In devastating testimony, James K. Galbraith challenges the pitchfork and torch crowd led by the deficit reduction committee.
5. The Only Way to Reduce Public Deficits is to Restore Private Credit.
The conclusion to draw from the above argument is that large deficits going forward are likely to have the same source as they do right now: stubbornly high unemployment.
The only way to reduce a deficit caused by unemployment is to reduce unemployment. And this must be done with a substantial component of private financing, which is to say by bank credit, if the public deficit is going to be reduced. This is a fact of accounting. It is not a matter of theory or ideology; it is merely a fact. The only way to grow out of our deficit is to cure the financial crisis.
To cure the financial crisis would require two comprehensive measures. The first is debt restructuring for the entire household sector, to restore private borrowing power. The second is a reconstruction of the banking system, effectively purging the toxic assets from bank balance sheets and also reforming the bank personnel and compensation and other practices that produced the financial crisis in the first place. To repeat: this is the only way to generate deficit-reducing, privately-funded growth and employment.
As a former top adviser in the Clinton White House, co-chairman Bowles no doubt knows that privately-funded economic growth produced the boom years of the late 1990s and the associated surplus in the federal budget. He must also know that the practices of banks and investment banks with which they were closely associated worked to destroy the financial system a decade later. But I would wager that the Commission has spent no time, so far, on a discussion of the relationship between deficit reduction and financial reform.
To be clear: unemployment can be cured without private-sector financing, if public deficits are large enough -- as was done during World War II. But if the objective is to reduce public deficits, for whatever reason, then a large contribution from private credit is essential.
One more time: without private credit, deficit reduction plans through fiscal austerity, now or in the future, will fail. They cannot succeed. If at the time the cuts take effect the economy is still relying on public expenditure to fund economic activity, then reducing expenditure (or increasing taxes) will simply reduce GDP and the deficits will not go away.
Further, if the finances of the private sector could be fixed, then an austerity program would be entirely unnecessary to reduce public debt. The entire national experience from 1946 to 1980, when public debt fell from 121 to about 33 percent of GDP and again from 1994 to 2000, proves this. In those years the debt-to-GDP ratio fell mainly because of credit driven economic growth -- certainly not because of public-sector austerity programs. And this is why the deficits returned, in 1980-2 and in 2000, once the credit markets froze up and the private economy entered recession.
Thus until the private financial sector is fully reformed -- or supplemented by parallel financing institutions as was done in the New Deal -- high deficits and a high public-debt-to-GDP ratio are inevitable. In the limit, if there is no private financial recovery, debt-to-GDP will converge to some steady-state value, probably near 100 percent - a normal number in some countries - and at that point the public deficit will be the sole engine of new economic growth going forward. Only when the private sector steps up, will the debt-to-GDP ratio begin to decline.
For this reason, a Commission report focused on "entitlement reform" rather than "financial reform" would be entirely beside the point. Entitlement cuts, no matter how severe, cannot and will not achieve deficit reduction. They cannot "meaningfully improve the long-term fiscal outlook," as required by your charter. All they will accomplish is to impoverish vulnerable Americans, impairing the functioning of the private economy and the taxing capacity of the government.
Friday, July 30, 2010
Thursday, July 29, 2010
Bad economics and bad forecasting inform Deficit commisssion
Continuing with James K. Galbraith's critique of the Deficit Commission empaneled to, apparently, get social security and Medicare on the table, i.e., chopping block.
Galbraith's testimony continues from yesterday:
Let me now turn to the economic questions. A first economic question is, what caused the deficits and rising public debt? The answer comes in two parts: present deficits and projected future deficits.
2. Current Deficits and Rising Debt were Caused by the Financial Crisis.
Overwhelmingly, the present deficits are caused by the financial crisis. The financial crisis, the fall in asset (especially housing) values, and withdrawal of bank lending to business and households has meant a sharp decline in economic activity, and therefore a sharp decrease in tax revenues and an increase in automatic payments for unemployment insurance and the like. According to a new IMF staff analysis, fully half of the large increase in budget deficits in major economies around the world is due to collapsing tax revenues, and a further large share to low (often negative) growth in relation to interest payments on existing debt. Less than ten percent is due to increased discretionary public expenditure, as in stimulus packages.
This point is important because it shows that the claim that deficits have resulted from "overspending" is false, both in the United States and abroad.
3. Future Deficit Projections are Generally Based on Forecasts which Begin by Assuming Full Recovery, but this Assumption is Highly Unrealistic.
Unlike the present deficits, expected future deficits are not usually considered to be due to continued recession and high unemployment. To understand how the discussion of future deficits is being framed, it is necessary to grasp the work of the principal forecasting authority, the Congressional Budget Office. CBO's projections proceed in two steps. First, they wipe out the current deficits, over a very short time horizon, by assuming a full economic recovery. Second, they create an entirely new source of future deficits, essentially out of whole cloth. The critical near-term assumption in the CBO baseline concerns employment. CBO claims to expect a relatively rapid return, over five years, to high levels of employment, and the baseline incorporates a correspondingly high rate of real growth in the early recovery from the great crisis. If this were to happen, then tax revenues would recover, and ordinarily the projected deficits would disappear. This is what did happen under full employment in the late 1990s.
But under present financial conditions this scenario of a rapid return to high employment is highly unrealistic. It can only happen if the credit system finances economic growth, which implies a rising level of private (household and company) debt relative to GDP. And that clearly is not going to happen. On the contrary, de-leveraging in the private sector is sure to remain the rule for a long time, as mortgages and other debts default or are paid down, and as many households remain effectively insolvent due to their mortgage debt.
With high unemployment, high public deficits are inevitable. The only choice is between an active deficit, incurred by putting people to work or otherwise serving national needs -- such as providing a decent retirement and health care to the aged -- and a passive deficit, incurred because at high unemployment tax revenues necessarily fail to cover public spending. Cutting public spending or raising taxes, now or in the future, by any amount, cannot reduce a deficit due to high unemployment. The only fiscal effect is to convert an active deficit into a passive one -- with disastrous economic and social effects.
4. Having Cured the Deficits with an Unrealistic Forecast, CBO Recreates them with Another, Very Different, but Equally Unrealistic Forecast.
In the CBO models, high future deficits and rising debt relative to GDP are expected. But the source is not a weak economy. It is a set of assumptions describing an economy after full recovery from the present crisis. In the CBO forecasts, big future deficits arise from a combination of (a) rapidly rising health care costs and (b) rising short-term interest rates, in the context of (c) a rapid return to high employment and (d) continued low overall inflation. This combination produces, mechanically, a very large net interest payout and a rapidly rising public debt in relation to a slowly rising nominal GDP.
Even if CBO were right about recovery, which it is not, this projection is internally inconsistent and wholly implausible. It isn't going to happen. Low overall inflation (at two percent) is inconsistent with the projected rise of short-term interest rates to nearly five percent. Why would the central bank carry out such a policy when no threat of inflation justifies it? But the assumed rise in interest rates drives the projected debt-to-GDP dynamic.
Similarly, the rise in projected interest payments is inconsistent with low nominal inflation. Interest payments rising to over 20 percent of GDP by mid-century would constitute new federal spending similar in scale to the mobilization for World War II. Obviously this cannot happen with two percent inflation. And although a higher inflation rate is undesirable, arithmetically it means a lower debt-to-GDP ratio.
Finally, rapidly rising health care costs and low overall inflation are mutually consistent only if all prices except health care are rising at less than that low overall inflation rate -- including energy and food prices in a time of increasing scarcity. This too is extremely unlikely. Either overall health care costs will decelerate (relieving the so-called Medicare funding problem) or the overall inflation rate will accelerate -- reducing the debt-to-GDP ratio.
In sum: the economic forecasts on which you are being asked to develop a credible plan for reducing deficits over the medium term are a mess. The unemployment and growth forecasts are implausibly optimistic, while the inflation and interest rates projections are implausibly pessimistic and mutually inconsistent.
Good policy cannot be based on bad forecasts. As a first step in your work -- long overdue -- the Commission should require the development of internally consistent, and factually plausible, economic forecasts on which to base future deficit and debt projections.
Galbraith's testimony continues from yesterday:
Let me now turn to the economic questions. A first economic question is, what caused the deficits and rising public debt? The answer comes in two parts: present deficits and projected future deficits.
2. Current Deficits and Rising Debt were Caused by the Financial Crisis.
Overwhelmingly, the present deficits are caused by the financial crisis. The financial crisis, the fall in asset (especially housing) values, and withdrawal of bank lending to business and households has meant a sharp decline in economic activity, and therefore a sharp decrease in tax revenues and an increase in automatic payments for unemployment insurance and the like. According to a new IMF staff analysis, fully half of the large increase in budget deficits in major economies around the world is due to collapsing tax revenues, and a further large share to low (often negative) growth in relation to interest payments on existing debt. Less than ten percent is due to increased discretionary public expenditure, as in stimulus packages.
This point is important because it shows that the claim that deficits have resulted from "overspending" is false, both in the United States and abroad.
3. Future Deficit Projections are Generally Based on Forecasts which Begin by Assuming Full Recovery, but this Assumption is Highly Unrealistic.
Unlike the present deficits, expected future deficits are not usually considered to be due to continued recession and high unemployment. To understand how the discussion of future deficits is being framed, it is necessary to grasp the work of the principal forecasting authority, the Congressional Budget Office. CBO's projections proceed in two steps. First, they wipe out the current deficits, over a very short time horizon, by assuming a full economic recovery. Second, they create an entirely new source of future deficits, essentially out of whole cloth. The critical near-term assumption in the CBO baseline concerns employment. CBO claims to expect a relatively rapid return, over five years, to high levels of employment, and the baseline incorporates a correspondingly high rate of real growth in the early recovery from the great crisis. If this were to happen, then tax revenues would recover, and ordinarily the projected deficits would disappear. This is what did happen under full employment in the late 1990s.
But under present financial conditions this scenario of a rapid return to high employment is highly unrealistic. It can only happen if the credit system finances economic growth, which implies a rising level of private (household and company) debt relative to GDP. And that clearly is not going to happen. On the contrary, de-leveraging in the private sector is sure to remain the rule for a long time, as mortgages and other debts default or are paid down, and as many households remain effectively insolvent due to their mortgage debt.
With high unemployment, high public deficits are inevitable. The only choice is between an active deficit, incurred by putting people to work or otherwise serving national needs -- such as providing a decent retirement and health care to the aged -- and a passive deficit, incurred because at high unemployment tax revenues necessarily fail to cover public spending. Cutting public spending or raising taxes, now or in the future, by any amount, cannot reduce a deficit due to high unemployment. The only fiscal effect is to convert an active deficit into a passive one -- with disastrous economic and social effects.
4. Having Cured the Deficits with an Unrealistic Forecast, CBO Recreates them with Another, Very Different, but Equally Unrealistic Forecast.
In the CBO models, high future deficits and rising debt relative to GDP are expected. But the source is not a weak economy. It is a set of assumptions describing an economy after full recovery from the present crisis. In the CBO forecasts, big future deficits arise from a combination of (a) rapidly rising health care costs and (b) rising short-term interest rates, in the context of (c) a rapid return to high employment and (d) continued low overall inflation. This combination produces, mechanically, a very large net interest payout and a rapidly rising public debt in relation to a slowly rising nominal GDP.
Even if CBO were right about recovery, which it is not, this projection is internally inconsistent and wholly implausible. It isn't going to happen. Low overall inflation (at two percent) is inconsistent with the projected rise of short-term interest rates to nearly five percent. Why would the central bank carry out such a policy when no threat of inflation justifies it? But the assumed rise in interest rates drives the projected debt-to-GDP dynamic.
Similarly, the rise in projected interest payments is inconsistent with low nominal inflation. Interest payments rising to over 20 percent of GDP by mid-century would constitute new federal spending similar in scale to the mobilization for World War II. Obviously this cannot happen with two percent inflation. And although a higher inflation rate is undesirable, arithmetically it means a lower debt-to-GDP ratio.
Finally, rapidly rising health care costs and low overall inflation are mutually consistent only if all prices except health care are rising at less than that low overall inflation rate -- including energy and food prices in a time of increasing scarcity. This too is extremely unlikely. Either overall health care costs will decelerate (relieving the so-called Medicare funding problem) or the overall inflation rate will accelerate -- reducing the debt-to-GDP ratio.
In sum: the economic forecasts on which you are being asked to develop a credible plan for reducing deficits over the medium term are a mess. The unemployment and growth forecasts are implausibly optimistic, while the inflation and interest rates projections are implausibly pessimistic and mutually inconsistent.
Good policy cannot be based on bad forecasts. As a first step in your work -- long overdue -- the Commission should require the development of internally consistent, and factually plausible, economic forecasts on which to base future deficit and debt projections.
Wednesday, July 28, 2010
Deficit committee's proceedings "clouded by illegitimacy," says Galbraith
The presidential commission charged with finding bipartisan solutions to lowering the nation's trillion-dollar budget deficit met this morning for the fourth time since April.
The 18-member commission heard from Maya MacGuineas, president of the Committee for a Responsible Federal Budget, and Barry Anderson, who recently served as head of the Budgeting and Public Expenditures Division of the Organization for Economic Cooperation and Development (OECD). They discussed the fiscal outlook for the United States and global economy and possible solutions to the debt crisis.
The committee is stacked. Its concern is the public debt, when the private debt is the millstone around the economy's neck. This week we offer Jamie Galbraith's analysis and testimony, beginning today.
Professor Jamie Galbraith's testimony to Deficit Commission
Statement to the Commission on Deficit Reduction
James K. Galbraith, Lloyd M. Bentsen, jr., Chair in Government/Business
Relations, Lyndon B. Johnson School of Public Affairs, The University of Texas at Austin
June 30, 2010
Mr. Chairmen, members of the commission, thank you for inviting this statement.
I am a professional economist, but I have served in a political role, as Executive Director of the Joint Economic Committee of the United States Congress. I am offering this statement on behalf of Americans for Democratic Action, an organization co-founded in 1949 by (among others) Eleanor Roosevelt, John Kenneth Galbraith, Arthur M. Schlesinger, jr., and Ronald Reagan. Accordingly I would like to begin with a political comment.
1. Clouds Over the Work of the Commission.
Your proceedings are clouded by illegitimacy. In this respect, there are four major issues.
First, most of your meetings are secret, apart from two open sessions before this one, which were plainly for show. There is no justification for secret meetings on deficit reduction. No secrets of any kind are involved. Nothing you say will affect financial markets. Congress long ago -- in 1975 -- reformed its procedures to hold far more sensitive and complicated meetings, notably legislative markups, in the broad light of day.
Secrecy breeds suspicion: first, that your discussions are at a level of discourse so low that you feel it would be embarrassing to disclose them. Second, that some members of the commission are proceeding from fixed, predetermined agendas. Third, that the purpose of the secrecy is to defer public discussion of cuts in Social Security and Medicare until after the 2010 elections. You could easily dispel these suspicions by publishing video transcripts of all of your meetings on the Internet, and by holding all future meetings in public. Please do so.
Second, there is a question of leadership. A bipartisan commission should approach its task in a judicious, open-minded and dispassionate way. For this, the attitude and temperament of the leadership are critical.
I first met Senator Simpson when we were both on Capitol Hill; at Harvard he became friends with my late parents. He is admirably frank in his views. But Senator Simpson has plainly shown that he lacks the temperament to do a fair and impartial job on this commission. This is very clear from the abusive response he made recently to Alex Lawson of Social Security Works, who was asking important questions about the substance of the commission's work, as well as calling attention to the illegitimate secrecy under which you are operating.
A general cannot speak of the President with contempt. Likewise the leader of a commission intended to sway the public cannot display contempt for the public. With due respect, Senator Simpson's conduct fails that test.
Third, most members of the Commission are political leaders, not economists. With all respect for Alice Rivlin, with just one economist on board you are denied access to the professional arguments surrounding this highly controversial issue. In general, it is impossible to have a fair discussion of any important question when the professional participants in that discussion have been picked, in advance, to represent a single point of view.
Conflicts of interest constitute the fourth major problem. The fact that the Commission has accepted support from Peter G. Peterson, a man who has for decades conducted a relentless campaign to cut Social Security and Medicare, raises the most serious questions. Quite apart from the merits of Mr. Peterson's arguments, this act must be condemned. A Commission serving public purpose cannot accept funds or other help from a private party with a strong interest in the outcome of that Commission's work. Your having done so is a disgrace.
In my view you also should not have accepted help from the Economic Policy Institute, even though EPI's positions on the merits are substantially closer to mine.
The 18-member commission heard from Maya MacGuineas, president of the Committee for a Responsible Federal Budget, and Barry Anderson, who recently served as head of the Budgeting and Public Expenditures Division of the Organization for Economic Cooperation and Development (OECD). They discussed the fiscal outlook for the United States and global economy and possible solutions to the debt crisis.
The committee is stacked. Its concern is the public debt, when the private debt is the millstone around the economy's neck. This week we offer Jamie Galbraith's analysis and testimony, beginning today.
Professor Jamie Galbraith's testimony to Deficit Commission
Statement to the Commission on Deficit Reduction
James K. Galbraith, Lloyd M. Bentsen, jr., Chair in Government/Business
Relations, Lyndon B. Johnson School of Public Affairs, The University of Texas at Austin
June 30, 2010
Mr. Chairmen, members of the commission, thank you for inviting this statement.
I am a professional economist, but I have served in a political role, as Executive Director of the Joint Economic Committee of the United States Congress. I am offering this statement on behalf of Americans for Democratic Action, an organization co-founded in 1949 by (among others) Eleanor Roosevelt, John Kenneth Galbraith, Arthur M. Schlesinger, jr., and Ronald Reagan. Accordingly I would like to begin with a political comment.
1. Clouds Over the Work of the Commission.
Your proceedings are clouded by illegitimacy. In this respect, there are four major issues.
First, most of your meetings are secret, apart from two open sessions before this one, which were plainly for show. There is no justification for secret meetings on deficit reduction. No secrets of any kind are involved. Nothing you say will affect financial markets. Congress long ago -- in 1975 -- reformed its procedures to hold far more sensitive and complicated meetings, notably legislative markups, in the broad light of day.
Secrecy breeds suspicion: first, that your discussions are at a level of discourse so low that you feel it would be embarrassing to disclose them. Second, that some members of the commission are proceeding from fixed, predetermined agendas. Third, that the purpose of the secrecy is to defer public discussion of cuts in Social Security and Medicare until after the 2010 elections. You could easily dispel these suspicions by publishing video transcripts of all of your meetings on the Internet, and by holding all future meetings in public. Please do so.
Second, there is a question of leadership. A bipartisan commission should approach its task in a judicious, open-minded and dispassionate way. For this, the attitude and temperament of the leadership are critical.
I first met Senator Simpson when we were both on Capitol Hill; at Harvard he became friends with my late parents. He is admirably frank in his views. But Senator Simpson has plainly shown that he lacks the temperament to do a fair and impartial job on this commission. This is very clear from the abusive response he made recently to Alex Lawson of Social Security Works, who was asking important questions about the substance of the commission's work, as well as calling attention to the illegitimate secrecy under which you are operating.
A general cannot speak of the President with contempt. Likewise the leader of a commission intended to sway the public cannot display contempt for the public. With due respect, Senator Simpson's conduct fails that test.
Third, most members of the Commission are political leaders, not economists. With all respect for Alice Rivlin, with just one economist on board you are denied access to the professional arguments surrounding this highly controversial issue. In general, it is impossible to have a fair discussion of any important question when the professional participants in that discussion have been picked, in advance, to represent a single point of view.
Conflicts of interest constitute the fourth major problem. The fact that the Commission has accepted support from Peter G. Peterson, a man who has for decades conducted a relentless campaign to cut Social Security and Medicare, raises the most serious questions. Quite apart from the merits of Mr. Peterson's arguments, this act must be condemned. A Commission serving public purpose cannot accept funds or other help from a private party with a strong interest in the outcome of that Commission's work. Your having done so is a disgrace.
In my view you also should not have accepted help from the Economic Policy Institute, even though EPI's positions on the merits are substantially closer to mine.
Tuesday, July 27, 2010
Get America Back to Work -- A manifesto from leading economists
GET AMERICA BACK TO WORK
DAILY BEAST
Fourteen million out of work! Sixteen notable economists and historians have joined in a consensus statement for The Daily Beast demanding urgent action on unemployment and the faltering recovery. Joseph Stiglitz, Alan Blinder, Robert Reich, Richard Parker, Derek Shearer, Laura Tyson, Sir Harold Evans, and other thought leaders have produced a manifesto calling for more government stimulus and tax credits to put America back to work.
Fourteen million unemployed represents a gigantic waste of human capital, an irrecoverable loss of wealth and spending power, and an affront to the ideals of America. Some 6.8 million have been out of work for 27 weeks or more. Members of Congress went home to celebrate July 4 having failed to extend unemployment benefits.
We recognize the necessity of a program to cut the mid- and long-term federal deficit but the imperative requirement now, and the surest course to balance the budget over time, is to restore a full measure of economic activity. As in the 1930s, the economy is suffering a sharp decline in aggregate demand and loss of business confidence. Long experience shows that monetary policy may not be enough, particularly in deep slumps, as Keynes noted.
• Update: 24 More Economists Sign Manifesto The urgent need is for government to replace the lost purchasing power of the unemployed and their families and to employ other tax-cut and spending programs to boost demand. Making deficit reduction the first target, without addressing the chronic underlying deficiency of demand, is exactly the error of the 1930s. It will prolong the great recession, harm the social cohesion of the country, and continue inflicting unnecessary hardship on millions of Americans.
PLUS
http://www.thedailybeast.com/blogs-and-stories/2010-07-22/deficit-spending-and-the-recession-the-daily-beast-manifesto/?cid=hp:mainpromo5
MINUS
Wednesday, July 21, 2010
Deficit Doves Meet the Deficit Owls
By Paul Davidson, James K. Galbraith and Lord Robert Skidelsky** First published at New Deal 2.0
On July 19, The Daily Beast published a piece by Harold Evans, Joseph Stiglitz, Alan Blinder, Robert Reich and others, urging greater fiscal stimulus in the short-term and renewed fiscal discipline over the medium- and longer-term horizon. A number of bloggers on this site were asked to support their deficit-dove petition. We declined, and so did the three wise owls who wrote the following statement, which first appeared at New Deal 2.0.
"We three were each asked to sign the letter organized by Sir Harold Evans and now co-signed by many of our friends, including Joseph Stiglitz, Robert Reich, Laura Tyson, Derek Shearer, Alan Blinder and Richard Parker. We support the central objective of the letter — a full employment policy now, based on sharply expanded public effort. Yet we each, separately, declined to sign it.
Our reservations centered on one sentence, namely, "We recognize the necessity of a program to cut the mid-and long-term federal deficit…" Since we do not agree with this statement, we could not sign the letter. Why do we disagree with this statement? The answer is that apart from the effects of unemployment itself the United States does not in fact face a serious deficit problem over the next generation, and for this reason there is no "necessity [for] a program to cut the mid-and long-term deficit."
On the contrary: If unemployment can be cured, the deficits we presently face will necessarily shrink. This is the universal experience of rapid economic growth: tax revenues rise, public welfare spending falls, and the budget moves toward balance. There is indeed no other experience in modern peacetime American history, most recently in the late 1990s when the budget went into surplus as full employment was reached.
We agree that health care costs are an important issue. But health care is a burden faced by both the public and private sectors, and cost control is a job for health policy, not budget policy. Cutting the public element in health care - Medicare, especially - in response to the health care cost problem is just a way of invidiously targeting the elderly who are covered by that program. We oppose this.
The long-term deficit scare story plays into the hands of those who will argue, very soon, for cuts in Social Security as though these were necessary for economic reasons. In fact, Social Security is a highly successful program which (along with Medicare) maintains our entire elderly population out of poverty and helps to stabilize the macroeconomy. It is a transfer program and indefinitely sustainable as it is.
We call on fellow economists to reconsider their casual willingness to concede to an unfounded hysteria over supposed long-term deficits, and to concentrate instead on solving the vast problems we presently face. It would be tragic if the Evans letter and similar efforts - whose basic purpose we strongly support - led to acquiescence in Social Security and Medicare cuts that impoverish America's elderly just a few years from now."
DAILY BEAST
Fourteen million out of work! Sixteen notable economists and historians have joined in a consensus statement for The Daily Beast demanding urgent action on unemployment and the faltering recovery. Joseph Stiglitz, Alan Blinder, Robert Reich, Richard Parker, Derek Shearer, Laura Tyson, Sir Harold Evans, and other thought leaders have produced a manifesto calling for more government stimulus and tax credits to put America back to work.
Fourteen million unemployed represents a gigantic waste of human capital, an irrecoverable loss of wealth and spending power, and an affront to the ideals of America. Some 6.8 million have been out of work for 27 weeks or more. Members of Congress went home to celebrate July 4 having failed to extend unemployment benefits.
We recognize the necessity of a program to cut the mid- and long-term federal deficit but the imperative requirement now, and the surest course to balance the budget over time, is to restore a full measure of economic activity. As in the 1930s, the economy is suffering a sharp decline in aggregate demand and loss of business confidence. Long experience shows that monetary policy may not be enough, particularly in deep slumps, as Keynes noted.
• Update: 24 More Economists Sign Manifesto The urgent need is for government to replace the lost purchasing power of the unemployed and their families and to employ other tax-cut and spending programs to boost demand. Making deficit reduction the first target, without addressing the chronic underlying deficiency of demand, is exactly the error of the 1930s. It will prolong the great recession, harm the social cohesion of the country, and continue inflicting unnecessary hardship on millions of Americans.
PLUS
http://www.thedailybeast.com/blogs-and-stories/2010-07-22/deficit-spending-and-the-recession-the-daily-beast-manifesto/?cid=hp:mainpromo5
MINUS
Wednesday, July 21, 2010
Deficit Doves Meet the Deficit Owls
By Paul Davidson, James K. Galbraith and Lord Robert Skidelsky** First published at New Deal 2.0
On July 19, The Daily Beast published a piece by Harold Evans, Joseph Stiglitz, Alan Blinder, Robert Reich and others, urging greater fiscal stimulus in the short-term and renewed fiscal discipline over the medium- and longer-term horizon. A number of bloggers on this site were asked to support their deficit-dove petition. We declined, and so did the three wise owls who wrote the following statement, which first appeared at New Deal 2.0.
"We three were each asked to sign the letter organized by Sir Harold Evans and now co-signed by many of our friends, including Joseph Stiglitz, Robert Reich, Laura Tyson, Derek Shearer, Alan Blinder and Richard Parker. We support the central objective of the letter — a full employment policy now, based on sharply expanded public effort. Yet we each, separately, declined to sign it.
Our reservations centered on one sentence, namely, "We recognize the necessity of a program to cut the mid-and long-term federal deficit…" Since we do not agree with this statement, we could not sign the letter. Why do we disagree with this statement? The answer is that apart from the effects of unemployment itself the United States does not in fact face a serious deficit problem over the next generation, and for this reason there is no "necessity [for] a program to cut the mid-and long-term deficit."
On the contrary: If unemployment can be cured, the deficits we presently face will necessarily shrink. This is the universal experience of rapid economic growth: tax revenues rise, public welfare spending falls, and the budget moves toward balance. There is indeed no other experience in modern peacetime American history, most recently in the late 1990s when the budget went into surplus as full employment was reached.
We agree that health care costs are an important issue. But health care is a burden faced by both the public and private sectors, and cost control is a job for health policy, not budget policy. Cutting the public element in health care - Medicare, especially - in response to the health care cost problem is just a way of invidiously targeting the elderly who are covered by that program. We oppose this.
The long-term deficit scare story plays into the hands of those who will argue, very soon, for cuts in Social Security as though these were necessary for economic reasons. In fact, Social Security is a highly successful program which (along with Medicare) maintains our entire elderly population out of poverty and helps to stabilize the macroeconomy. It is a transfer program and indefinitely sustainable as it is.
We call on fellow economists to reconsider their casual willingness to concede to an unfounded hysteria over supposed long-term deficits, and to concentrate instead on solving the vast problems we presently face. It would be tragic if the Evans letter and similar efforts - whose basic purpose we strongly support - led to acquiescence in Social Security and Medicare cuts that impoverish America's elderly just a few years from now."
Monday, July 26, 2010
Transcript: 397 Unusual uncertainty in Bernanke's step
Listen to this episode
[Transcript was corrupted part way through]
News
Fin Reg
An AP account up on the blog in the coming week is long, but is the best summary we've seen so far of the recently passed financial regulation.
Our view is the Act is a good beginning, but only a beginning. The most substantial piece is the Consumer Protection Bureau. Yes, it is nice to level the playing field with a consumer advocate, provide some symetry in information, Joe Stiglitz might say. But to us, it is the one big step to structuring markets. It involves no intrusive regulation, but only a means to standardize and make safe the products, and thus make possible a competitive market. Financial industry objections are thus exposed as anti-market.
Due to thelanguage of the bill, however, the person heading the bureau will likely have a good deal to say about how well it works, or doesn't work. We -- along with the rest of the informed population -- favor Elizabeth Warren as first head of the bureau.
Also on the blog this week is testimony to the Commission on Deficit Reduction, the sham committee set up by the Obama Administration to faciliate dangerous and uncalled-for cuts in Social Security and Medicare. The testimony is from the pen of James K. Galbraith. It is presented in several parts, for easy digestion.
Galbraith is notable for not signing the patently demand side manifesto released through the Daily Beast under the names of Joseph Stiglitz, Alan Blinder, Robert Reich, Laura Tyson, and others, including Robert Pollin. Perhaps more deafening than Galbraith's objections was the non-response from the Market Fundamentalist economics that produced the current mess. The reason for Galbraith and co-authors Paul Davidson and Keynes' biographer Robert Skidelsky not signing on was that they do not share the alarm about even medium term government deficits. Both manifesto and response are up on the blog, Tuesday, I think.
Links are in the transcript
DAILY BEAST
http://www.thedailybeast.com/blogs-and-stories/2010-07-19/save-the-economy-a-manifesto-by-harry-evans-joseph-stiglitz-alan-blinder-and-other-leaders/?cid=hp:mainpromo2
PLUS
http://www.thedailybeast.com/blogs-and-stories/2010-07-22/deficit-spending-and-the-recession-the-daily-beast-manifesto/?cid=hp:mainpromo5
MINUS
http://neweconomicperspectives.blogspot.com/2010/07/deficit-doves-meet-deficit-owls.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+EconomicPerspectivesFromKansasCity+%28Economic+Perspectives+from+Kansas+City%29
Galbraith also got into it with Paul Krugman on this subject. Krugman called him out for his contention that deficits have a benign effect in an economic depression. Unfortunately Krugman's mathematical refutation went off the rails into elementary quantity theory erros and leaps of assumption.
Demand Side is with Jamie Galbraith on this, after reviewing the arguments. Deficits don't have to grow, however. We see ample idle resources on corporate balance sheets to tap for new revenue. We also call for big new revenues from hiking top income tax rates, removing eh cap on payroll taxes, getting a tiny part of the casino action with a financial transactions tax, and of course, the simple but essential carbon tax. Lowering deficits by these economically efficient means would rebalance the economy.
Still, the important point is that deficits are a result of the capitalist excesses. Lowering them will not inspire a capitalist recovery. Quite the opposite.
BREAK
MARTIN WOLF AND TAXES
The noted columnist for the Financial Times is having a more and more difficult time relaying his opinion of policy actions by his own government and others such as the G-20 without breaking from his measured, considered and thoughtful tone. Recently terms such as "insane" and "if the moon were made of green cheese" and so on have crept into his commentary. The blind ignorance displayed by the new Cameron government in pursuit of fiscal austerity has particularly drawn his ire.
But here we relay his comments on taxation. He takes off from the British system, but seems to be channeling Michael Hudson, who you may recall on a relay at the first of the year, advocated taxing away the rents to land and resources. Hudson described this as the object of the classical economics leading up to the Twentieth Century. But you can get that there. Here is Martin Wolf. On the value of land speculation.
WOLF
TRANSCRIPT INTERRUPTED.
A computer crash lost the remainder of today's transcript. We include the following as partial replacement
FIN REG ONE WEEK LATER
described by the Wall Street Journal as "the most extensive remapping of financial regulation since the 1930s." It is nothing of the kind.
Where to open a critique is as much a problem as where to close it. So, this will start and end at the source: the Federal Reserve. In a single sentence, the Journal captured the most compelling reason to heave the proposed legislation into the BP oil spill: "The Federal Reserve would emerge as the pre-eminent regulator, with responsibility for the most complex financial companies."
The Federal Reserve has less understanding of banking than Bonnie and Clyde. Fed Chairman Ben S. Bernanke is unable to comprehend there was cause-and-effect between the boom the 1920s and the Great Depression of the 1930s. His ineptitude gave then-Federal Reserve Chairman Alan Greenspan the academic cover to reduce the fed funds rate to one percent in 2003. The most egregious credit bubble in the history of the world followed. Learning nothing, Simple Ben has now cut the funds rate to zero, creating an even greater credit bubble than the behemoth that collapsed in 2007.
Bernanke and his cohorts have no excuse for their ignorance. Federal Reserve policy in the 1920s was central to the credit write-offs that sank bank balance sheets later. This story was chronicled by dozens of economists in the 1930s. Their contribution is resurrected in "Masses of Worthless Paper," now posted on the AuContrarian.com website, in the "Articles" section. This was originally written for the May, 2010, Gloom, Boom, and Doom Report.
It is too late to escape the consequences of what Greenspan and Bernanke have done. But, there is no excuse for allowing the ruin to continue inflating. Chairman Bernanke keeps adding fuel to the conflagration. He should be handed a one-way ticket on a coal car to Princeton this afternoon.
Frederick Sheehan writes a blog at www.aucontrarian.com
James K. Galbraith:
The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. There is no chance that the banks will simply resume normal long-term lending. To whom would they lend? For what? Against what collateral? And if banks are recapitalized without changing their management, why should we expect them to change the behavior that caused the insolvency in the first place?
...
A brief reflection on this history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around.
That being so, what must now be done? The first thing we need, in the wake of the recovery bill, is more recovery bills. The next efforts should be larger, reflecting the true scale of the emergency. There should be open-ended support for state and local governments, public utilities, transit authorities, public hospitals, schools, and universities for the duration, and generous support for public capital investment in the short and long term. To the extent possible, all the resources being released from the private residential and commercial construction industries should be absorbed into public building projects. There should be comprehensive foreclosure relief, through a moratorium followed by restructuring or by conversion-to-rental, except in cases of speculative investment and borrower fraud. The president’s foreclosure-prevention plan is a useful step to relieve mortgage burdens on at-risk households, but it will not stop the downward spiral of home prices and correct the chronic oversupply of housing that is the cause of that.
Second, we should offset the violent drop in the wealth of the elderly population as a whole. The squeeze on the elderly has been little noted so far, but it hits in three separate ways: through the fall in the stock market; through the collapse of home values; and through the drop in interest rates, which reduces interest income on accumulated cash. For an increasing number of the elderly, Social Security and Medicare wealth are all they have.
That means that the entitlement reformers have it backward: instead of cutting Social Security benefits, we should increase them, especially for those at the bottom of the benefit scale. Indeed, in this crisis, precisely because it is universal and efficient, Social Security is an economic recovery ace in the hole. Increasing benefits is a simple, direct, progressive, and highly efficient way to prevent poverty and sustain purchasing power for this vulnerable population. I would also argue for lowering the age of eligibility for Medicare to (say) fifty-five, to permit workers to retire earlier and to free firms from the burden of managing health plans for older workers.
...
Finally, there is the big problem: How to recapitalize the household sector? How to restore the security and prosperity they’ve lost? How to build the productive economy for the next generation? Is there anything today that we might do that can compare with the transformation of World War II? Almost surely, there is not: World War II doubled production in five years.
Today the largest problems we face are energy security and climate change—massive issues because energy underpins everything we do, and because climate change threatens the survival of civilization. And here, obviously, we need a comprehensive national effort. Such a thing, if done right, combining planning and markets, could add 5 or even 10 percent of GDP to net investment. That’s not the scale of wartime mobilization. But it probably could return the country to full employment and keep it there, for years.
Moreover, the work does resemble wartime mobilization in important financial respects. Weatherization, conservation, mass transit, renewable power, and the smart grid are public investments. As with the armaments in World War II, work on them would generate incomes not matched by the new production of consumer goods. If handled carefully—say, with a new program of deferred claims to future purchasing power like war bonds—the incomes earned by dealing with oil security and climate change have the potential to become a foundation of restored financial wealth for the middle class.
This cannot be made to happen over just three years, as we did in 1942–44. But we could manage it over, say, twenty years or a bit longer. What is required are careful, sustained planning, consistent policy, and the recognition now that there are no quick fixes, no easy return to "normal," no going back to a world run by bankers—and no alternative to taking the long view.
A paradox of the long view is that the time to embrace it is right now. We need to start down that path before disastrous policy errors, including fatal banker bailouts and cuts in Social Security and Medicare, are put into effect. It is therefore especially important that thought and learning move quickly. Does the Geithner team, forged and trained in normal times, have the range and the flexibility required? If not, everything finally will depend, as it did with Roosevelt, on the imagination and character of President Obama.
[Transcript was corrupted part way through]
News
Fin Reg
An AP account up on the blog in the coming week is long, but is the best summary we've seen so far of the recently passed financial regulation.
Our view is the Act is a good beginning, but only a beginning. The most substantial piece is the Consumer Protection Bureau. Yes, it is nice to level the playing field with a consumer advocate, provide some symetry in information, Joe Stiglitz might say. But to us, it is the one big step to structuring markets. It involves no intrusive regulation, but only a means to standardize and make safe the products, and thus make possible a competitive market. Financial industry objections are thus exposed as anti-market.
Due to thelanguage of the bill, however, the person heading the bureau will likely have a good deal to say about how well it works, or doesn't work. We -- along with the rest of the informed population -- favor Elizabeth Warren as first head of the bureau.
Also on the blog this week is testimony to the Commission on Deficit Reduction, the sham committee set up by the Obama Administration to faciliate dangerous and uncalled-for cuts in Social Security and Medicare. The testimony is from the pen of James K. Galbraith. It is presented in several parts, for easy digestion.
Galbraith is notable for not signing the patently demand side manifesto released through the Daily Beast under the names of Joseph Stiglitz, Alan Blinder, Robert Reich, Laura Tyson, and others, including Robert Pollin. Perhaps more deafening than Galbraith's objections was the non-response from the Market Fundamentalist economics that produced the current mess. The reason for Galbraith and co-authors Paul Davidson and Keynes' biographer Robert Skidelsky not signing on was that they do not share the alarm about even medium term government deficits. Both manifesto and response are up on the blog, Tuesday, I think.
Links are in the transcript
DAILY BEAST
http://www.thedailybeast.com/blogs-and-stories/2010-07-19/save-the-economy-a-manifesto-by-harry-evans-joseph-stiglitz-alan-blinder-and-other-leaders/?cid=hp:mainpromo2
PLUS
http://www.thedailybeast.com/blogs-and-stories/2010-07-22/deficit-spending-and-the-recession-the-daily-beast-manifesto/?cid=hp:mainpromo5
MINUS
http://neweconomicperspectives.blogspot.com/2010/07/deficit-doves-meet-deficit-owls.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+EconomicPerspectivesFromKansasCity+%28Economic+Perspectives+from+Kansas+City%29
Galbraith also got into it with Paul Krugman on this subject. Krugman called him out for his contention that deficits have a benign effect in an economic depression. Unfortunately Krugman's mathematical refutation went off the rails into elementary quantity theory erros and leaps of assumption.
Demand Side is with Jamie Galbraith on this, after reviewing the arguments. Deficits don't have to grow, however. We see ample idle resources on corporate balance sheets to tap for new revenue. We also call for big new revenues from hiking top income tax rates, removing eh cap on payroll taxes, getting a tiny part of the casino action with a financial transactions tax, and of course, the simple but essential carbon tax. Lowering deficits by these economically efficient means would rebalance the economy.
Still, the important point is that deficits are a result of the capitalist excesses. Lowering them will not inspire a capitalist recovery. Quite the opposite.
BREAK
MARTIN WOLF AND TAXES
The noted columnist for the Financial Times is having a more and more difficult time relaying his opinion of policy actions by his own government and others such as the G-20 without breaking from his measured, considered and thoughtful tone. Recently terms such as "insane" and "if the moon were made of green cheese" and so on have crept into his commentary. The blind ignorance displayed by the new Cameron government in pursuit of fiscal austerity has particularly drawn his ire.
But here we relay his comments on taxation. He takes off from the British system, but seems to be channeling Michael Hudson, who you may recall on a relay at the first of the year, advocated taxing away the rents to land and resources. Hudson described this as the object of the classical economics leading up to the Twentieth Century. But you can get that there. Here is Martin Wolf. On the value of land speculation.
WOLF
TRANSCRIPT INTERRUPTED.
A computer crash lost the remainder of today's transcript. We include the following as partial replacement
FIN REG ONE WEEK LATER
described by the Wall Street Journal as "the most extensive remapping of financial regulation since the 1930s." It is nothing of the kind.
Where to open a critique is as much a problem as where to close it. So, this will start and end at the source: the Federal Reserve. In a single sentence, the Journal captured the most compelling reason to heave the proposed legislation into the BP oil spill: "The Federal Reserve would emerge as the pre-eminent regulator, with responsibility for the most complex financial companies."
The Federal Reserve has less understanding of banking than Bonnie and Clyde. Fed Chairman Ben S. Bernanke is unable to comprehend there was cause-and-effect between the boom the 1920s and the Great Depression of the 1930s. His ineptitude gave then-Federal Reserve Chairman Alan Greenspan the academic cover to reduce the fed funds rate to one percent in 2003. The most egregious credit bubble in the history of the world followed. Learning nothing, Simple Ben has now cut the funds rate to zero, creating an even greater credit bubble than the behemoth that collapsed in 2007.
Bernanke and his cohorts have no excuse for their ignorance. Federal Reserve policy in the 1920s was central to the credit write-offs that sank bank balance sheets later. This story was chronicled by dozens of economists in the 1930s. Their contribution is resurrected in "Masses of Worthless Paper," now posted on the AuContrarian.com website, in the "Articles" section. This was originally written for the May, 2010, Gloom, Boom, and Doom Report.
It is too late to escape the consequences of what Greenspan and Bernanke have done. But, there is no excuse for allowing the ruin to continue inflating. Chairman Bernanke keeps adding fuel to the conflagration. He should be handed a one-way ticket on a coal car to Princeton this afternoon.
Frederick Sheehan writes a blog at www.aucontrarian.com
James K. Galbraith:
The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. There is no chance that the banks will simply resume normal long-term lending. To whom would they lend? For what? Against what collateral? And if banks are recapitalized without changing their management, why should we expect them to change the behavior that caused the insolvency in the first place?
...
A brief reflection on this history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around.
That being so, what must now be done? The first thing we need, in the wake of the recovery bill, is more recovery bills. The next efforts should be larger, reflecting the true scale of the emergency. There should be open-ended support for state and local governments, public utilities, transit authorities, public hospitals, schools, and universities for the duration, and generous support for public capital investment in the short and long term. To the extent possible, all the resources being released from the private residential and commercial construction industries should be absorbed into public building projects. There should be comprehensive foreclosure relief, through a moratorium followed by restructuring or by conversion-to-rental, except in cases of speculative investment and borrower fraud. The president’s foreclosure-prevention plan is a useful step to relieve mortgage burdens on at-risk households, but it will not stop the downward spiral of home prices and correct the chronic oversupply of housing that is the cause of that.
Second, we should offset the violent drop in the wealth of the elderly population as a whole. The squeeze on the elderly has been little noted so far, but it hits in three separate ways: through the fall in the stock market; through the collapse of home values; and through the drop in interest rates, which reduces interest income on accumulated cash. For an increasing number of the elderly, Social Security and Medicare wealth are all they have.
That means that the entitlement reformers have it backward: instead of cutting Social Security benefits, we should increase them, especially for those at the bottom of the benefit scale. Indeed, in this crisis, precisely because it is universal and efficient, Social Security is an economic recovery ace in the hole. Increasing benefits is a simple, direct, progressive, and highly efficient way to prevent poverty and sustain purchasing power for this vulnerable population. I would also argue for lowering the age of eligibility for Medicare to (say) fifty-five, to permit workers to retire earlier and to free firms from the burden of managing health plans for older workers.
...
Finally, there is the big problem: How to recapitalize the household sector? How to restore the security and prosperity they’ve lost? How to build the productive economy for the next generation? Is there anything today that we might do that can compare with the transformation of World War II? Almost surely, there is not: World War II doubled production in five years.
Today the largest problems we face are energy security and climate change—massive issues because energy underpins everything we do, and because climate change threatens the survival of civilization. And here, obviously, we need a comprehensive national effort. Such a thing, if done right, combining planning and markets, could add 5 or even 10 percent of GDP to net investment. That’s not the scale of wartime mobilization. But it probably could return the country to full employment and keep it there, for years.
Moreover, the work does resemble wartime mobilization in important financial respects. Weatherization, conservation, mass transit, renewable power, and the smart grid are public investments. As with the armaments in World War II, work on them would generate incomes not matched by the new production of consumer goods. If handled carefully—say, with a new program of deferred claims to future purchasing power like war bonds—the incomes earned by dealing with oil security and climate change have the potential to become a foundation of restored financial wealth for the middle class.
This cannot be made to happen over just three years, as we did in 1942–44. But we could manage it over, say, twenty years or a bit longer. What is required are careful, sustained planning, consistent policy, and the recognition now that there are no quick fixes, no easy return to "normal," no going back to a world run by bankers—and no alternative to taking the long view.
A paradox of the long view is that the time to embrace it is right now. We need to start down that path before disastrous policy errors, including fatal banker bailouts and cuts in Social Security and Medicare, are put into effect. It is therefore especially important that thought and learning move quickly. Does the Geithner team, forged and trained in normal times, have the range and the flexibility required? If not, everything finally will depend, as it did with Roosevelt, on the imagination and character of President Obama.
Sunday, July 25, 2010
AP summary of the Financial Regulation Bill
WASHINGTON (AP) -- Two years after the global financial system nearly collapsed, a vast revamping of regulation has been signed into law. The measure targets the risky banking and oversight failures that led to the last crisis. The goal is to make another crisis less likely -- and, if it does happen, less costly for taxpayers.
Most of the new rules won't take effect right away. The Obama administration has a full year, for example, to empower a Bureau of Consumer Financial Protection that is being created.
Regulators will take months to study dozens of issues in the 2,300-page law before drafting rules. Among them: Should the government limit the size of banks? How should stockbrokers be held accountable for advice they give to clients? How can credit ratings be made more reliable?
All of that means the real-world impact of the law will depend on how it's interpreted by regulators -- the same regulators who were blamed for failing to head off the financial crisis.
Still, the bill is now law. And regulators must enact rules consistent with Congress' blueprint.
Here's a look at the framework they will operate from:
EYES ON THE ENTIRE FINANCIAL SYSTEM
CHANGES TO BANK REGULATION
LIMITING BANKS' ACTIVITIES
MONITORING OTHER FINANCIAL PLAYERS
A NEW CONSUMER WATCHDOG
A new agency will oversee consumer products and services, from mortgages to check cashing. It will regulate many nonbank companies, such as payday lenders. Before the crisis, no regulator with financial expertise oversaw the most reckless mortgage lenders.
OVERHAULING MORTGAGE RULES
The law revamps the mortgage system to protect consumers and discourage risky lending.
GIVING THE FED MORE POWER AND TRANSPARENCY
The Fed gained some power. It will be the lead regulator for the biggest, most interconnected financial companies -- those whose failures could threaten the system. But its independence was also reined in, to an extent:
Most of the new rules won't take effect right away. The Obama administration has a full year, for example, to empower a Bureau of Consumer Financial Protection that is being created.
Regulators will take months to study dozens of issues in the 2,300-page law before drafting rules. Among them: Should the government limit the size of banks? How should stockbrokers be held accountable for advice they give to clients? How can credit ratings be made more reliable?
All of that means the real-world impact of the law will depend on how it's interpreted by regulators -- the same regulators who were blamed for failing to head off the financial crisis.
Still, the bill is now law. And regulators must enact rules consistent with Congress' blueprint.
Here's a look at the framework they will operate from:
EYES ON THE ENTIRE FINANCIAL SYSTEM
- A council of regulators will identify threats to the system. The Treasury secretary will lead the council.
- One potential threat: Big, interconnected financial companies. The council will have authority to review both banks and nonbank companies, such as insurers and credit unions, that haven't faced bank-style regulation, to see if they could threaten the system. All such companies must meet tougher standards. For example, their use of borrowed money will be limited. Fuller disclosures, onsite supervision by Federal Reserve regulators and stiffer accounting rules will apply, too.
- The law provides an orderly way to close big companies. Companies the council feels could eventually pose a threat must write a "funeral plan." If regulators decide a company is endangering the system, they could dismantle it and sell off the pieces.
- The idea is to prevent panic from spreading. The Treasury would pay the bank's obligations. Treasury would be repaid with industry fees and money raised from the failed company's shareholders, bondholders and asset sales. But taxpayers could end up on the hook, the Congressional Budget Office says. Republicans complain this system "makes bailouts permanent."
- Some further complications:
- The shutdown plan isn't certain to prevent panics. Regulators might hesitate to close a financial services company until the system already is in crisis. Still, regulators will be better able to defuse threats. And the system's health might be restored more quickly.
- The bill won't fix the "too big to fail" problem. During the financial crisis, the government refused to let the largest banks collapse. Officials wanted to contain the crisis. So they propped up faltering banks or helped sell them off. Trillions of taxpayer dollars were put at risk. The law aims to make such failures rarer and less jarring to markets. But a handful of megabanks still dominate the industry. None would be allowed to fail because officials still fear that could spark panic.
CHANGES TO BANK REGULATION
- A national bank regulator will replace the two agencies that oversee national banks and thrifts: the Office of the Comptroller of the Currency and the Office of Thrift Supervision. Before the crisis, the OTS offered loose oversight. For example, it let banks avoid setting aside money for future losses. The banks were allowed to assume that the riskiest mortgages would be repaid. That's why many risky lenders chose the OTS as their main regulator. The overhaul would prevent such "regulator shopping" by creating one regulator for national bank and thrifts.
- But as before, no one regulator will monitor the entire banking system. And there still will be different standards for different types of companies -- one for credit unions, for instance, and another for thrifts. Take state-chartered banks. They're regulated by both state and federal agencies. But their federal regulation is split between two agencies: the Federal Deposit Insurance Corp. and the Federal Reserve. That won't change.
- Banks must keep a sturdier financial base -- what's known as capital. Capital is the stable money banks sit on. It includes money not at risk, such as shareholder equity. Think of it as an expanded rainy day fund.
- Regulators decide how much capital banks must have to cover unexpected big losses. The law instructs regulators to raise these standards. But they'll have broad discretion. And they will be influenced by international negotiations about how bank capital should be calculated.
LIMITING BANKS' ACTIVITIES
- The bill bans "proprietary trading." That's when banks place bets for their own profit, rather than for their clients. It's unclear how strictly the ban will be enforced. It can be hard to tell, for example, whether an investment is intended to benefit a bank or its clients and whether federally insured deposits could be put at risk by these trades. Regulators will draft rules after doing a study.
- The ban is part of the Volcker Rule, named for Former Fed Chairman Paul Volcker. Volcker, now a White House adviser, says banks should stick to taking deposits and making loans. He thinks dealmaking and investment banking should be left to firms that taxpayers wouldn't have to bail out.
- Another part of the Volcker Rule will limits banks' investments in hedge funds and private equity funds. These are lightly regulated investment pools. Banks can't own more than 3 percent of such a fund. And a bank's investments in such funds can't exceed 3 percent of its capital. But banks can still put clients' money into the funds.
- Many financial derivatives will be regulated for the first time. Derivatives are investments whose value depends on the future price of some other investment. Stock options and corn futures are examples. Many companies use derivatives to reduce risk. A company might hold a derivative whose profit would allow it to recoup part of the cost if a raw material's price soared. Before the crisis, some investors used derivatives purely for speculation: They arranged side bets on the housing market. Once the market crashed, their bad bets magnified the crisis.
- Under existing rules, many derivatives are traded outside the view of regulators. The new law will require that most derivatives trade openly on exchanges.
- Derivatives for the first time will also trade through clearinghouses. These intermediaries settle trades and are on the hook if the owner can't pay off its derivatives contracts. Clearinghouses will require derivatives sellers to set aside money for each contract in case their bets go bad.
- Banks won't be able to trade derivatives that are thought to pose the most risk. These include those based on energy and most metals. The ban is designed to protect taxpayer-insured bank deposits from being used to cover losses caused by derivatives. If derivatives bets wiped out a bank's capital, taxpayers could have to pay up.
- But banks can still trade most derivatives. Examples include those based on gold, interest rates and foreign currencies.
- Other derivatives operators will face tougher oversight. Examples include companies that sell purely speculative derivatives to hedge funds and wealthy investors.
- Derivatives companies must set aside money to cover possible losses. And the companies can be punished for using derivatives to mask the health of a business or government. The idea is to block deals like the one Goldman Sachs was accused of arranging to help Greece hide its deficit.
- There are exceptions to the clearinghouse and exchange-trading requirements. One is for nonfinancial companies that use derivatives solely to offset business risks. They can still trade derivatives outside exchanges and clearinghouses. And they won't have to set aside money to cover possible losses. They'll have to report their trades to regulators, however.
- Some derivatives are custom-made to meet a buyer's business needs. Custom derivatives can't be traded on exchanges. This creates a loophole: Derivatives dealers could steer buyers into custom-made contracts, making those trades less transparent.
MONITORING OTHER FINANCIAL PLAYERS
- Credit rating agencies will be held more accountable. Before the crisis, they gave high ratings to investments that turned out to be worthless. Under existing case law, the agencies can't be sued for ignoring an investment's risks -- only for fraud. The overhaul ends that protection; investors can sue agencies for recklessly ignoring risks. Also, the agencies must explain more fully how they assign ratings. If an agency performs poorly over time, the Securities and Exchange Commission could cancel its registration.
- The law will also reduce the influence of the three big rating agencies -- Moody's, Standard & Poor's and Fitch Ratings. Regulators and government agencies have used their ratings to decide which investments are appropriate for, say, banks and pension funds, which enjoy some government backing. But the overhaul lets the SEC and others develop new ways to grade investment risk.
- Still undecided is how to address the agencies' conflict of interest: They're paid by the banks whose investments they rate. Before the crisis, the agencies lowered standards to compete for banks' business. One option: Randomly assigning investments to agencies to rate.
- Shareholders of public companies can weigh in on pay packages for top executives. They can vote to approve or disapprove of pay deals as part of the proxy process. That's the annual ballot that shareholders use to elect boards of directors. The votes on pay will be held at least once every three years.
- But shareholders won't be able to block pay packages they see as excessive. Their votes will be nonbinding.
- Shareholders will find it easier to nominate board members and have a chance to influence a board's decisions. Fewer shares will qualify a stockholder to nominate a director. Directors who represent shareholders are more likely to vote to limit pay or reduce the company's financial risks.
- Brokers offering personalized investment advice must act in clients' best interests. The rules will hold brokers to the same standard that investment advisers already must meet. The change won't occur until regulators have studied the issue.
- Hedge funds must register as investment advisers. Retirement funds, money managers and wealthy individuals often invest in hedge funds, which use complex trades to seek big returns.
- Once hedge funds have registered with the SEC, they'll undergo periodic examinations and be required to disclose more information about their trades. This is a big change for hedge funds. But it's not nearly as rigorous as bank supervision.
- Insurance companies escaped with few changes. A new office at Treasury will monitor the industry and help decide if an insurer is big enough to warrant tighter oversight. Today, insurers are regulated by the insurance commissions of each state in which they operate.
- Regulators can limit the fees retailers pay when shoppers use debit cards. Merchants argue that the fees -- often up to 2 percent of the transaction cost -- are too high. Still, the fees help defray losses on credit card loans. Debit cards carry no such risk for the issuer.
A NEW CONSUMER WATCHDOG
A new agency will oversee consumer products and services, from mortgages to check cashing. It will regulate many nonbank companies, such as payday lenders. Before the crisis, no regulator with financial expertise oversaw the most reckless mortgage lenders.
- The regulator will police companies that dominate consumer finance, such as credit card companies and the biggest banks. The agency will write rules and ban products it deems unsafe, such as mortgages that require payment of interest only. It can ban confusing language in documents. And the agency can punish companies that don't comply.
- The agency's rules apply to community banks, too. But its enforcement won't. Instead, existing regulators will oversee the community banks' compliance. These regulators failed to protect consumers before the crisis. Community banks weren't involved in the risky investing that shook Wall Street. But they issued some high-risk mortgages that consumers couldn't repay. And their lending practices caused the previous banking crisis -- the savings and loan crisis of the 1980s and 1990s .
- The biggest loophole is for auto dealers that provide loans financed by banks. The bureau can't scrutinize or punish them. It can't even ban misleading fine print.
- The agency won't police companies the SEC regulates, such as stockbrokers.
- Some other groups that won exemptions from the consumer agency's oversight: Mobile-home sellers, real estate brokers, accountants and insurers.
OVERHAULING MORTGAGE RULES
The law revamps the mortgage system to protect consumers and discourage risky lending.
- Before the crisis, lenders funneled trillions into the overheated housing market. Many lenders didn't care if borrowers couldn't repay because they quickly resold the loans to investment banks. Banks bundled the loans, then sliced them into bonds. Investors, such as insurers and pension funds, bought the bonds. When borrowers stopped paying, those investors suffered deep losses.
- The biggest change: Lenders must verify that borrowers can afford their mortgages. The lenders can be punished if they fail to review borrowers' income and credit histories.
- Any company that pools loans into mortgage investments must keep at least 5 percent of the investments on its books. That way, banks know they will lose money if they sell too many investments backed by poor-quality loans.
- The bill doesn't include a fix for Fannie Mae and Freddie Mac. Those two companies are at the heart of the mortgage finance system. They buy mortgages from lenders and resell them to investors. When their investments lost money, the government had to intervene. The bailouts have cost taxpayers $145 billion so far.
- Now banned: Bonuses for brokers based on the cost of a mortgage. These payments encouraged brokers to stick borrowers with higher rates and fees.
GIVING THE FED MORE POWER AND TRANSPARENCY
The Fed gained some power. It will be the lead regulator for the biggest, most interconnected financial companies -- those whose failures could threaten the system. But its independence was also reined in, to an extent:
- The Government Accountability Office will conduct a one-time audit of the emergency lending programs the Fed used to stabilize markets during the crisis. The audit will include the Fed's discount lending to banks.
- The Fed's emergency lending powers will be more transparent and subject to greater oversight. During the crisis, the Fed used this authority to craft huge bailouts behind closed doors. It withheld details about programs that rescued individual companies. The overhaul bans lending programs designed to save individual companies. The Fed must also disclose details of the programs, typically a year after they expire. And the Fed can't invoke its emergency powers without the Treasury secretary's permission.
Saturday, July 24, 2010
Double Dip Week: David Levy
Bernanke Is Wrong! Double-Dip Recession Looming
David Levy
Levy Forecasting
June 11, 2010
Federal Reserve Chairman Ben Bernanke testified before Congress Wednesday that the U.S. economy is recovering, and he predicts the nation will not experience a double-dip recession.
Economist David Levy is far less optimistic -- he sees a 60% chance of a another recession in 2011.
Levy, who is chairman of The Jerome Levy Forecasting Center, says the factors that caused profits to rebound at the end of 2009 and the beginning of 2010 will not be there to bolster the economy in the coming months.
U.S. consumers, particularly high net worth individuals, who were terrified of losing their money in 2009, started spending again from the holiday season last year into the first few months of 2010. Now, they've tensed up again, he says. As a result, the profits of retailers, particularly high-end stores, are falling, as detailed here.
"We are starting to see those numbers slip up, become a little below plan, as we've gotten about eight weeks from that strength," Levy says. "That is going to fade more."
(Update: Right on cue, Friday's May retail sales figures were disappointing, falling 1.2%, and 1.1% ex-autos. Expectations were for a small rise in both categories, and the drop in the headline figure was the largest in 8 months.)
Levy says that investors, who are already wary of the stock market, are going to see a lot more that will make them nervous. He predicts that earnings will be very disappointing in the second half of 2010.
Deficit Spending a Huge Boost for Profits
According to Levy, the deficit spending that lifted the economy is tapering off, and the private sector cannot maintain the recovery on its own. In the accompanying clip, he tells Aaron Task that the stimulus money was integral to the economy's recovery.
"The federal deficit was the dominant force pulling us out" of recession, Levy says.
"When the government spends huge amounts of money -- directly or indirectly -- it becomes huge business revenue without [companies] having to pay the people to give them that income. It's a huge, huge boost to profits."
Because the economy is so dependent on the support of the federal government, Levy recommends that the deficit spending continue, but not necessarily in the manner it's been spent to date
"What we should do is more long-term federal investments, infrastructure repair, education, rebuild military hardware," Levy says. "If we are going to run a deficit that is creating debt, we should be putting on assets at the same time."
David Levy
Levy Forecasting
June 11, 2010
Federal Reserve Chairman Ben Bernanke testified before Congress Wednesday that the U.S. economy is recovering, and he predicts the nation will not experience a double-dip recession.
Economist David Levy is far less optimistic -- he sees a 60% chance of a another recession in 2011.
Levy, who is chairman of The Jerome Levy Forecasting Center, says the factors that caused profits to rebound at the end of 2009 and the beginning of 2010 will not be there to bolster the economy in the coming months.
U.S. consumers, particularly high net worth individuals, who were terrified of losing their money in 2009, started spending again from the holiday season last year into the first few months of 2010. Now, they've tensed up again, he says. As a result, the profits of retailers, particularly high-end stores, are falling, as detailed here.
"We are starting to see those numbers slip up, become a little below plan, as we've gotten about eight weeks from that strength," Levy says. "That is going to fade more."
(Update: Right on cue, Friday's May retail sales figures were disappointing, falling 1.2%, and 1.1% ex-autos. Expectations were for a small rise in both categories, and the drop in the headline figure was the largest in 8 months.)
Levy says that investors, who are already wary of the stock market, are going to see a lot more that will make them nervous. He predicts that earnings will be very disappointing in the second half of 2010.
Deficit Spending a Huge Boost for Profits
According to Levy, the deficit spending that lifted the economy is tapering off, and the private sector cannot maintain the recovery on its own. In the accompanying clip, he tells Aaron Task that the stimulus money was integral to the economy's recovery.
"The federal deficit was the dominant force pulling us out" of recession, Levy says.
"When the government spends huge amounts of money -- directly or indirectly -- it becomes huge business revenue without [companies] having to pay the people to give them that income. It's a huge, huge boost to profits."
Because the economy is so dependent on the support of the federal government, Levy recommends that the deficit spending continue, but not necessarily in the manner it's been spent to date
"What we should do is more long-term federal investments, infrastructure repair, education, rebuild military hardware," Levy says. "If we are going to run a deficit that is creating debt, we should be putting on assets at the same time."
Friday, July 23, 2010
Double Dip Week: Stephanie Kelton
Gift-Wrapping the White House for the GOP
by Stephanie Kelton
New Economic Perspectives
July 15, 2010
It looks like Christmas has come early for one of President Obama's most vocal critics. Rush Limbaugh said he hoped the president would fail, and the GOP is doing everything it can to make sure he does. The party stands united in its opposition to a (much-needed) ramping up of the federal stimulus effort. And, at the moment, the president is playing right into their hands.
Sen. Jon Kyl, R-Ariz., has called the $787 billion stimulus effort a "flop," adding:
The only thing more disappointing than hoping the president – any president – will fail is actively working to keep millions of Americans unemployed in order to score political points in the coming election. But that's exactly what's happening, and the president may be painting himself into a losing corner.
President Obama has insisted that: (1) the stimulus is working as planned; (2) a second stimulus is not needed; and (3) he will cut the deficit in half by the end of his first term.
If he sticks to his guns, I believe he will dig his own political grave (not to mention prolonging the agony for millions of Americans). He cannot have it both ways. He cannot reverse the effects of the worst economic downturn since the Great Depression and do it on a shoestring.
That isn't to imply that $787 billion is chump change, but it pales in comparison to the losses that have already been borne by homeowners, businesses and investors. As Dean Baker recently pointed out, annual consumption is down about $700 billion (due to the loss of roughly $16 trillion in real estate and stock market wealth). Add to that "a reduction in annual rates of construction of about $450 billion" and a decline of "approximately $200 billion" in demand due to losses in the non-residential sector, and Baker says we're looking at an annual loss of about $1,350 billion. And we're trying to offset it with $300 billion or so (the annual stimulus) in spending by the federal government! It's like using an umbrella to stop an avalanche. It won't work.
But it gets worse, because Baker's figures don't account for the void that has been created by state and local governments, where expenditures have fallen by more than $64 billion in the last two quarters alone. And, with virtually every state bracing for even bigger cuts next year, we could easily lose another $100 billion or so in fiscal 2010. Then, of course, there's the multiplier, which has been hard at work, exacerbating the magnitude of these cuts and costing us untold trillions in lost GDP.
But the president seems convinced that $787 billion will do the trick – at least according to his definition of the trick. You see, the Obama administration has not set the bar very high, and this seems to be why the president believes the stimulus has "worked as intended." As he explained, it "wasn't designed to restore the economy to full health on its own, but to provide the boost necessary to stop the free fall." And this is why even bad news – e.g. 565,000 people filing first time jobless claims – can be interpreted as an indication that the stimulus is working as intended. (Recall that this was the smallest number since January 2009.)
Indeed, the president's top economic advisors have always been careful to use the words "create or save" when describing the objective of the stimulus plan. And this means that net job creation isn't the goal. The economy can continue to lose jobs faster than it creates them, and the policy will be described as "working" because the stimulus money helped at least some workers keep their jobs.
So the stimulus may be working "as intended," but I don't think the president can rely on semantics to carry him to victory in 2012. If President Obama wants a second term, he must join the growing chorus of voices calling for another stimulus and press forward with an ambitious program to create jobs and halt the foreclosure crisis. I have outlined my twelve-step recovery program, and others on this blog have put forward similar ideas. A payroll tax holiday that cuts FICA contributions to zero will provide immediate relief to millions of working families and their employers, boosting take-home pay as well as business profits. An additional $1,000 per capita will help ease the on-going budget crisis so that states can avoid further cuts to education and social services. A job-guarantee program, modeled on the WPA, will provide useful work and retraining opportunities for the many Americans who will not find jobs even after the economy recovers. Investing in our nation's infrastructure – roads, bridges, transmission lines, etc. – will address years of neglect and improve the safety and security of all Americans.
These are the kinds of tangibles the American people will think about when they decide for themselves whether the stimulus was a success. At the end of the day, President Obama must cut loose the deficit bogy and abandon any date-specific goal for cutting the deficit in half. It is his Achilles heel. Let the deficit (and the debt) go where it will. With a sufficiently flexible fiscal response, GDP will explode, tax receipts will pour in, and the dreaded debt-to-GDP ratio will drop like a rock.
by Stephanie Kelton
New Economic Perspectives
July 15, 2010
It looks like Christmas has come early for one of President Obama's most vocal critics. Rush Limbaugh said he hoped the president would fail, and the GOP is doing everything it can to make sure he does. The party stands united in its opposition to a (much-needed) ramping up of the federal stimulus effort. And, at the moment, the president is playing right into their hands.
Sen. Jon Kyl, R-Ariz., has called the $787 billion stimulus effort a "flop," adding:
"The reality is, it hasn't helped yet. . . Only about 6.8 percent of the money has actually been spent. What I propose is, after you complete the contracts that are already committed, the things that are in the pipeline, stop it."In other words, he thinks the stimulus isn't working because the government isn't spending the money FAST enough. And, with the lion's share of the spending about to kick in, he wants to scrap the entire effort, just to make sure it won't work.
The only thing more disappointing than hoping the president – any president – will fail is actively working to keep millions of Americans unemployed in order to score political points in the coming election. But that's exactly what's happening, and the president may be painting himself into a losing corner.
President Obama has insisted that: (1) the stimulus is working as planned; (2) a second stimulus is not needed; and (3) he will cut the deficit in half by the end of his first term.
If he sticks to his guns, I believe he will dig his own political grave (not to mention prolonging the agony for millions of Americans). He cannot have it both ways. He cannot reverse the effects of the worst economic downturn since the Great Depression and do it on a shoestring.
That isn't to imply that $787 billion is chump change, but it pales in comparison to the losses that have already been borne by homeowners, businesses and investors. As Dean Baker recently pointed out, annual consumption is down about $700 billion (due to the loss of roughly $16 trillion in real estate and stock market wealth). Add to that "a reduction in annual rates of construction of about $450 billion" and a decline of "approximately $200 billion" in demand due to losses in the non-residential sector, and Baker says we're looking at an annual loss of about $1,350 billion. And we're trying to offset it with $300 billion or so (the annual stimulus) in spending by the federal government! It's like using an umbrella to stop an avalanche. It won't work.
But it gets worse, because Baker's figures don't account for the void that has been created by state and local governments, where expenditures have fallen by more than $64 billion in the last two quarters alone. And, with virtually every state bracing for even bigger cuts next year, we could easily lose another $100 billion or so in fiscal 2010. Then, of course, there's the multiplier, which has been hard at work, exacerbating the magnitude of these cuts and costing us untold trillions in lost GDP.
But the president seems convinced that $787 billion will do the trick – at least according to his definition of the trick. You see, the Obama administration has not set the bar very high, and this seems to be why the president believes the stimulus has "worked as intended." As he explained, it "wasn't designed to restore the economy to full health on its own, but to provide the boost necessary to stop the free fall." And this is why even bad news – e.g. 565,000 people filing first time jobless claims – can be interpreted as an indication that the stimulus is working as intended. (Recall that this was the smallest number since January 2009.)
Indeed, the president's top economic advisors have always been careful to use the words "create or save" when describing the objective of the stimulus plan. And this means that net job creation isn't the goal. The economy can continue to lose jobs faster than it creates them, and the policy will be described as "working" because the stimulus money helped at least some workers keep their jobs.
So the stimulus may be working "as intended," but I don't think the president can rely on semantics to carry him to victory in 2012. If President Obama wants a second term, he must join the growing chorus of voices calling for another stimulus and press forward with an ambitious program to create jobs and halt the foreclosure crisis. I have outlined my twelve-step recovery program, and others on this blog have put forward similar ideas. A payroll tax holiday that cuts FICA contributions to zero will provide immediate relief to millions of working families and their employers, boosting take-home pay as well as business profits. An additional $1,000 per capita will help ease the on-going budget crisis so that states can avoid further cuts to education and social services. A job-guarantee program, modeled on the WPA, will provide useful work and retraining opportunities for the many Americans who will not find jobs even after the economy recovers. Investing in our nation's infrastructure – roads, bridges, transmission lines, etc. – will address years of neglect and improve the safety and security of all Americans.
These are the kinds of tangibles the American people will think about when they decide for themselves whether the stimulus was a success. At the end of the day, President Obama must cut loose the deficit bogy and abandon any date-specific goal for cutting the deficit in half. It is his Achilles heel. Let the deficit (and the debt) go where it will. With a sufficiently flexible fiscal response, GDP will explode, tax receipts will pour in, and the dreaded debt-to-GDP ratio will drop like a rock.
Wednesday, July 21, 2010
Double Dip Week: Paul Krugman
The Third Depression
By PAUL KRUGMAN
New York Times
June 27, 2010
Recessions are common; depressions are rare. As far as I can tell, there were only two eras in economic history that were widely described as “depressions” at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929-31.
Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses.
We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.
And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.
In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.
But future historians will tell us that this wasn’t the end of the third depression, just as the business upturn that began in 1933 wasn’t the end of the Great Depression. After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.
In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.
As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels.
Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.
It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.
So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.
And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.
By PAUL KRUGMAN
New York Times
June 27, 2010
Recessions are common; depressions are rare. As far as I can tell, there were only two eras in economic history that were widely described as “depressions” at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929-31.
Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses.
We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.
And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.
In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.
But future historians will tell us that this wasn’t the end of the third depression, just as the business upturn that began in 1933 wasn’t the end of the Great Depression. After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.
In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.
As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels.
Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.
It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.
So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.
And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.
Double Dip Week: James K. Galbraith
No Return to Normal
Why the economic crisis, and its solution,
are bigger than you think.
By James K. Galbraith
Washington Monthly
April, 2010
Barack Obama’s presidency began in hope and goodwill, but its test will be its success or failure on the economics. Did the president and his team correctly diagnose the problem? Did they act with sufficient imagination and force? And did they prevail against the political obstacles—and not only that, but also against the procedures and the habits of thought to which official Washington is addicted?
The president has an economic program. But there is, so far, no clear statement of the thinking behind that program, and there may not be one, until the first report of the new Council of Economic Advisers appears next year. We therefore resort to what we know about the economists: the chair of the National Economic Council, Lawrence Summers; the CEA chair, Christina Romer; the budget director, Peter Orszag; and their titular head, Treasury Secretary Timothy Geithner. This is plainly a capable, close-knit group, acting with energy and commitment. Deficiencies of their program cannot, therefore, be blamed on incompetence. Rather, if deficiencies exist, they probably result from their shared background and creed—in short, from the limitations of their ideas.
The deepest belief of the modern economist is that the economy is a self-stabilizing system. This means that, even if nothing is done, normal rates of employment and production will someday return. Practically all modern economists believe this, often without thinking much about it. (Federal Reserve Chairman Ben Bernanke said it reflexively in a major speech in London in January: "The global economy will recover." He did not say how he knew.) The difference between conservatives and liberals is over whether policy can usefully speed things up. Conservatives say no, liberals say yes, and on this point Obama’s economists lean left. Hence the priority they gave, in their first days, to the stimulus package.
But did they get the scale right? Was the plan big enough? Policies are based on models; in a slump, plans for spending depend on a forecast of how deep and long the slump would otherwise be. The program will only be correctly sized if the forecast is accurate. And the forecast depends on the underlying belief. If recovery is not built into the genes of the system, then the forecast will be too optimistic, and the stimulus based on it will be too small.
Consider the baseline economic forecast of the Congressional Budget Office, the nonpartisan agency lawmakers rely on to evaluate the economy and their budget plans. In its early-January forecast, the CBO measured and projected the difference between actual economic performance and "normal" economic performance—the so-called GDP gap. The forecast has two astonishing features. First, the CBO did not expect the present recession to be any worse than that of 1981–82, our deepest postwar recession. Second, the CBO expected a turnaround beginning late this year, with the economy returning to normal around 2015, even if Congress had taken no action at all.
With this projection in mind, the recovery bill pours a bit less than 2 percent of GDP into new spending per year, plus some tax cuts, for two years, into a GDP gap estimated to average 6 percent for three years. The stimulus does not need to fill the whole gap, because the CBO expects a "multiplier effect," as first-round spending on bridges and roads, for example, is followed by second-round spending by steelworkers and road crews. The CBO estimates that because of the multiplier effect, two dollars of new public spending produces about three dollars of new output. (For tax cuts the numbers are lower, since some of the cuts will be saved in the first round.) And with this help, the recession becomes fairly mild. After two years, growth would be solidly established and Congress’s work would be done. In this way, the duration as well as the scale of action was driven, behind the scenes, by the CBO’s baseline forecast.
Why did the CBO reach this conclusion? On depth, CBO’s model is based on the postwar experience, and such models cannot predict outcomes more serious than anything already seen. If we are facing a downturn worse than 1982, our computers won’t tell us; we will be surprised. And if the slump is destined to drag on, the computers won’t tell us that either. Baked into the CBO model we find a "natural rate of unemployment" of 4.8 percent; the model moves the economy back toward that value no matter what. In the real world, however, there is no reason to believe this will happen. Some alternative forecasts, freed of the mystical return to "normal," now project a GDP gap twice as large as the CBO model predicts, and with no near-term recovery at all.
Considerations of timing also influenced the choice of line items. The bill tilted toward "shovel-ready" projects like refurbishing schools and fixing roads, and away from projects requiring planning and long construction lead times, like urban mass transit. The push for speed also influenced the bill in another way. Drafting new legislative authority takes time. In an emergency, it was sensible for Chairman David Obey of the House Appropriations Committee to mine the legislative docket for ideas already commanding broad support (especially within the Democratic caucus). In this way he produced a bill that was a triumph of fast drafting, practical politics, and progressive principle—a good bill which the Republicans hated. But the scale of action possible by such means is unrelated, except by coincidence, to what the economy needs.
Three further considerations limited the plan. There was, to begin with, the desire for political consensus; President Obama chose to start his administration with a bill that might win bipartisan support and pass in Congress by wide margins. (He was, of course, spurned by the Republicans.) Second, the new team also sought consensus of another type. Christina Romer polled a bipartisan group of professional economists, and Larry Summers told Meet the Press that the final package reflected a "balance" of their views. This procedure guarantees a result near the middle of the professional mind-set. The method would be useful if the errors of economists were unsystematic. But they are not. Economists are a cautious group, and in any extreme situation the midpoint of professional opinion is bound to be wrong.
Third, the initial package was affected by the new team’s desire to get past this crisis and to return to the familiar problems of their past lives. For these protégés of Robert Rubin, veterans in several cases of Rubin’s Hamilton Project, a key preconception has always been the budget deficit and what they call the "entitlement problem." This is D.C.-speak for rolling back Social Security and Medicare, opening new markets for fund managers and private insurers, behind a wave of budget babble about "long-term deficits" and "unfunded liabilities." To this our new president is not immune. Even before the inauguration Obama was moved to commit to "entitlement reform," and on February 23 he convened what he called a "fiscal responsibility summit." The idea took hold that after two years or so of big spending, the return to normal would be under way, and the costs of fiscal relief and infrastructure improvement might be recouped, in part by taking a pound of flesh from the incomes and health care of the old.
The chance of a return to normal depends, in turn, on the banking strategy. To Obama’s economists a "normal" economy is led and guided by private banks. When domestic credit booms are under way, they tend to generate high employment and low inflation; this makes the public budget look good, and spares the president and Congress many hard decisions. For this reason the new team instinctively seeks to return the bankers to their normal position at the top of the economic hill. Secretary Geithner told CNBC, "We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system."
But, is this a realistic hope? Is it even a possibility? The normal mechanics of a credit cycle do involve interludes when asset values crash and credit relations collapse. In 1981, Paul Volcker’s campaign against inflation caused such a crash. But, though they came close, the big banks did not fail then. (I learned recently from William Isaac, Ronald Reagan’s chair of the FDIC, that the government had contingency plans to nationalize the large banks in 1982, had Mexico, Argentina, or Brazil defaulted outright on their debts.) When monetary policy relaxed and the delayed tax cuts of 1981 kicked in, there was both pent-up demand for credit and the capacity to supply it. The final result was that the economy recovered quickly. Again in 1994, after a long period of credit crunch, banks and households were strong enough, even without a stimulus, to support a vast renewal of lending which propelled the economy forward for six years.
The Bush-era disasters guarantee that these happy patterns will not be repeated. For the first time since the 1930s, millions of American households are financially ruined. Families that two years ago enjoyed wealth in stocks and in their homes now have neither. Their 401(k)s have fallen by half, their mortgages are a burden, and their homes are an albatross. For many the best strategy is to mail the keys to the bank. This practically assures that excess supply and collapsed prices in housing will continue for years. Apart from cash—protected by deposit insurance and now desperately being conserved—the American middle class finds today that its major source of wealth is the implicit value of Social Security and Medicare—illiquid and intangible but real and inalienable in a way that home and equity values are not. And so it will remain, as long as future benefits are not cut.
In addition, some of the biggest banks are bust, almost for certain. Having abandoned prudent risk management in a climate of regulatory negligence and complicity under Bush, these banks participated gleefully in a poisonous game of abusive mortgage originations followed by rounds of pass-the-bad-penny-to-the-greater-fool. But they could not pass them all. And when in August 2007 the music stopped, banks discovered that the markets for their toxic-mortgage-backed securities had collapsed, and found themselves insolvent. Only a dogged political refusal to admit this has since kept the banks from being taken into receivership by the Federal Deposit Insurance Corporation—something the FDIC has the power to do, and has done as recently as last year with IndyMac in California.
Geithner’s banking plan would prolong the state of denial. It involves government guarantees of the bad assets, keeping current management in place and attempting to attract new private capital. (Conversion of preferred shares to equity, which may happen with Citigroup, conveys no powers that the government, as regulator, does not already have.) The idea is that one can fix the banks from the top down, by reestablishing markets for their bad securities. If the idea seems familiar, it is: Henry Paulson also pressed for this, to the point of winning congressional approval. But then he abandoned the idea. Why? He learned it could not work.
Paulson faced two insuperable problems. One was quantity: there were too many bad assets. The project of buying them back could be likened to "filling the Pacific Ocean with basketballs," as one observer said to me at the time. (When I tried to find out where the original request for $700 billion in the Troubled Asset Relief Program came from, a senior Senate aide replied, "Well, it’s a number between five hundred billion and one trillion.")
The other problem was price. The only price at which the assets could be disposed of, protecting the taxpayer, was of course the market price. In the collapse of the market for mortgage-backed securities and their associated credit default swaps, this price was too low to save the banks. But any higher price would have amounted to a gift of public funds, justifiable only if there was a good chance that the assets might recover value when "normal" conditions return.
That chance can be assessed, of course, only by doing what any reasonable private investor would do: due diligence, meaning a close inspection of the loan tapes. On the face of it, such inspections will reveal a very high proportion of missing documentation, inflated appraisals, and other evidence of fraud. (In late 2007 the ratings agency Fitch conducted this exercise on a small sample of loan files, and found indications of misrepresentation or fraud present in practically every one.) The reasonable inference would be that many more of the loans will default. Geithner’s plan to guarantee these so-called assets, therefore, is almost sure to overstate their value; it is only a way of delaying the ultimate public recognition of loss, while keeping the perpetrators afloat.
Delay is not innocuous. When a bank’s insolvency is ignored, the incentives for normal prudent banking collapse. Management has nothing to lose. It may take big new risks, in volatile markets like commodities, in the hope of salvation before the regulators close in. Or it may loot the institution—nomenklatura privatization, as the Russians would say—through unjustified bonuses, dividends, and options. It will never fully disclose the extent of insolvency on its own.
The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. There is no chance that the banks will simply resume normal long-term lending. To whom would they lend? For what? Against what collateral? And if banks are recapitalized without changing their management, why should we expect them to change the behavior that caused the insolvency in the first place?
The oddest thing about the Geithner program is its failure to act as though the financial crisis is a true crisis—an integrated, long-term economic threat—rather than merely a couple of related but temporary problems, one in banking and the other in jobs. In banking, the dominant metaphor is of plumbing: there is a blockage to be cleared. Take a plunger to the toxic assets, it is said, and credit conditions will return to normal. This, then, will make the recession essentially normal, validating the stimulus package. Solve these two problems, and the crisis will end. That’s the thinking.
But the plumbing metaphor is misleading. Credit is not a flow. It is not something that can be forced downstream by clearing a pipe. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness, meaning a secure income and, usually, a house with equity in it. Asset prices therefore matter. With a chronic oversupply of houses, prices fall, collateral disappears, and even if borrowers are willing they can’t qualify for loans. The other requirement is a willingness to borrow, motivated by what Keynes called the "animal spirits" of entrepreneurial enthusiasm. In a slump, such optimism is scarce. Even if people have collateral, they want the security of cash. And it is precisely because they want cash that they will not deplete their reserves by plunking down a payment on a new car.
The credit flow metaphor implies that people came flocking to the new-car showrooms last November and were turned away because there were no loans to be had. This is not true—what happened was that people stopped coming in. And they stopped coming in because, suddenly, they felt poor.
Strapped and afraid, people want to be in cash. This is what economists call the liquidity trap. And it gets worse: in these conditions, the normal estimates for multipliers—the bang for the buck—may be too high. Government spending on goods and services always increases total spending directly; a dollar of public spending is a dollar of GDP. But if the workers simply save their extra income, or use it to pay debt, that’s the end of the line: there is no further effect. For tax cuts (especially for the middle class and up), the new funds are mostly saved or used to pay down debt. Debt reduction may help lay a foundation for better times later on, but it doesn’t help now. With smaller multipliers, the public spending package would need to be even larger, in order to fill in all the holes in total demand. Thus financial crisis makes the real crisis worse, and the failure of the bank plan practically assures that the stimulus also will be too small.
In short, if we are in a true collapse of finance, our models will not serve. It is then appropriate to reach back, past the postwar years, to the experience of the Great Depression. And this can only be done by qualitative and historical analysis. Our modern numerical models just don’t capture the key feature of that crisis—which is, precisely, the collapse of the financial system.
If the banking system is crippled, then to be effective the public sector must do much, much more. How much more? By how much can spending be raised in a real depression? And does this remedy work? Recent months have seen much debate over the economic effects of the New Deal, and much repetition of the commonplace that the effort was too small to end the Great Depression, something achieved, it is said, only by World War II. A new paper by the economist Marshall Auerback has usefully corrected this record. Auerback plainly illustrates by how much Roosevelt’s ambition exceeded anything yet seen in this crisis:
[Roosevelt’s] government hired about 60 per cent of the unemployed in public works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York’s Lincoln Tunnel and Triborough Bridge complex, the Tennessee Valley Authority and the aircraft carriers Enterprise and Yorktown. It also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and a thousand airfields. And it employed 50,000 teachers, rebuilt the country’s entire rural school system, and hired 3,000 writers, musicians, sculptors and painters, including Willem de Kooning and Jackson Pollock.
In other words, Roosevelt employed Americans on a vast scale, bringing the unemployment rates down to levels that were tolerable, even before the war—from 25 percent in 1933 to below 10 percent in 1936, if you count those employed by the government as employed, which they surely were. In 1937, Roosevelt tried to balance the budget, the economy relapsed again, and in 1938 the New Deal was relaunched. This again brought unemployment down to about 10 percent, still before the war.
The New Deal rebuilt America physically, providing a foundation (the TVA’s power plants, for example) from which the mobilization of World War II could be launched. But it also saved the country politically and morally, providing jobs, hope, and confidence that in the end democracy was worth preserving. There were many, in the 1930s, who did not think so.
What did not recover, under Roosevelt, was the private banking system. Borrowing and lending—mortgages and home construction—contributed far less to the growth of output in the 1930s and ’40s than they had in the 1920s or would come to do after the war. If they had savings at all, people stayed in Treasuries, and despite huge deficits interest rates for federal debt remained near zero. The liquidity trap wasn’t overcome until the war ended.
It was the war, and only the war, that restored (or, more accurately, created for the first time) the financial wealth of the American middle class. During the 1930s public spending was large, but the incomes earned were spent. And while that spending increased consumption, it did not jumpstart a cycle of investment and growth, because the idle factories left over from the 1920s were quite sufficient to meet the demand for new output. Only after 1940 did total demand outstrip the economy’s capacity to produce civilian private goods—in part because private incomes soared, in part because the government ordered the production of some products, like cars, to halt.
All that extra demand would normally have driven up prices. But the federal government prevented this with price controls. (Disclosure: this writer’s father, John Kenneth Galbraith, ran the controls during the first year of the war.) And so, with nowhere else for their extra dollars to go, the public bought and held government bonds. These provided claims to postwar purchasing power. After the war, the existence of those claims could, and did, establish creditworthiness for millions, making possible the revival of private banking, and on the broadly based, middle-class foundation that so distinguished the 1950s from the 1920s. But the relaunching of private finance took twenty years, and the war besides.
A brief reflection on this history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around.
That being so, what must now be done? The first thing we need, in the wake of the recovery bill, is more recovery bills. The next efforts should be larger, reflecting the true scale of the emergency. There should be open-ended support for state and local governments, public utilities, transit authorities, public hospitals, schools, and universities for the duration, and generous support for public capital investment in the short and long term. To the extent possible, all the resources being released from the private residential and commercial construction industries should be absorbed into public building projects. There should be comprehensive foreclosure relief, through a moratorium followed by restructuring or by conversion-to-rental, except in cases of speculative investment and borrower fraud. The president’s foreclosure-prevention plan is a useful step to relieve mortgage burdens on at-risk households, but it will not stop the downward spiral of home prices and correct the chronic oversupply of housing that is the cause of that.
Second, we should offset the violent drop in the wealth of the elderly population as a whole. The squeeze on the elderly has been little noted so far, but it hits in three separate ways: through the fall in the stock market; through the collapse of home values; and through the drop in interest rates, which reduces interest income on accumulated cash. For an increasing number of the elderly, Social Security and Medicare wealth are all they have.
That means that the entitlement reformers have it backward: instead of cutting Social Security benefits, we should increase them, especially for those at the bottom of the benefit scale. Indeed, in this crisis, precisely because it is universal and efficient, Social Security is an economic recovery ace in the hole. Increasing benefits is a simple, direct, progressive, and highly efficient way to prevent poverty and sustain purchasing power for this vulnerable population. I would also argue for lowering the age of eligibility for Medicare to (say) fifty-five, to permit workers to retire earlier and to free firms from the burden of managing health plans for older workers.
This suggestion is meant, in part, to call attention to the madness of talk about Social Security and Medicare cuts. The prospect of future cuts in this modest but vital source of retirement security can only prompt worried prime-age workers to spend less and save more today. And that will make the present economic crisis deeper. In reality, there is no Social Security "financing problem" at all. There is a health care problem, but that can be dealt with only by deciding what health services to provide, and how to pay for them, for the whole population. It cannot be dealt with, responsibly or ethically, by cutting care for the old.
Third, we will soon need a jobs program to put the unemployed to work quickly. Infrastructure spending can help, but major building projects can take years to gear up, and they can, for the most part, provide jobs only for those who have the requisite skills. So the federal government should sponsor projects that employ people to do what they do best, including art, letters, drama, dance, music, scientific research, teaching, conservation, and the nonprofit sector, including community organizing—why not?
Finally, a payroll tax holiday would help restore the purchasing power of working families, as well as make it easier for employers to keep them on the payroll. This is a particularly potent suggestion, because it is large and immediate. And if growth resumes rapidly, it can also be scaled back. There is no error in doing too much that cannot easily be repaired, by doing a bit less.
As these measures take effect, the government must take control of insolvent banks, however large, and get on with the business of reorganizing, re-regulating, decapitating, and recapitalizing them. Depositors should be insured fully to prevent runs, and private risk capital (common and preferred equity and subordinated debt) should take the first loss. Effective compensation limits should be enforced—it is a good thing that they will encourage those at the top to retire. As Senator Christopher Dodd of Connecticut correctly stated in the brouhaha following the discovery that Senate Democrats had put tough limits into the recovery bill, there are many competent replacements for those who leave.
Ultimately the big banks can be resold as smaller private institutions, run on a scale that permits prudent credit assessment and risk management by people close enough to their client communities to foster an effective revival, among other things, of household credit and of independent small business—another lost hallmark of the 1950s. No one should imagine that the swaggering, bank-driven world of high finance and credit bubbles should be made to reappear. Big banks should be run largely by men and women with the long-term perspective, outlook, and temperament of middle managers, and not by the transient, self-regarding plutocrats who run them now.
The chorus of deficit hawks and entitlement reformers are certain to regard this program with horror. What about the deficit? What about the debt? These questions are unavoidable, so let’s answer them. First, the deficit and the public debt of the U.S. government can, should, must, and will increase in this crisis. They will increase whether the government acts or not. The choice is between an active program, running up debt while creating jobs and rebuilding America, or a passive program, running up debt because revenues collapse, because the population has to be maintained on the dole, and because the Treasury wishes, for no constructive reason, to rescue the big bankers and make them whole.
Second, so long as the economy is placed on a path to recovery, even a massive increase in public debt poses no risk that the U.S. government will find itself in the sort of situation known to Argentines and Indonesians. Why not? Because the rest of the world recognizes that the United States performs certain indispensable functions, including acting as the lynchpin of collective security and a principal source of new science and technology. So long as we meet those responsibilities, the rest of the world is likely to want to hold our debts.
Third, in the debt deflation, liquidity trap, and global crisis we are in, there is no risk of even a massive program generating inflation or higher long-term interest rates. That much is obvious from current financial conditions: interest rates on long-maturity Treasury bonds are amazingly low. Those rates also tell you that the markets are not worried about financing Social Security or Medicare. They are more worried, as I am, that the larger economic outlook will remain very bleak for a long time.
Finally, there is the big problem: How to recapitalize the household sector? How to restore the security and prosperity they’ve lost? How to build the productive economy for the next generation? Is there anything today that we might do that can compare with the transformation of World War II? Almost surely, there is not: World War II doubled production in five years.
Today the largest problems we face are energy security and climate change—massive issues because energy underpins everything we do, and because climate change threatens the survival of civilization. And here, obviously, we need a comprehensive national effort. Such a thing, if done right, combining planning and markets, could add 5 or even 10 percent of GDP to net investment. That’s not the scale of wartime mobilization. But it probably could return the country to full employment and keep it there, for years.
Moreover, the work does resemble wartime mobilization in important financial respects. Weatherization, conservation, mass transit, renewable power, and the smart grid are public investments. As with the armaments in World War II, work on them would generate incomes not matched by the new production of consumer goods. If handled carefully—say, with a new program of deferred claims to future purchasing power like war bonds—the incomes earned by dealing with oil security and climate change have the potential to become a foundation of restored financial wealth for the middle class.
This cannot be made to happen over just three years, as we did in 1942–44. But we could manage it over, say, twenty years or a bit longer. What is required are careful, sustained planning, consistent policy, and the recognition now that there are no quick fixes, no easy return to "normal," no going back to a world run by bankers—and no alternative to taking the long view.
A paradox of the long view is that the time to embrace it is right now. We need to start down that path before disastrous policy errors, including fatal banker bailouts and cuts in Social Security and Medicare, are put into effect. It is therefore especially important that thought and learning move quickly. Does the Geithner team, forged and trained in normal times, have the range and the flexibility required? If not, everything finally will depend, as it did with Roosevelt, on the imagination and character of President Obama.
Why the economic crisis, and its solution,
are bigger than you think.
By James K. Galbraith
Washington Monthly
April, 2010
Barack Obama’s presidency began in hope and goodwill, but its test will be its success or failure on the economics. Did the president and his team correctly diagnose the problem? Did they act with sufficient imagination and force? And did they prevail against the political obstacles—and not only that, but also against the procedures and the habits of thought to which official Washington is addicted?
The president has an economic program. But there is, so far, no clear statement of the thinking behind that program, and there may not be one, until the first report of the new Council of Economic Advisers appears next year. We therefore resort to what we know about the economists: the chair of the National Economic Council, Lawrence Summers; the CEA chair, Christina Romer; the budget director, Peter Orszag; and their titular head, Treasury Secretary Timothy Geithner. This is plainly a capable, close-knit group, acting with energy and commitment. Deficiencies of their program cannot, therefore, be blamed on incompetence. Rather, if deficiencies exist, they probably result from their shared background and creed—in short, from the limitations of their ideas.
The deepest belief of the modern economist is that the economy is a self-stabilizing system. This means that, even if nothing is done, normal rates of employment and production will someday return. Practically all modern economists believe this, often without thinking much about it. (Federal Reserve Chairman Ben Bernanke said it reflexively in a major speech in London in January: "The global economy will recover." He did not say how he knew.) The difference between conservatives and liberals is over whether policy can usefully speed things up. Conservatives say no, liberals say yes, and on this point Obama’s economists lean left. Hence the priority they gave, in their first days, to the stimulus package.
But did they get the scale right? Was the plan big enough? Policies are based on models; in a slump, plans for spending depend on a forecast of how deep and long the slump would otherwise be. The program will only be correctly sized if the forecast is accurate. And the forecast depends on the underlying belief. If recovery is not built into the genes of the system, then the forecast will be too optimistic, and the stimulus based on it will be too small.
Consider the baseline economic forecast of the Congressional Budget Office, the nonpartisan agency lawmakers rely on to evaluate the economy and their budget plans. In its early-January forecast, the CBO measured and projected the difference between actual economic performance and "normal" economic performance—the so-called GDP gap. The forecast has two astonishing features. First, the CBO did not expect the present recession to be any worse than that of 1981–82, our deepest postwar recession. Second, the CBO expected a turnaround beginning late this year, with the economy returning to normal around 2015, even if Congress had taken no action at all.
With this projection in mind, the recovery bill pours a bit less than 2 percent of GDP into new spending per year, plus some tax cuts, for two years, into a GDP gap estimated to average 6 percent for three years. The stimulus does not need to fill the whole gap, because the CBO expects a "multiplier effect," as first-round spending on bridges and roads, for example, is followed by second-round spending by steelworkers and road crews. The CBO estimates that because of the multiplier effect, two dollars of new public spending produces about three dollars of new output. (For tax cuts the numbers are lower, since some of the cuts will be saved in the first round.) And with this help, the recession becomes fairly mild. After two years, growth would be solidly established and Congress’s work would be done. In this way, the duration as well as the scale of action was driven, behind the scenes, by the CBO’s baseline forecast.
Why did the CBO reach this conclusion? On depth, CBO’s model is based on the postwar experience, and such models cannot predict outcomes more serious than anything already seen. If we are facing a downturn worse than 1982, our computers won’t tell us; we will be surprised. And if the slump is destined to drag on, the computers won’t tell us that either. Baked into the CBO model we find a "natural rate of unemployment" of 4.8 percent; the model moves the economy back toward that value no matter what. In the real world, however, there is no reason to believe this will happen. Some alternative forecasts, freed of the mystical return to "normal," now project a GDP gap twice as large as the CBO model predicts, and with no near-term recovery at all.
Considerations of timing also influenced the choice of line items. The bill tilted toward "shovel-ready" projects like refurbishing schools and fixing roads, and away from projects requiring planning and long construction lead times, like urban mass transit. The push for speed also influenced the bill in another way. Drafting new legislative authority takes time. In an emergency, it was sensible for Chairman David Obey of the House Appropriations Committee to mine the legislative docket for ideas already commanding broad support (especially within the Democratic caucus). In this way he produced a bill that was a triumph of fast drafting, practical politics, and progressive principle—a good bill which the Republicans hated. But the scale of action possible by such means is unrelated, except by coincidence, to what the economy needs.
Three further considerations limited the plan. There was, to begin with, the desire for political consensus; President Obama chose to start his administration with a bill that might win bipartisan support and pass in Congress by wide margins. (He was, of course, spurned by the Republicans.) Second, the new team also sought consensus of another type. Christina Romer polled a bipartisan group of professional economists, and Larry Summers told Meet the Press that the final package reflected a "balance" of their views. This procedure guarantees a result near the middle of the professional mind-set. The method would be useful if the errors of economists were unsystematic. But they are not. Economists are a cautious group, and in any extreme situation the midpoint of professional opinion is bound to be wrong.
Third, the initial package was affected by the new team’s desire to get past this crisis and to return to the familiar problems of their past lives. For these protégés of Robert Rubin, veterans in several cases of Rubin’s Hamilton Project, a key preconception has always been the budget deficit and what they call the "entitlement problem." This is D.C.-speak for rolling back Social Security and Medicare, opening new markets for fund managers and private insurers, behind a wave of budget babble about "long-term deficits" and "unfunded liabilities." To this our new president is not immune. Even before the inauguration Obama was moved to commit to "entitlement reform," and on February 23 he convened what he called a "fiscal responsibility summit." The idea took hold that after two years or so of big spending, the return to normal would be under way, and the costs of fiscal relief and infrastructure improvement might be recouped, in part by taking a pound of flesh from the incomes and health care of the old.
The chance of a return to normal depends, in turn, on the banking strategy. To Obama’s economists a "normal" economy is led and guided by private banks. When domestic credit booms are under way, they tend to generate high employment and low inflation; this makes the public budget look good, and spares the president and Congress many hard decisions. For this reason the new team instinctively seeks to return the bankers to their normal position at the top of the economic hill. Secretary Geithner told CNBC, "We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system."
But, is this a realistic hope? Is it even a possibility? The normal mechanics of a credit cycle do involve interludes when asset values crash and credit relations collapse. In 1981, Paul Volcker’s campaign against inflation caused such a crash. But, though they came close, the big banks did not fail then. (I learned recently from William Isaac, Ronald Reagan’s chair of the FDIC, that the government had contingency plans to nationalize the large banks in 1982, had Mexico, Argentina, or Brazil defaulted outright on their debts.) When monetary policy relaxed and the delayed tax cuts of 1981 kicked in, there was both pent-up demand for credit and the capacity to supply it. The final result was that the economy recovered quickly. Again in 1994, after a long period of credit crunch, banks and households were strong enough, even without a stimulus, to support a vast renewal of lending which propelled the economy forward for six years.
The Bush-era disasters guarantee that these happy patterns will not be repeated. For the first time since the 1930s, millions of American households are financially ruined. Families that two years ago enjoyed wealth in stocks and in their homes now have neither. Their 401(k)s have fallen by half, their mortgages are a burden, and their homes are an albatross. For many the best strategy is to mail the keys to the bank. This practically assures that excess supply and collapsed prices in housing will continue for years. Apart from cash—protected by deposit insurance and now desperately being conserved—the American middle class finds today that its major source of wealth is the implicit value of Social Security and Medicare—illiquid and intangible but real and inalienable in a way that home and equity values are not. And so it will remain, as long as future benefits are not cut.
In addition, some of the biggest banks are bust, almost for certain. Having abandoned prudent risk management in a climate of regulatory negligence and complicity under Bush, these banks participated gleefully in a poisonous game of abusive mortgage originations followed by rounds of pass-the-bad-penny-to-the-greater-fool. But they could not pass them all. And when in August 2007 the music stopped, banks discovered that the markets for their toxic-mortgage-backed securities had collapsed, and found themselves insolvent. Only a dogged political refusal to admit this has since kept the banks from being taken into receivership by the Federal Deposit Insurance Corporation—something the FDIC has the power to do, and has done as recently as last year with IndyMac in California.
Geithner’s banking plan would prolong the state of denial. It involves government guarantees of the bad assets, keeping current management in place and attempting to attract new private capital. (Conversion of preferred shares to equity, which may happen with Citigroup, conveys no powers that the government, as regulator, does not already have.) The idea is that one can fix the banks from the top down, by reestablishing markets for their bad securities. If the idea seems familiar, it is: Henry Paulson also pressed for this, to the point of winning congressional approval. But then he abandoned the idea. Why? He learned it could not work.
Paulson faced two insuperable problems. One was quantity: there were too many bad assets. The project of buying them back could be likened to "filling the Pacific Ocean with basketballs," as one observer said to me at the time. (When I tried to find out where the original request for $700 billion in the Troubled Asset Relief Program came from, a senior Senate aide replied, "Well, it’s a number between five hundred billion and one trillion.")
The other problem was price. The only price at which the assets could be disposed of, protecting the taxpayer, was of course the market price. In the collapse of the market for mortgage-backed securities and their associated credit default swaps, this price was too low to save the banks. But any higher price would have amounted to a gift of public funds, justifiable only if there was a good chance that the assets might recover value when "normal" conditions return.
That chance can be assessed, of course, only by doing what any reasonable private investor would do: due diligence, meaning a close inspection of the loan tapes. On the face of it, such inspections will reveal a very high proportion of missing documentation, inflated appraisals, and other evidence of fraud. (In late 2007 the ratings agency Fitch conducted this exercise on a small sample of loan files, and found indications of misrepresentation or fraud present in practically every one.) The reasonable inference would be that many more of the loans will default. Geithner’s plan to guarantee these so-called assets, therefore, is almost sure to overstate their value; it is only a way of delaying the ultimate public recognition of loss, while keeping the perpetrators afloat.
Delay is not innocuous. When a bank’s insolvency is ignored, the incentives for normal prudent banking collapse. Management has nothing to lose. It may take big new risks, in volatile markets like commodities, in the hope of salvation before the regulators close in. Or it may loot the institution—nomenklatura privatization, as the Russians would say—through unjustified bonuses, dividends, and options. It will never fully disclose the extent of insolvency on its own.
The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. There is no chance that the banks will simply resume normal long-term lending. To whom would they lend? For what? Against what collateral? And if banks are recapitalized without changing their management, why should we expect them to change the behavior that caused the insolvency in the first place?
The oddest thing about the Geithner program is its failure to act as though the financial crisis is a true crisis—an integrated, long-term economic threat—rather than merely a couple of related but temporary problems, one in banking and the other in jobs. In banking, the dominant metaphor is of plumbing: there is a blockage to be cleared. Take a plunger to the toxic assets, it is said, and credit conditions will return to normal. This, then, will make the recession essentially normal, validating the stimulus package. Solve these two problems, and the crisis will end. That’s the thinking.
But the plumbing metaphor is misleading. Credit is not a flow. It is not something that can be forced downstream by clearing a pipe. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness, meaning a secure income and, usually, a house with equity in it. Asset prices therefore matter. With a chronic oversupply of houses, prices fall, collateral disappears, and even if borrowers are willing they can’t qualify for loans. The other requirement is a willingness to borrow, motivated by what Keynes called the "animal spirits" of entrepreneurial enthusiasm. In a slump, such optimism is scarce. Even if people have collateral, they want the security of cash. And it is precisely because they want cash that they will not deplete their reserves by plunking down a payment on a new car.
The credit flow metaphor implies that people came flocking to the new-car showrooms last November and were turned away because there were no loans to be had. This is not true—what happened was that people stopped coming in. And they stopped coming in because, suddenly, they felt poor.
Strapped and afraid, people want to be in cash. This is what economists call the liquidity trap. And it gets worse: in these conditions, the normal estimates for multipliers—the bang for the buck—may be too high. Government spending on goods and services always increases total spending directly; a dollar of public spending is a dollar of GDP. But if the workers simply save their extra income, or use it to pay debt, that’s the end of the line: there is no further effect. For tax cuts (especially for the middle class and up), the new funds are mostly saved or used to pay down debt. Debt reduction may help lay a foundation for better times later on, but it doesn’t help now. With smaller multipliers, the public spending package would need to be even larger, in order to fill in all the holes in total demand. Thus financial crisis makes the real crisis worse, and the failure of the bank plan practically assures that the stimulus also will be too small.
In short, if we are in a true collapse of finance, our models will not serve. It is then appropriate to reach back, past the postwar years, to the experience of the Great Depression. And this can only be done by qualitative and historical analysis. Our modern numerical models just don’t capture the key feature of that crisis—which is, precisely, the collapse of the financial system.
If the banking system is crippled, then to be effective the public sector must do much, much more. How much more? By how much can spending be raised in a real depression? And does this remedy work? Recent months have seen much debate over the economic effects of the New Deal, and much repetition of the commonplace that the effort was too small to end the Great Depression, something achieved, it is said, only by World War II. A new paper by the economist Marshall Auerback has usefully corrected this record. Auerback plainly illustrates by how much Roosevelt’s ambition exceeded anything yet seen in this crisis:
[Roosevelt’s] government hired about 60 per cent of the unemployed in public works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York’s Lincoln Tunnel and Triborough Bridge complex, the Tennessee Valley Authority and the aircraft carriers Enterprise and Yorktown. It also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and a thousand airfields. And it employed 50,000 teachers, rebuilt the country’s entire rural school system, and hired 3,000 writers, musicians, sculptors and painters, including Willem de Kooning and Jackson Pollock.
In other words, Roosevelt employed Americans on a vast scale, bringing the unemployment rates down to levels that were tolerable, even before the war—from 25 percent in 1933 to below 10 percent in 1936, if you count those employed by the government as employed, which they surely were. In 1937, Roosevelt tried to balance the budget, the economy relapsed again, and in 1938 the New Deal was relaunched. This again brought unemployment down to about 10 percent, still before the war.
The New Deal rebuilt America physically, providing a foundation (the TVA’s power plants, for example) from which the mobilization of World War II could be launched. But it also saved the country politically and morally, providing jobs, hope, and confidence that in the end democracy was worth preserving. There were many, in the 1930s, who did not think so.
What did not recover, under Roosevelt, was the private banking system. Borrowing and lending—mortgages and home construction—contributed far less to the growth of output in the 1930s and ’40s than they had in the 1920s or would come to do after the war. If they had savings at all, people stayed in Treasuries, and despite huge deficits interest rates for federal debt remained near zero. The liquidity trap wasn’t overcome until the war ended.
It was the war, and only the war, that restored (or, more accurately, created for the first time) the financial wealth of the American middle class. During the 1930s public spending was large, but the incomes earned were spent. And while that spending increased consumption, it did not jumpstart a cycle of investment and growth, because the idle factories left over from the 1920s were quite sufficient to meet the demand for new output. Only after 1940 did total demand outstrip the economy’s capacity to produce civilian private goods—in part because private incomes soared, in part because the government ordered the production of some products, like cars, to halt.
All that extra demand would normally have driven up prices. But the federal government prevented this with price controls. (Disclosure: this writer’s father, John Kenneth Galbraith, ran the controls during the first year of the war.) And so, with nowhere else for their extra dollars to go, the public bought and held government bonds. These provided claims to postwar purchasing power. After the war, the existence of those claims could, and did, establish creditworthiness for millions, making possible the revival of private banking, and on the broadly based, middle-class foundation that so distinguished the 1950s from the 1920s. But the relaunching of private finance took twenty years, and the war besides.
A brief reflection on this history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around.
That being so, what must now be done? The first thing we need, in the wake of the recovery bill, is more recovery bills. The next efforts should be larger, reflecting the true scale of the emergency. There should be open-ended support for state and local governments, public utilities, transit authorities, public hospitals, schools, and universities for the duration, and generous support for public capital investment in the short and long term. To the extent possible, all the resources being released from the private residential and commercial construction industries should be absorbed into public building projects. There should be comprehensive foreclosure relief, through a moratorium followed by restructuring or by conversion-to-rental, except in cases of speculative investment and borrower fraud. The president’s foreclosure-prevention plan is a useful step to relieve mortgage burdens on at-risk households, but it will not stop the downward spiral of home prices and correct the chronic oversupply of housing that is the cause of that.
Second, we should offset the violent drop in the wealth of the elderly population as a whole. The squeeze on the elderly has been little noted so far, but it hits in three separate ways: through the fall in the stock market; through the collapse of home values; and through the drop in interest rates, which reduces interest income on accumulated cash. For an increasing number of the elderly, Social Security and Medicare wealth are all they have.
That means that the entitlement reformers have it backward: instead of cutting Social Security benefits, we should increase them, especially for those at the bottom of the benefit scale. Indeed, in this crisis, precisely because it is universal and efficient, Social Security is an economic recovery ace in the hole. Increasing benefits is a simple, direct, progressive, and highly efficient way to prevent poverty and sustain purchasing power for this vulnerable population. I would also argue for lowering the age of eligibility for Medicare to (say) fifty-five, to permit workers to retire earlier and to free firms from the burden of managing health plans for older workers.
This suggestion is meant, in part, to call attention to the madness of talk about Social Security and Medicare cuts. The prospect of future cuts in this modest but vital source of retirement security can only prompt worried prime-age workers to spend less and save more today. And that will make the present economic crisis deeper. In reality, there is no Social Security "financing problem" at all. There is a health care problem, but that can be dealt with only by deciding what health services to provide, and how to pay for them, for the whole population. It cannot be dealt with, responsibly or ethically, by cutting care for the old.
Third, we will soon need a jobs program to put the unemployed to work quickly. Infrastructure spending can help, but major building projects can take years to gear up, and they can, for the most part, provide jobs only for those who have the requisite skills. So the federal government should sponsor projects that employ people to do what they do best, including art, letters, drama, dance, music, scientific research, teaching, conservation, and the nonprofit sector, including community organizing—why not?
Finally, a payroll tax holiday would help restore the purchasing power of working families, as well as make it easier for employers to keep them on the payroll. This is a particularly potent suggestion, because it is large and immediate. And if growth resumes rapidly, it can also be scaled back. There is no error in doing too much that cannot easily be repaired, by doing a bit less.
As these measures take effect, the government must take control of insolvent banks, however large, and get on with the business of reorganizing, re-regulating, decapitating, and recapitalizing them. Depositors should be insured fully to prevent runs, and private risk capital (common and preferred equity and subordinated debt) should take the first loss. Effective compensation limits should be enforced—it is a good thing that they will encourage those at the top to retire. As Senator Christopher Dodd of Connecticut correctly stated in the brouhaha following the discovery that Senate Democrats had put tough limits into the recovery bill, there are many competent replacements for those who leave.
Ultimately the big banks can be resold as smaller private institutions, run on a scale that permits prudent credit assessment and risk management by people close enough to their client communities to foster an effective revival, among other things, of household credit and of independent small business—another lost hallmark of the 1950s. No one should imagine that the swaggering, bank-driven world of high finance and credit bubbles should be made to reappear. Big banks should be run largely by men and women with the long-term perspective, outlook, and temperament of middle managers, and not by the transient, self-regarding plutocrats who run them now.
The chorus of deficit hawks and entitlement reformers are certain to regard this program with horror. What about the deficit? What about the debt? These questions are unavoidable, so let’s answer them. First, the deficit and the public debt of the U.S. government can, should, must, and will increase in this crisis. They will increase whether the government acts or not. The choice is between an active program, running up debt while creating jobs and rebuilding America, or a passive program, running up debt because revenues collapse, because the population has to be maintained on the dole, and because the Treasury wishes, for no constructive reason, to rescue the big bankers and make them whole.
Second, so long as the economy is placed on a path to recovery, even a massive increase in public debt poses no risk that the U.S. government will find itself in the sort of situation known to Argentines and Indonesians. Why not? Because the rest of the world recognizes that the United States performs certain indispensable functions, including acting as the lynchpin of collective security and a principal source of new science and technology. So long as we meet those responsibilities, the rest of the world is likely to want to hold our debts.
Third, in the debt deflation, liquidity trap, and global crisis we are in, there is no risk of even a massive program generating inflation or higher long-term interest rates. That much is obvious from current financial conditions: interest rates on long-maturity Treasury bonds are amazingly low. Those rates also tell you that the markets are not worried about financing Social Security or Medicare. They are more worried, as I am, that the larger economic outlook will remain very bleak for a long time.
Finally, there is the big problem: How to recapitalize the household sector? How to restore the security and prosperity they’ve lost? How to build the productive economy for the next generation? Is there anything today that we might do that can compare with the transformation of World War II? Almost surely, there is not: World War II doubled production in five years.
Today the largest problems we face are energy security and climate change—massive issues because energy underpins everything we do, and because climate change threatens the survival of civilization. And here, obviously, we need a comprehensive national effort. Such a thing, if done right, combining planning and markets, could add 5 or even 10 percent of GDP to net investment. That’s not the scale of wartime mobilization. But it probably could return the country to full employment and keep it there, for years.
Moreover, the work does resemble wartime mobilization in important financial respects. Weatherization, conservation, mass transit, renewable power, and the smart grid are public investments. As with the armaments in World War II, work on them would generate incomes not matched by the new production of consumer goods. If handled carefully—say, with a new program of deferred claims to future purchasing power like war bonds—the incomes earned by dealing with oil security and climate change have the potential to become a foundation of restored financial wealth for the middle class.
This cannot be made to happen over just three years, as we did in 1942–44. But we could manage it over, say, twenty years or a bit longer. What is required are careful, sustained planning, consistent policy, and the recognition now that there are no quick fixes, no easy return to "normal," no going back to a world run by bankers—and no alternative to taking the long view.
A paradox of the long view is that the time to embrace it is right now. We need to start down that path before disastrous policy errors, including fatal banker bailouts and cuts in Social Security and Medicare, are put into effect. It is therefore especially important that thought and learning move quickly. Does the Geithner team, forged and trained in normal times, have the range and the flexibility required? If not, everything finally will depend, as it did with Roosevelt, on the imagination and character of President Obama.
Tuesday, July 20, 2010
Double Dip Week: Calculated Risk
Double Dip Discussion
Calculated Risk
July 17, 2010
The frequency of "double dip" searches keeps increasing, see Google Trends ...
Paul Krugman writes: De Facto Double Dips
And from Nouriel Roubini: Double-Dip Days
Some day growth will pickup again. The debt problems will be with us for some time, but one of the keys for more growth is absorption of excess capacity. New investment is already happening for semiconductor manufacturing (see AMAT and other semi-equipment manufactures, and the WSJ Applied Materials Boosts Revenue Forecast)
But there is too much capacity in most of the economy. We see this in housing (the good news is there will be a record low number of new housing units delivered this year), and in overall industrial capacity utilization. As an example, domestic auto production is still about 25% below the level of 2006 - so there is no need to expand production. There is also excess capacity in office space, retail space, and other categories of commercial real estate.
The U.S. population is still growing, new households are being formed, and eventually this excess capacity will be absorbed. Until then the recovery will be sluggish and choppy (at best) ... and there are still the debt issues.
As Nouriel wrote: "Fasten your seat belts for a very bumpy ride."
Calculated Risk
July 17, 2010
The frequency of "double dip" searches keeps increasing, see Google Trends ...
Paul Krugman writes: De Facto Double Dips
Let’s be clear: a recovery that involves growth so slow that unemployment and excess capacity rise, not fall, isn’t really a recovery. If we have only have 1 1/2 percent growth, that will amount to a double dip in all the senses that matter.I've been focused on a technical double dip (see Recession Dating and a "Double Dip"), but I agree with Krugman that a further slowdown - following the below trend first half of 2010 - will definitely feel like a recession - and it will probably lead to an unemployment rate "double dip".
And from Nouriel Roubini: Double-Dip Days
The global economy, artificially boosted since the recession of 2008-2009 by massive monetary and fiscal stimulus and financial bailouts, is headed towards a sharp slowdown this year as the effect of these measures wanes.The 2nd half slowdown is here. I still think we will avoid a technical double-dip recession, but it will probably feel like one.
...
At best, we face a protracted period of anemic, below-trend growth in advanced economies as deleveraging by households, financial institutions, and governments starts to feed through to consumption and investment.
...
The global slowdown – already evident in second-quarter data for 2010 – will accelerate in the second half of the year. ... The likely scenario for advanced economies is a mediocre U-shaped recovery, even if we avoid a W-shaped double dip. In the US, annual growth was already below trend in the first half of 2010 (2.7% in the first quarter and estimated at a mediocre 2.2% in April-June). Growth is set to slow further, to 1.5% in the second half of this year and into 2011.
...
Fasten your seat belts for a very bumpy ride.
Some day growth will pickup again. The debt problems will be with us for some time, but one of the keys for more growth is absorption of excess capacity. New investment is already happening for semiconductor manufacturing (see AMAT and other semi-equipment manufactures, and the WSJ Applied Materials Boosts Revenue Forecast)
But there is too much capacity in most of the economy. We see this in housing (the good news is there will be a record low number of new housing units delivered this year), and in overall industrial capacity utilization. As an example, domestic auto production is still about 25% below the level of 2006 - so there is no need to expand production. There is also excess capacity in office space, retail space, and other categories of commercial real estate.
The U.S. population is still growing, new households are being formed, and eventually this excess capacity will be absorbed. Until then the recovery will be sluggish and choppy (at best) ... and there are still the debt issues.
As Nouriel wrote: "Fasten your seat belts for a very bumpy ride."
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