But instead of calling for increased Federal spending over the short term, the GOP is demanding immediate, substantial cuts in Federal expenditures. And the President is calling for tax increases, along with expenditure cuts. Taken together both the GOP and President are advocating a powerful austerity program, the worst policy approach to address a shortfall in aggregate demand, leading to underperformance of the economy.  Both approaches powerfully reduce demand.

There is one reasonable way out of the morass. Laura Tyson:

There is a logical way out of this policy conundrum: pair temporary fiscal measures targeted at job creation during the next few years with a multiyear, multitrillion-dollar deficit reduction plan that would begin to take effect once the economy is closer to full employment. Pass both now as a package. Current signals from Washington indicate that this way out will be not taken: instead, partisanship and politics will trump logic and premature fiscal contraction will undermine the already anaemic recovery. Even worse, a political stalemate over the debt limit could precipitate a financial crisis…

More from Krugman:

Updated: And lest you believe that fiscal stimulus will cause a spike in inflation and interest rates, take a look at this chart from the Federal Reserve Bank of St. Louis:

As you can see despite the large deficits from 2007 on, and constant harangues from inflation hawks about the purported danger of such deficits, while unemployment remains high, there is no sign whatsoever of surging interest rates (reflecting a lack of inflation). Of course, this should not be surprising given the huge underutilization of our productive resources reflected in the unemployment numbers.  Inflation is cause by too many dollars chasing too few assets. Our country is currently brimming with unused and underutilized assets.  The low interest rates shown also reflect a continuing willingness on the part of international investors and sovereign funds to purchase our Treasury obligations.  Simply stated, despite the deficits and Federal debt, the rest of the world continues to view the US as a safe haven.  (via Paul Krugman)

And there is this from David Leonhardt:

Financial crises have long hangovers, and this one is no exception. Home sales and car sales remain depressed, nowhere near their earlier peaks, even though the population has continued growing. Europe still has the potential to upset global financial markets. If Congress doesn’t act on the debt ceiling soon, so does the United States.

In all kinds of ways — consumer demand, the federal deficit, even the weather — the medium-term future is highly uncertain. But this uncertainty, while the main problem, is not the only problem. We are also committing an unforced economic error. We’re cutting government at the same time that the private sector is cutting.

It is the classic mistake to make after a financial crisis. Hoover and even Roosevelt made a version of it in the 1930s. The Japanese made a version of it in the 1990s. Now we are making it.