Thursday, March 24, 2011

I think Yglesias is Wrong

He writes:

"Atrios says “All the various cuts that our horrible new Republican governors are trying to implement aren’t just going to make the residents of their states suffer, they’re also going to work against the macroeconomy.”

I don’t really think that’s true. Federal spending cuts shrink the federal budget deficit and constitute a negative shock to aggregate demand. States have to balance their budgets, so the alternative to a lower level of spending would be a higher level of taxes. In AD terms, it’s basically going to be a wash either way. Its the failure of congress to enact some kind of state/local bailout appropriation that’s forcing the anti-stimulative state level stuff."

First, states don't have to balance their budgets, they choose to. One of the best things that could happen for both federalism and macroeconomic policy would be for the states to abandon that old shibboleth the way the federal government did eighty years ago. If they did, we'd see more robust states rights and a more stable macroeconomy.

But even setting that point aside, I still think Yglesias is wrong here. Issuing more government bonds helps get us from Keynes's economy to Hicks's economy. Keynes said liquidity preference (Brad DeLong would say highly-secure-financial-asset-preference) kept interest rates too high. Investment was depressed because the interest rate (the cost of capital) don't coincide with equilibrium in the loanable funds market. Running deficits and accomodative monetary policy pushes interest rates down and gets you to Hicks's economy. Hicks talked about an economy where the interest rate did coincide with equilibrium in the loanable funds market, but there was still slack in output.

How do we take care of that? Deficit spending, as Yglesias points out. "Shifting the IS curve". Also committing to inflation which will lower interest rates further and errode savings which will get people stuff less in their matresses. But these investment effects operate on the economy through the multiplier, and you can increase the multiplier by increasing the marginal propensity to consume. State-level spending will still do this regardless of how it finances it. Higher MPC means a higher multiplier for the private investment, deficit spending, and monetary policy going on.

UPDATE: waterzooi comments that he's not sure I'm right when I say that states don't have to balance their budgets, because most have balanced budget requirements. Allow me to clarify: states don't have to have balanced budgets - they choose to impose that constraint on themselves. There's nothing forcing them to constitutionally require themselves to balance their budgets. There was a time when this was not a constitutional requirement for most states, and many states did incur public debt. Many ran into trouble with that, which lead to a wave of these constitutional amendments. But they don't have to have those amendments and in my opinion they should probably be scrapped. I don't know the details, but even these constitutional requirements give some leeway, depending on how the books are kept on certain capital investments.


  1. Not sure you are correct about balanced budgets...

    The National Conference of State Legislatures (NCSL) has traditionally reported that 49 states must balance their budgets, with Vermont being the exception. Other authorities add Wyoming and North Dakota as exceptions, and some authorities in Alaska contend that it does not have an explicit requirement for a balanced budget. Two points can be made with certainty, however: Most states have formal balanced budget requirements with some degree of stringency, and state political cultures reinforce the requirements.

  2. Right - sorry for the confusion. I mean they oughta just change their constitutions. It's definitely because of their constitutions that we have so many states cutting spending right now.

  3. "One of the best things that could happen for both federalism and macroeconomic policy would be for the states to abandon that old shibboleth the way the federal government did eighty years ago. If they did, we'd see more robust states rights and a more stable macroeconomy."

    Is this what careful study of Europe has shown?

  4. I'm not sure I follow, mobsrule. Europe has substantially more sub-central decision making than the United States right now. If the EU ran larger deficits and the member states were constrained to balance their budgets, I think it's fairly obvious that the sovereignty of the member states would shrink tremendously and the EU would play a much bigger role.

  5. I think that mobsrule is referring to the erosion of national sovereignty under way in europe right now being a consequence of certain member states running massive deficits and accumulating huge debts that they couldn't pay back. As a result theyve been forced to get bailouts from the EU on the condition that the EU plays a greater part in determining their domestic policy than ever before.

  6. OK - and in many ways this was similar to how our federal government got a lot of its initial power as well.

    A lot of this depends on starting points.

    Given full control over your own budget, power is yours to lose. If you manage it poorly a central authority may push you into its arms. Sure.

    Given an effective abdication of control over your own budget and a fiscally active central authority, it can only improve your ability to assert your rights and provide for your citizens if take more control of your own affairs.

    There will alwyas be power struggles, of course. And that's healthy - I'm not suggesting the existence of central power is inherently a bad thing. But the states have tied one hand behind their back. Could some screw up? Sure. But I don't see how giving themselves more fiscal latitude could diminish their power vis a vis the federal government. Much of the growth of the federal government vis a vis the states in the last century has happened because the states have rendered themselves powerless to be responsive institutions of self-governance.

  7. And Europe should probably centralize some. I don't know if that's such a bad direction for Europe to move, given its monetary unification especially.

    IMO, we should move in the opposite direction in a major way.

  8. Which Euro countries have the most stable macroeconomy... those with a commitment to balanced budgets or otherwise?
    Should the states print their own currencies?
    Should Euro countries have eschewed the Euro, and if so, why shouldn't U.S. states eschew the dollar?
    Does this idea of perpetual government debt apply to cities, too? Why or not?
    At what level of governance does it stop making sense to deficit spend?

  9. Which European countries run balanced budgets?

    I'm not saying go Greek. I'm saying don't restrict yourself to a balanced budget constitutionally. If you run an unsustainable debt obviously that's not going to be good for growth, but that's not an argument against all debt. You don't use someone with tens of thousands of credit card debt as an example of why nobody should buy on credit. That's essentially what most states (with some wiggle room) have constrained themselves to. No buying on credit whatsoever.

    I don't know enough about whether the Euro was a good idea, but I'm not second guessing that and I'm certainly not second guessing the dollar.

  10. As your friends at the Roosevelt Institute have made clear, the U.S. doesn't have to worry about balancing its budget because it can always print money to pay off its debts. It can "stimulate" the "macroeconomy" until the cows come home. How are states supposed to run large deficits without having their own currencies? I've heard over and over that the Euro was doomed because the individual countries liked to devalue their currencies at different rates; how can states "stimulate" their economies without aid of the feds as you would recommend and without just printing up a bunch of bumwad? Are they supposed to just sell a ton of bonds to rich doofusses who think the power of future taxation is limitless?

  11. "Go Greek." That's silly. It should be "Go PIIGS" at the least... but any fool knows that there are a lot of other countries run by Keynesian knuckleheads that are hell-bound because of debt.

  12. My friends at the Roosevelt Institute? What are you talking about? Do you think this is some kind of MMT blog?

    What do you mean "who think the power of future taxation is limitless"? What kind of scale do you think I'm talking about here?

    As for "hell-bound because of debt" - I didn't realize Keynesian public finance was a mortal sin!

  13. The demand to hold money is not the demand to save. Keynes' liquidity preference is demand-based, which is categorically separate from the concept of time preference and savings - and thus has no impact on the loanable funds market.

    Keynes argues for a liquidity preference theory of interest, but this is impossible. An increased liquidity preference only has the effect of increasing cash balances, not savings.

    A good majority of Keynes' fallacies (I'm not sure to what extent this continues through Hicks, Samuelson and beyond) rest on this confusion regarding the interest rate.

  14. It's precisely because liquidity preference influences the interest rate that it has implications for the loanable funds market.

  15. It does not influence the interest rate because liquidity preference is not "savings" preference. It's a preference for cash balances (which are a result of uncertainty) and not savings (which are a result of time preference).

    They are categorically different phenomenon.

  16. Dude - I am well aware that demand for cash is not demand for savings.

    That fact does not demonstrate that it does not influence the interest rate.

  17. Sure it does. The interest rate is a manifestation of the loanable funds market. An increase in cash holdings is not "loanable" when its held in cash.

    Hoppe is quite clear of this distinction in "The Misesian Case Against Keynes"

  18. Mattheus - the whole disagreement is over whether it is just a price in the loanable funds market. You can't cite your position as proof.

    DeLong made the point quite clearly here:

  19. I don't cite my position as proof. I have no proof (get it - we're rationalists?? I crack myself up).

    What is objectionable about Hoppe's critique?

    It just seems to me that you know very little about Austrian monetary and interest theories. I would suggest reading Menger and Bohm-Bawerk if you ever have the inclination.

  20. Whenever I disagree with Austrian monetary or interest theories or even whenever I simply note the difference between Keynesian and Austrian theories, you somehow seem to conclude I don't understand Austrian theory.

  21. Well, you've never elaborated on why you disagree with the theories so the only alternative is that you don't really understand them.

    I repeat: What is objectionable about Hoppe's critique?

    As far as DeLong's blog goes, you don't see the irony in this statement:

    The second is that the inverse of the price of U.S. Treasury bonds--the Treasury nominal interest rate--is the price of liquidity: the amount of interest income you forego by keeping your wealth in cash rather than in securities. According to this second argument, the supply-and-demand is the supply and demand for cash: when the supply of cash is high, the price of liquidity is low, and since the price of liquidity is the short-term Treasury interest rate the short-term Treasury interest rate should be very low.?????

    He just asserts that interest rates are influenced by liquidity preference (as you do) without giving ANY reason or justification why they should even be tangentially related. You tell me stop citing my position as proof and then link me to a DeLong post where he offers no substantiation to the claim you both are making. That's irony (but I always thought you were a bit funny...).

    If you really do understand Austrian monetary and capital theories, please give some substantial argumentation rather than just simple contradiction. Otherwise it just makes you appear lazy or uninformed (not that these are terrible anyway, but I'd just like to know).

    Finally, I offer you another critique of Keynes' theories on interest here:

    Specifically chapters 14 and 15, which are relevant for our discussion. I suggest you take an interest in what Austrians have to say against Keynes. Debate and argument is extremely helpful for refining your own position (even if you aren't convinced).

    As always, a pleasure arguing with you.

  22. I think I lost a comment, Daniel?

  23. Mattheus, I'm not playing this game tonight. If you don't think I elaborate on these things then just don't worry about reading the posts. This is one of the major issues that I regularly revisit and discuss in detail.

    I've read those portions of Hazlitt before, on your advice. I believe we had a very detailed thread where I laid out Hazlitt's confusion on the issue.

    I never said anything about Hoppe so I'm not sure why you think I'm saying it's objectionable - I haven't had the time to read that.

  24. You certainly express your disagreement, but I'm still at a loss for where you find theoretical disputes! Trust me, I'm really interested in what you have to say - it's just hard to pick it out sometimes.

    Ah ok, I seem to recall referring you to Hazlitt before but I couldn't be sure.

    You seemed to have an objection to Hoppe, but maybe I'm misunderstanding. At any rate, I hope you do read it and maybe we can get down to brass tax and avoid these semantics?


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