To extend, or not to extend

Lately I've been puzzled by this surge of interest on the part of the Democrats in letting the Bush tax cuts for the wealthy expire. I can't understand what possible benefit that could provide us right now. It only makes sense to me as an act of vengence - I see no macroeconomic benefit. Quite frankly, I'm not interested in vengence.

Don't get me wrong, I don't think the tax cuts were a good idea in the first place. They were unnecessary at the time, and they blew a big hole in the budget for no good reason. I would have prefered they never passed in the first place (or at least that a smaller cut, with a different structure was passed). It certainly should have been reconsidered when the war really started heating up. But that was then, and this is now. When the facts change, I change my mind. And my mind simply cannot come up with anything positive that could come from letting any of these tax cuts expire.

Until this morning, when I had a thought. Perhaps letting the cuts expire would make a few key votes in Congress less concerned about additional fiscal stimulus. Generally speak, spending is the key issue during a downturn, but if you can do that spending with deficits that's all the better. But really, at this point, we're going to be dealing with a bunch of second-best options. Is it better to raise taxes on the wealthy in the middle of a severe downturn and get more stimulus than it is to keep taxes low and have no stimulus? My preference would be to let the wealthy keep their tax cuts for the time being and have more stimulus, but if I can't have that which would I prefer? We might be better off with the expiration and additional stimulus.

Of course this is all just a thought experiment. There's no guarantee at all that a compensatory stimulus could come out of letting the tax cuts expire. And it would depend on a few key votes from some deficit hawks that are not ideologically opposed to fiscal stimulus (a small sub-population indeed). Republicans would see this as the worst of both worlds. It would only really be convincing for conservative Democrats who worry more about the deficit than they do about the wealthy, and it might not even work for them.

It's a dicey political game that's very unlikely - so I'm still in the "don't let it expire camp". But it was an interesting thought.

Can anyone furnish any good reason to let the tax cuts expire (right now at least)? I simply can't come up with one.

More on the owls...

In this post critiquing Davidson, Galbraith, and Skidelsky's passivity with respect to the long-term debt, I got several interesting responses from post-Keynesian commenters. A lot of it was resources on the "deficit owl" perspective. I spent a little time looking through each, and doing a cursory review of what they call "Modern Monetary Theory" and has also been called Chartalism (really not a strategically developed name, which I'm guessing has more than a little to do with the newer MMT designation!).

Most of the emphases of this school of thought are right on target. They specifically highlight the implications of sovereignty for the federal debt. A sovereign debt crisis in the U.S. is not a risk the way it is in Greece because we have the freedom to monetize our debt. Of course these guys also talk about functional finance, stabilization policy, and liquidity preference. This is all very good - it can be hard to get a New Keynesian to talk about liquidity preference sometimes! So the real sticking point seems to be the debt. We agree debt monetization removes the risk of a sovereign debt crisis - this is quite standard analysis and not anything that really distinguishes Galbraith, Davidson, and Skidelsky from Reich, Stiglitz, and Krugman. I think the Krugman point (recently, in a disagreement with Galbraith) is the important point to make - debt monetization provides budgetary flexibility (on top of the already substantial flexibility provided by our credit rating and the nature of sovereign governments), but it ultimately just kicks the can down the road. Problems emerge later in terms of inflation and interest rates, but more importantly real growth rates. Janos Kornai's famous observation that governments face "soft budget constraints" doesn't mean that they face no budget constraints. I read and buy into Keynes, Minsky, and Lerner - but I also read and buy into Reinhart and Rogoff (and, well, Keynes!) on the risks involved.

One intriguing option raised by Joe Firestone in the comment section of the last post is to stop issuing debt instruments and just start crediting bank accounts. He provides this link to that option, and L. Randall Wray discusses it further here. They essentially want to cut out the middle man of the Federal Reserve. I don't know enough about the implications of this, and I'd love to hear more discussion in the comment section, but two thoughts immediately come to mind. First, this would bring an end to independence in monetary policy, which is not a pleasant prospect for most economists. Second, as James Macdonald argues, public debt has historically been an essential element in restraining government. Hoarded treasure (aside from being macroeconomically inefficient) ensures that sovereigns are unaccountable to their citizens. Citizen creditors ensure that their government stays accountable. Cutting out this debt instrument gives a sovereign all the revenue-raising power of government bonds, without any of the risk of nervous creditors restraining policy. Perhaps a robust republic can be maintained in such an environment, but if the Macdonald point is right, the chance of abuses are very real.

OK, enough talk. Time for some links. Thanks to Joe Firestone for sharing most of these:

- New Economic Perspectives is a post-Keynesian blog I've followed for a little while now.

- Warren Mosler's blog

- This is Bill Mitchell's blog. Mitchell is at the University of Newcastle's Centre for Full Employment and Equity.

- Here is an interview of Randall Wray and Bill Mitchell, talking about MMT. This is the first one, there are several more that follow.

- Firedoglake and Corrente post regularly on Modern Monetary Theory. I've pulled the MMT tagged posts here (FDL) and here (Corrente) for your convenience.

- Recently these guys had a "fiscal sustainability teach-in" at my alma-mater, The George Washington University. The website for that event is here. I know a guy that was involved in this (Alex Lawson - big activist/advocate if any readers know of him), so I heard updates from it. It did a lot of important work I think - trying to educate people on why Social Security isn't the big risk a lot of people think it is. Of course, as my comments above suggest, I also think they down played more genuine risks.

- Joe Firestone shares this New Deal 2.0 post with me to "address some of the concerns" about the long-term debt. Of course nothing Wray writes in here is new to me or controversial to me, nor does it address the concerns I have. I'm not worried about our ability to pay back our debt. I understand why public debt is different from private debt. And regular readers can attest to the fact that I'm not shy about running up deficits. The bigger concern for me is the impact on real growth rates. And that, of course, is precisely the point that this blog post ignores. Anyway, I have two other reasons for highlighting this: (1.) New Deal 2.0 is another good site worth following, and (2.) an interesting historical point they make. The only time we've ever retired the debt was in 1835. In 1837 we had a severe depression. Does anyone know if these two events are related? I imagine at the time the federal budget was too small to make this sort of macroeconomic difference, but it's possible. Nothing says "liquidity preference" quite like a sinking fund. Anyway - just a query. Joe also provides, this, this, this, this, and this to "address my concerns".

- I'll also share once again the Levy Institute's website. This group does a lot of work with Minsky's theories, and also has strong post-Keynesian influences. This is their program on Monetary Policy, and this is an interesting recent working paper from them outlining what "fiscal responsibility" should mean. I thought this was an especially good passage. It highlights the MMT argument, and it provides an interesting philosophical justification and explanation of the role of government:

"If the government acts not as a self-interested individual, but in order to allow citizens to achieve their intended expenditure decisions, it must engage in policies that support private sector decisions in such a way that they lead to public good. It should act to coordinate and offset the incompatible combination of firms’ and households’ intentions. If households follow the rule of virtue and seek to save too much, then the government should run a fiscal deficit that is just equal to the shortfall between households’ desires to save and firms’ expectations of profits. By doing so it can allow each individual to achieve his desired objective. But, it also avoids the loss in income that would result from the mismatch. Here the government can intervene to make private vices into public virtue by encouraging prodigality when the private sector desires to be frugal. Government prodigality is the equivalent of supporting public virtue! This is the fiscal policy of a responsible government, responsible to insure that private sector decisions can be achieved rather thwarted by the law of unintended consequences."

I am a deficit goose

We've all heard of "deficit hawks" and "deficit doves".

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Deficit hawks like to run tight ships and avoid deficits, even running surpluses if possible. Historically, we almost always run deficits because sovereign debt is a very different beast from private debt. Nevertheless, a "deficit hawk" would still like to keep those deficits to a minimum, even if he is smart enough to know governments can run deficits from now until eternity, so long as the debt is run up at a sustainable pace.

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Deficit doves don't care so much about the debt and place great faith in the difference between sovereign debt and private debt. They usually think very highly of fiscal policy and macroeconomic stabilization, and don't have as many of those New Keynesian caveats and qualifications about when and where to do fiscal policy.

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Lately people have been talking about "deficit chicken-hawks". Usually these are Republicans that spend like Republicans think Democrats spend. Sometimes they're disingenuous, sometimes they're just oblivious - but they aren't deficit hawks.

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Now, the Post-Keynesian blog "New Economic Perspectives" has coined the term "deficit owl". Here's the deal - a bunch of solidly liberal Keynesians like Robert Reich and Joe Stiglitz drew up a petition saying we should do more fiscal stimulus as well as put renewed emphasis on dealing with the long-term debt. Three "more Keynesian than Keynes" Keynesians - Paul Davidson (Post-Keynesian grand poo-bah), Jamie Galbraith (price-control enthusiast John Kenneth Galbraith's son), and Robert Skidelsky (Keynes's biographer that sometimes forgets the title of Keynes's magnum opus) - refused to sign because of that statement about keeping down the long-term debt.

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This is all pretty crazy. First, Robert Reich and Joe Stiglitz are on the left wing of Keynesianism, much less the broader American economic-political spectrum. If you're refusing to sign a petition by Reich and Stiglitz because you think it's too hawkish on the debt, it means you are way out in left field. Second, what the hell is a "deficit owl"??? The blog post is titled "Deficit Doves meet Deficit Owls", but I'm not even quite sure which is which. Is an owl "softer" than a dove? I guess it means the three dissenters are wiser? Who is who here? I could understand deficit dove, deficit hawk, and deficit chicken-hawk but now I'm just confused. Maybe "deficit ostrich" would be better, since they ignore the long-term debt?

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Forget the owls - I'm coining a new term (clearly the only way to get clarity is to throw yet another fowl reference on the table). I am a deficit goose.

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You see, the problem with the hawk/dove dichotomy is that it assumes a constant stance on deficits. But like a good Keynesian, I believe that when the facts change we should change our minds (what do you do?). The reasonableness of a deficit is determined by lots of things, chief among them being macroeconomic conditions. Some people question whether this "functional finance" position (essentially counter-cyclical fiscal policy) is really Keynesian - I don't think it is the heart of Keynesianism, and it definitely pre-dates it - but it's certainly consistent with Keynesianism. I'd be very surprised if Keynes wouldn't have considered himself an advocate of "functional finance", but if he wouldn't have advocated it then he should have.

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Anyway, the point is what we really need are deficit geese. Deficit geese fly south for the winter and north for the summer. When their surroundings get dismal, they change their behavior to warm up their environment. When their surroundings heat up, they take action to cool things down.

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P.S. - if any budding ornithologists reading this know anything about the migratory patterns of doves, hawks, chicken-hawks, or owls that contradicts this post, just keep it to yourself.

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*Evan took that picture, in Michigan I believe

Much ado about austerity

There’s been a lot of talk recently about austerity as a spur for growth. Much of it has revolved around the work of Alberto Alesina, a Harvard economist. Bloomberg summarizes his position this way:

“Alesina argues that austerity can stimulate economic growth by calming bond markets, which lowers interest rates and promotes investment. In addition, he says, deficit-cutting reassures taxpayers that more wrenching fiscal adjustments won't be needed later. That revives their animal spirits and their spending. Alesina says that as a way to shrink deficits, spending cuts are better for growth than raising taxes.”

Bruce Bartlett highlights other work in this vein in The Fiscal Times.

Like so many arguments made by respectable economists, on one level this logic is perfectly fine. I have no doubt that fiscal conservatism can spur growth. I would be surprised to find anything else, in fact. But there is an important difference between:

(1.) Increasing GDP growth rates and spurring recovery, and
(2.) Spurring recovery in an economy with depressed aggregate demand and spurring a recovery in an economy suffering from other problems

For some reason, time after time, people act as if all downturns are created equal. If an economy is suffering from a demand shortfall, removing more demand exacerbates the problem. What isn’t a particular concern in an economy that doesn’t exhibit a notable shortfall in demand (say, the American economy of the early 1920s) becomes a major problem in an economy where demand is already quite weak.

The primary mechanism through which austerity operates for Alesina is the bond market. Austerity calms the bond markets, “which lowers interest rates and promotes investment”. No Keynesian would quibble with the importance of this mechanism. The point they raise (highlighted in the Bloomberg article) is that interest rates are already quite low. If nothing else, this suggests that bond markets aren’t concerned about government debt (removing the primary “confidence” argument that Alesina utilizes). So, perhaps cutting spending would lower rates somewhat more – but who honestly believes that government borrowing is propping up interest rates right now? If interest rates are a problem, the source is either (1.) a zero lower bound on interest rates, or (2.) lack of investment demand.

To believe Alesina you have to believe that fear of the U.S. government’s ability to pay back its debt is a bigger factor than unwillingness to make investments, and you have to believe that a zero lower bound on interest rates is not a serious constraint right now (perhaps because you think inflation will make that zero lower bound non-binding as a constraint on real interest rates). Both of those cases seem untenable to me, which is why I really don’t think this argument makes sense at a time like this, at least (it would certainly hold true under different conditions). The primary problem is investment demand. Cutting demand further doesn't address this primary problem. If there were another primary problem, I probably wouldn't have these sorts of doubts.

The other version of the Alesina argument is not a bond-market story but a taxpayer story, and it’s known as “Ricardian Equivalence”. Robert Barro suggested that taxpayers would recognize that increasing deficits would be mean higher taxes down the road, leading them to curtail spending in anticipation. To a certain extent this amounts to assuming his own conclusions. The only reason why they would anticipate higher taxes down the road (as opposed to the same taxes imposed on a larger economic pie) is if they expected deficits not to increase output. In other words, Ricardian Equivalence essentially says “deficit spending cannot stimulate the economy if it does not stimulate the economy” (because if it did stimulate the economy, taxpayers would expect that the government could pay off the debt with lower taxes on a broader tax base). So it’s somewhat nonsensical (or at least tautological) on that point alone. But Paul Krugman points out another problem. He writes:

“If the government introduces a new program that will spend $100 billion a year forever, then taxes must ultimately go up by the present-value equivalent of $100 billion forever. Assume that consumers want to reduce consumption by the same amount every year to offset this tax burden; then consumer spending will fall by $100 billion per year to compensate, wiping out any expansionary effect of the government spending.

But suppose that the increase in government spending is temporary, not permanent — that it will increase spending by $100 billion per year for only 1 or 2 years, not forever. This clearly implies a lower future tax burden than $100 billion a year forever, and therefore implies a fall in consumer spending of less than $100 billion per year. So the spending program IS expansionary in this case, EVEN IF you have full Ricardian equivalence.”

This gets back to my initial point that the impact of deficits on GDP growth rates is different from the impact of deficits on recovery. Even if you believe in Ricardian Equivalence, even if you believe there is exactly zero stimulus effect of government spending (i.e. – a multiplier of 1). Hell – even if you believe there is a multiplier of less than one, you still have the consumption smoothing effect of counter-cyclical deficits! They may do nothing for the net present value of wealth, but they can help out with the roller coaster ride that is the modern industrial economy.
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So if we’re thinking in terms of interest rates and bond markets, Alesina’s point doesn’t seem to apply to this particular downturn very well at all. If we’re thinking in terms of tax payers and public debt, Alesina’s point doesn’t seem to apply to any downturn. After those two, distinct critiques what we’re left with is that keeping a lid on public debt can improve long-term secular growth.
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Big whoop – you don’t need a Harvard economist to figure that one out.

Note: If you're a fan of George Mason economics, you might be interested in James Buchanan's critique of Robert Barro's argument here (sorry, can't find an ungated version). His concerns are along somewhat different lines.