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Tuesday, February 2, 2010

Transcript: 352 Continuum of Economists

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Today on the podcast, we return to our roots. We've been spending too much time banging away at the financial sector and its corruption, both structural and ethical. And we're going to provide the opening remarks of Peter Orzag, OMB director, and Christine Romer, the director of the Council of Economic Advisers, accompanying the rollout of the President's budget.

Next week we turn to development economics, with Bill Easterly, among others and featuring coverage of an interesting set-to between Jeffrey Sachs and Dambisa Moyo on Aid and how to finance it.

But today

As much as we get excited about the current state of corruption and confusion in the political slash economic arena, our original intention at Demand Side was to stick to macroeconomics and forecasting and to a longer-term and deeper assessment.

A note: There was no relay this past weekend, and when it does appear, because of bandwidth limitations, that relay appears only on the demandside lowercase one word version of the podcast.

Another note, we've taken down our forecast blog in preparation for a new project coming in the spring.

But let's take the view up fifty thousand feet and look at the situation as those ten years from now will be looking at it. Where are we in economics?

There is a continuum. Today we'll break the spectrum into four colors, ranging from the unreconstructed Market Fundamentalists and Supply Siders to, well, yours truly and the economic reconstructionists.

First we have unreconstructed market fundamentalists and their supply side fellow travelers. These economists are calling for more of the same tax cuts and hands off the markets that have bankrupted governments and let markets be dominated by the most powerful market players. You and I can look around and see the rubble, the failure of unregulated banking, the zero new jobs and $7 trillion in debt resulting directly from Bushonomics repeated tax cuts and markets' failure to produce any new jobs since 2000. We say this is evidence those policies were a disaster. But economists who promoted those ideas have fat salaries in Academia or at sponsored think tanks and have a lot of personal capital to protect. Their time is spent rationalizing why somehow what they recommended is in at least a limited way true. The predominant explanation is a combination of, one, it was an accident, and two, the government caused it by ... (phrase completed with extreme lameness).

Second we have the muddle throughers. This group includes the Obama brain trust, Summers, the Fed, the Treasury and their substantial support in all forms in the financial industry. While not quite agreeing that it was an accident, this group believes that the Fed brought us back from the brink and with enough glue and tape we can get the current structure back on the road and eventually resume where we left off. Unmentioned and minimized is the sorry fact that the glue and tape is a billion dollars per roll and "on the road" has to be done on roads that have fallen apart. Still, they have gotten the Cadillac looking pretty good. The financial sector may not be a moving part of any real economy, but it does have some shine, and it's not a bad ride if you don't want to go anywhere. Oh, sorry, its full of Wall Street barons.

Third, we have the "We're in a hell of a messers." The great majority of legitimate economists are in this rank, from Paul Krugman to Joseph Stiglitz. In his book FREEFALL, Stiglitz identifies the central identifier of this hell of a messers group -- he calls it the Krugman-Stiglitz doctrine, a term derived from the Powell doctrine. Where General Colin Powell articulated attacking with decisive force in military situations, Paul Krugman and Joseph Stiglitz advocated attacking with overwhelming economic force. A government can always hold back the extra ammunition if it has it ready to spend, says Stiglitz, but not having the ammunition ready can have long-lasting effects. Attacking the problem with insufficient ammunition is a dangerous strategy, especially as it turned out, when the strength of the downturn has been underestimated.

In this group we have everything will be okay if we just fix the banking sector guys like Simon Johnson, and everything will be okay if we just reallocate the policy frame toward the middle class, like Robert Reich.

Lacking, according to the third group, is a vision for the future of the American economy and its ailing financial sector.

And in this idea of vision the fourth group find their distinction. While financial sector regulation and structuring of markets are common ground between the third and fourth, the reconstruction of the economy itself is called for by James K. Galbraith, Robert Pollin, and others, including the present speaker. The we're in a hell of a messers project to a greater or lesser degree a return to the previous consumer-based economy and its corporate oligopoly, only with restrictions. The reconstructors view the experiment of the post-Reagan era as confirmation that the market-first economy cannot work and moreover has destroyed its own foundation by blowing up credit bubbles that are now debt swamps. Galbraith advocates open-ended assistance to states and basically ignoring the constraint on spending for the federal government. Pollin advocates a complete turnaround from consumer-based economics to public goods as the foundation. In both of these, we agree.

But we go further. We do not see the rationale for failing to fund the government from the oceans of cash sloshing around in the financial sector. That is, taxation. An analogy is the rampant homelessness we see when surrounded by acres of vacant homes. Full employment needs to be the first order of business, not a by-product of treatment to the financial sector.

And at the base of the problem is the debt. We do not see paying down debt as the appropriate way to deal with the Fundamentalist's blunders. We see writing it down. In the first case, with mandatory home mortgage renegotiation. But in the larger case, by not backstopping the next wave of failures and allowing bondholders to share the poverty. Willingness to do this type of thing is not unfamiliar to policy-makers. The eagerness to renege on the promises to Social Security is precisely this. The Social Security trust funds are fully adequate for the next twenty years. But these trust funds are full of government bonds. It is the inability or unwillingness to raise taxes to pay off on these legal bonds that is the motive to scale back social security.

A friend of mine said, What we need to do is live more simply. Perhaps our standard of living needs to decline, so long as we have security and stability.

I agree. And what is the way to this point. We could do that. Fully fund government. Create a fully employed economy producing public goods. By raising taxes. Targeting the rich, but not sparing all. A shared financing mechanism not based on debt financing. Of course, it would leave the private debt-holders in an untenable place if public backstopping ceased. But these were risk-based contracts in no way officially insured by the taxpayer. Why taxes should go to support them and the structure that allowed them to get out of control is a question that has no morally defensible answer in the affirmative.

In the interests of time, and noting I may be among few I would choose when I make this tax-financing pitch, let me just point to the deficits in the so-called recovery of the Bush years, which reached above $500 billion in some years. Deficits like this are not typical of recoveries. Indeed it was specifically argued that the tax cuts were essential for the economy to grow. We now see that it has not grown.

My point is not Peter Orzag's point, which you will hear on Friday, which is that the federal budget would look a lot better if we'd paid for the tax cuts (quote unquote paid) or Medicare drug benefit. Mine is to ask, Where did those tax cuts go? Undoubtedly they went into demand for assets, particularly housing. It is not too much to suggest that people took their tax cut and levered it into a larger house with more debt. It is this household debt that is now the dragon in the road. Not the relatively small problems of the federal budget. Yes. I am saying that the tax cuts not only did not help the economy, except to gin up temporary building and bubble activity to produce non-productive housing and fill it with new appliances, but into long-termprivate debt. The argument goes on. Perhaps we'll return to it in a future podcast.

So, bringing it back down. Let's summarize by reading from Stiglitz' book. This is a legitimate and clear description of what has happened.

Then let's see which end of the continuum holds the answers and which clings to its own interests in favor of rational thinking.

Led by declines in employment-related indicators, the Chicago Fed National Activity Index decreased to –0.61 in December, down from –0.39 in November. Three of the four broad categories of indicators that make up the index moved lower, although both the production and income category and the sales, orders, and inventories category made positive contributions.
In contrast to the monthly index, the index’s three-month moving average, CFNAI-MA3, increased slightly to –0.61 in December from –0.68 in November. December’s CFNAI-MA3 suggests that growth in national economic activity was below its historical trend; but the level of activity remained in a range historically consistent with the early stages of a recovery following a recession.
And weekly unemployment claims
In the week ending Jan. 23, the advance figure for seasonally adjusted initial claims was 470,000, a decrease of 8,000 from the previous week's revised figure of 478,000. The 4-week moving average was 456,250, an increase of 9,500 from the previous week's revised average of 446,750.

In our continuing defense of the call that we have not exited recession, we forward this paragraph from NBER, the agency which issues the official calls on recessions and recovery

In both recessions and expansions, brief reversals in economic activity may occur—a recession may include a short period of expansion followed by further decline; an expansion may include a short period of contraction followed by further growth. The Committee applies its judgment based on the above definitions of recessions and expansions and has no fixed rule to determine whether a contraction is only a short interruption of an expansion, or an expansion is only a short interruption of a contraction. The most recent example of such a judgment that was less than obvious was in 1980-1982, when the Committee determined that the contraction that began in 1981 was not a continuation of the one that began in 1980, but rather a separate full recession. [emphasis added]


  1. I would say that the problem was caused by the bankers. They wanted the returns that investment banking offered. They lobbied for an end to Glass-Steagall, and they got it. Then they lobbied for an end to regulation and the Republicans gave them that as well. Then the laissez faire attitude with in the regulators that basically let the problems pile up.

    Moving forward I think restoration of Glass-Steagall is a start.

    Then break the big banks up so that they are small enough to fail without endangering the financial system or the economy.

    Change the rules of investment banks so that they become partnerships again. Then their pay would not be a public issue. Though they should be forced to pay off their shareholders. That will remove a significant amount of funds that found their way into the director pockets rather than the shareholders. It would mean that the bank would have much less capital to play the markets and would reduce volatility of markets at the same time.

    Increase the FDIC levy on all banks to recover the cost of failures.

    Continue with a bill for simple vanilla consumer contracts. Banks will be mandated to have these available for all customers. The contract terms are to be limited to a single page of A4 paper with a minimum of 12 point text. That way there is no small print to trap the consumer. they will openly be allowed to compete on interest rate. As a deterrent to deliberately making them unattractive increase the levy on banks that do not have at least 40% of their customers with vanilla accounts. Simple accounts are straight forward and therefore less risky. Punish the banks who hide the vanilla accounts or make them too expensive for customers to use.

    The best way is to present these as simple bills so that the electorate can see what is being done. If they see the Republicans blocking vanilla products they can punish them in the midterms,

    As for your statement that "Perhaps our standards of living needs to decline", that has already happened. In the seventies you only needed a single wage to buy a house now you need two. Your standard of living has halved in that alone. Other figures show that wages of workers have been stagnant for nearly 30 years in real terms also shows that workers have not benefited from the economic growth of the last three decades.

    The pain will continue for a number of years. People are de-leveraging and that is not a quick process.

  2. Just so. Banking is a means to an end, not an end in itself, but it has become an industry whose profits are compared to those of the real economy. It was the genius of the New Deal that constrained banking for the benefit of public insurance and goods and for the real economy.

    The reappointment of Bernanke is a bad sign, though, and one that indicates the next crisis will again be the occasion not for discipline to the banking sector, but for opportunistic looting of the public by the banks.

  3. Re: de-leveraging. As you say, this is a slow process and if it means paying down the full value of the debts, then it means an asymmetric bearing of the costs of the calamity by the borrower, even as it watches the lenders being bailed out.

    A recipe for stagnation and decline.

  4. Banking and Finance are an industry that does not create any wealth, they are support industries. Wealth creation comes from farming, mining and manufacturing. Domestic banking and the other FIRE industries need to be shrunk to free up resources to the wealth creating industries. Higher capital gains taxes will eliminate their current comparative advantage. Though the problem is that these industries are labour intensive, and the middle classes may not want to see a reduction in sectors where they are employed. That will be a problem in the UK. Possibly in the US as well, even with the anger against the banks.

    De-leveraging is very problematic. If it happens fast it will mean huge write offs and a drop in tax income. if slowly it means that the economy grows slower. Personally I am in favour of a fast write down and breaking up any financial institution that hits problems. Then banks like Bank of America could be broken up into dozens of smaller regional banks.