A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Wednesday, July 15, 2009

Podcast Transcript 07.15.09 The Alternative to Stimulus is What?

The naive are punished

Our forecast and understanding of what lies ahead is based on the idea that policy-makers will alter a course that does not go in the appropriate direction. This is apparently a naive opinion. Neither policy-makers, pundits, nor the public has adapted in the sense we assumed. Instead, the adaptation has been an acceptance of the status quo, a shifting of the load of blame to others, and an entrenchment along ideological lines. Trying everything until it works, the pragmatism of FDR, is what we counted on with Obama. By this process of elimination, we expected demand side remedies to get a fair shake. Once their effectiveness became apparent, we expected them to be reinforected. This process is not yet in evidence.

Particularly instructive has been the response to the stimulus package, the Recovery Act. The airwaves have been saturated with critiques and analysis of what effect the stimulus is having. Where are the jobs? Where is the much-ballyhooed recovery? Krugman said, What didn't the vice president know and when didn't he know it?

But some of us did predict the double digit unemployment rate. It was, after all, baked in, we said. Absent a massive stimulus, it was going to be a lot worse.

Here, again, from Krugman, shortly after his "What didn't the vice president know, and when did he not know it?" comment.

Seriously, the economy isn’t doing all that much worse than a number of people warned was probable. And the whole political economy thing was, sadly, predictable:

I wrote during the political skirmishing leading up to the stimulus

This really does look like a plan that falls well short of what advocates of strong stimulus were hoping for — and it seems as if that was done in order to win Republican votes. Yet even if the plan gets the hoped-for 80 votes in the Senate, which seems doubtful, responsibility for the plan’s perceived failure, if it’s spun that way, will be placed on Democrats.

I see the following scenario: a weak stimulus plan, perhaps even weaker than what we’re talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says “See, government spending doesn’t work.”

Let’s hope I’ve got this wrong.

Apparently I didn’t.

No, he didn't have it wrong. The package got three Republican votes in the Senate, one of whom, Arlen Specter subsequently skipped to the D side, and two of whom remain to constitute the entirety of the Moderate Wing of the Republican Party.

The Demand Side framework has been this: The economy was weak in 2001 when the Fed began its one percent interest rate policy and the Bush Administration instituted the tax cuts for the rich. For the next five years it floated on the paper of residential housing financing. When that huge debt bubble collapsed, the weak economy beneath was exposed. It had no way of supporting the collapse and the entire financial system broke through. Now we're scrambling around in the rubble trying to find our way out.

We have the weak economy of 2001, along with credit markets that do not even function, let alone pump out debt for consumers. State and local government revenues have shrunk, taking down more demand. From the demand side, the only game in town is federal spending. But the Recovery Act is barely replacing the loss of state and local spending, much less filling the hole left by the housing bubble and systemic collapse of the financial system.

The process is made all the more difficult for the blow to consumer confidence, which shrinks the multiplier by shrinking the consumption function.

It is all about demand. Household demand has plummeted along with household wealth. State and local demand has dropped because their revenues have dropped. Business investment demand is nonexistent because there is overcapacity in every area and no prospects for profit on any front.

Yes, the infrastructure is crumbling. We could spend two hundred billion a year for the next twenty years and barely get back to adequate. Yes, global warming requires a complete reformation of transportation and energy and support for developing countries to do the same. These are needs and challenges, but they are not being translated into effective economic demand. Only the government can do that.

Our prescription has been to rebuild the American economy by rebuilding America.

The counter is what? First, do as little as possible. The second .... I'm not clear on what the second is. Just don't do whatever Obama is doing.

A great deal of the problem with government spending is the idea that it will pump up inflation. First we have to ignore the historical fact that there has been no demand-pull inflation for more than forty years, so a modest increase in government spending in the worst economic downturn since the great depression is not going to cause a fever of buying that would bid up the prices of ... what? ... food, clothing, gasoline, houses, what is going to be bid up?

Oh, and just because I have to do it every time inflation is mentioned, look at oil prices. Look at inflation. Notice that oil prices have not responded to demand-supply. Notice that oil prices have led every inflation since 1970. This is called cost-push inflation in our terminology. It would be different if asset prices were included. Then you would have housing or stocks pushing inflation. But it would always be a financial bubble, not demand, pushing up prices. End of Demand Side aside.

What about just trusting monetary policy. Let's not mention that the nay-sayers conflate the Fed's policy with stimulus building infrastructure, bailing out states and extending unemployment. Let's just take the zero interest rate part first.

Yes, monetary policy acts with a lag. Maybe up to 18 months. Eighteen months after the Fed began aggressive action on interest rates, the U.S. had the worst quarter for GDP and employment in a quarter century. Low interest rates gave the players more chips to play with, but it gave nothing to the real economy. Zilch. Zero. Nada.

Particularly now, when there is no other consumer bubble to blow up. The ex-Enron traders at Goldman Sachs may invent higher oil prices and milk the casino markets for more big profits, but a widespread consumer boom from lower interest rates. It is not going to happen. When will they give it up? Monetary policy simply does not work. It needs to accommodate growth, but it is never going to cause recovery.

Zero rates is distinct from the Fed's policy of bailing out the banks. This is similar to scrounging around in the rubble for broken beams to spend billions of dollars taping back together again and rebuilding the house. No. Throw them out. The government didn't break them, they broke themselves. Use the pieces that are not broken, the smaller banks, and get a new system. Maybe it has to be a smaller financial house, but why the hell was it so big in the first place? Certainly not because it was sheltering the great majority of us. Financial houses made nice digs for the financial players. The rest of us? Not so much.

We could, of course, try more tax cuts. After all, the great Bush tax cuts of the early part of the decade did so well. Oh. And the first stimulus? 2007 tax cuts from Bush? Immediate, but ineffective. They immediately had no effect. Economy-wide, that is. It was nice to have the check and it helped cushion the blow, but jump-starting the economy? No. Nearly everybody agrees with that now, so long as we're talking about the past. Several more voices join in when the discussion of tax cuts in time shifts to the future. Always there is the Heritage Foundation.

But ...

Here's more Krugman

Whenever you encounter “research” from the Heritage Foundation, you always have to bear in mind that Heritage isn’t really a think tank; it’s a propaganda shop. Everything it says is automatically suspect.

Greg Mankiw forgets this rule, and approvingly (yes, it’s obvious he approves -no wiggling out) links to a recent Heritage attempt to explain away Medicare’s low administrative costs...

Well, whaddya know — this is an old argument, and has been thoroughly refuted. ...

You should always remember:

1. Don’t believe anything Heritage says.

2. If you find what Heritage is saying plausible, remember rule 1.

The suggestion that the Recovery is too slow portends bad things when the recovery does not produce robust growth. After all, barely ten percent of it has gone out the door. The vast majority will be spent in 2010 and beyond. And it is not compared with the lagged effects of monetary policy.

More bad news:

The IMF says the world is pulling out of recession.

The famous bastion of Neoliberalism is marking up its growth forecasts for next year and hinting that it might reduce its estimates for bank losses.

The IMF's chief economist, Olivier Blanchard, proclaimed, “The recovery is coming,” But it is likely to be a weak recovery.

Maybe another jobless recovery like the first Bush recession. A jobless recovery is not a recovery. It is simply an obsession with GDP which is monetized activity which in this case was a housing bubble.

Here in the latest Harper's

Unless Obama changes course, he’ll look more like Hoover than FDR

an account from New Deal 2.0 by Lynn Parramore reads

Since his inauguration and even before, Barack Obama has garnered countless comparisons to FDR. In this month’s Harper’s magazine, Kevin Baker says there’s a more apt presidential parallel: Herbert Hoover.

Baker writes:

“The comparison is not meant to be flippant. It has nothing to do with the received image of Hoover, the dour, round-collared, gerbil-cheeked technocrat who looked on with indifference while the country went to pieces. To understand how dire our situation is now it is necessary to remember that when he was elected president in 1928, Herbert Hoover was widely considered the most capable public figure in the country. Hoover—like Obama—was almost certainly someone gifted with more intelligence, a better education, and a greater range of life experience than FDR. And Hoover, through the first three years of the Depression, was also the man who comprehended better than anyone else what was happening and what needed to be done. And yet he failed.”

We're putting up our counter to Obama as Hoover this next week. Or beginning it. That is the historical fact and statistics that show that a Democrat in the White House has meant good things for GDP, employment and investment. First, this week, it will be GDP.

By Bureau of Economic Analysis statistics, since 1948 growth in real GDP has averaged 4.0 percent per year under Democrats. Under Republicans 2.7 percent. No Democrat has seen this number under 3.7 percent. That being Clinton. No Republican has seen growth over 3.4 percent, that being Ronald Reagan. In fact, only Reagan is above 3 percent at all, and the two Bushes are closer to 2 percent.

We'll get into that, and into even more evidence showing Democrats mean good things for economy, even after Roosevelt.

For now, this is Alan Harvey, from the Demand Side

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