Tuesday, July 27, 2010

Yeah, We Needed Just a Few Trillion More Dollars of "Stimulus"

I had no idea that Ezra Klein is a brilliant economist, but apparently he agrees with Paul Krugman, so he needs no more qualifications. Granted, he had his flash of brilliance more than a year after Krugman's epiphany, but nonetheless he still is brilliant.

Klein's "insight" is that the government did not spend enough money this past year. Krugman, on the other hand, said last year that the "stimulus" was not generous enough and would fail to stem the economic downturn. Here is Klein:
The original stimulus package should've been bigger. Rep. David Obey, chairman of the House Appropriations Committee, says the Treasury Department originally asked for $1.4 trillion. Sen. Kent Conrad, chairman of the Senate Budget Committee, wanted $1.2 trillion. What we got was a shade under $800 billion, and something more like $700 billion when you took out the AMT patch that was jammed into the package. So we knew it was too small then, and the recession it was designed to fight turned out to be larger than we'd predicted. In the end, we took a soapbox racer to a go-kart track and then realized we were competing against actual cars.

This was a mistake, of course. But the mistake may not just have been the size of the stimulus package. I wonder if it wasn't fed by a belief that there'd be other chances. If all we needed was the $700 billion package, then great. But if unemployment remained high and the recovery had trouble taking hold, surely there would be the votes for further stimulus and relief spending. No one in the political system could possibly look at 10 percent unemployment and walk away from it, right?

Wrong. Ten percent unemployment and a terrible recession ended up discrediting the people trying to do more for the economy, as their previous intervention was deemed a failure. That, in turn, empowered the people attempting to do less for the economy. So rather than a modestly sized stimulus leaving the door open for more stimulus if needed, its modest size was used to discredit the idea of more stimulus when it became needed.
So, for lack of an extra $400 billion, all we got was this lousy depression. Krugman last year declared:
...many economists, myself included, actually argued that the plan was too small and too cautious. The latest data confirm those worries — and suggest that the Obama administration’s economic policies are already falling behind the curve.

To see how bad the numbers are, consider this: The administration’s budget proposals, released less than two weeks ago, assumed an average unemployment rate of 8.1 percent for the whole of this year. In reality, unemployment hit that level in February — and it’s rising fast.
So, if I am to interpret this stuff correctly, had Obama had Tim Geithner sell just another $400 billion of Treasuries to the world, the economy would have gained "traction" (Krugman's favorite term) and we would be bouncing toward recovery as we speak.

Sorry, folks, that dog won't hunt. The problem was not that we spent too little; the problem was that the government refuses to understand that credit-fed booms are unsustainable and that this Keynesian "hair of the dog" strategy (in which we don't take just a little whiskey, but drink an entire case) is doomed to failure.

Ironically, in the name of "avoiding the mistakes of the 1930s," our government is taking us down the same path that Hoover and FDR took us. Happy Unemployment, America.

7 comments:

Jonathan M. F. Catalán said...

Professor Anderson,

I think we would have all been better off had the Obama administration gathered a group of New Keynesians - Krugman, Stiglitz, Klein, et. al. - and and allowed them to come up with a concrete figure for the amount of stimulus they thought would be necessary to bring about a recovery (and, I'm sure such a figure could be calculated, starting from knowing more or less the amount of GDP the current output gap represents; I'm sure this figure would be not much better than some type of estimate, but alas this is to humor the Keynesians).

So, this new figure represents the stimulus package. The Obama administration would shovel it out according to a time table devised by these same economists, so that the stimulus could have the greatest effect as per Keynesian theory.

We can test the validity of Keynesian theory in this fashion. I'm sure they would come up with some excuse if it wouldn't work, but at least they would suffer from grave embarrassment and maybe we could shut them out of the mainstream in this form.

With $700 billion down the gutter, what's another $400 billion (although, maybe now, they might claim that the $700 billion were wasted, so we need an all new and complete stimulus package).

Nevertheless, given the mismatch between actual fact and the numbers the Obama administration were producing (the without and with stimulus figures), I think that team of economists should prob. work a little on their accuracy.

AP Lerner said...

“So, if I am to interpret this stuff correctly, had Obama had Tim Geithner sell just another $400 billion of Treasuries to the world, the economy would have gained "traction"”

Not surprising, you are interpreting incorrectly. Krugman actually suggested in early 2009 a spending program that matched the output gap, which was estimated to be roughly $2T. You may not have realized this, but 40% of the stimulus was tax cuts, not spending. So no, it is absolutely false to say “Tim Geithner sell just another $400 billion of Treasuries to the world, the economy would have gained "traction"”. This is not what Krugman said. And not what Krugman implied. Never. He said it was too small from day one, and not enough spending. Now, it’s pretty clear you don’t truly understand a Keynsians stimulus, which is fine, but if you are going to attempt to criticize Krugman, it would helpful to get the facts straight first, and then figure out the analysis.

And I will not even comment on the selling treasuries comment, since it’s clear you do not understand the monetary system of the US, and do not realize treasuries are not ‘sold to the world’. The ‘world’ does not ‘fund’ the US government.

“the problem was that the government refuses to understand that credit-fed booms are unsustainable”

This is sort of accurate. But not really. You see, in the world we live in, public deficits always equal private savings. Always. This is not ideology. It’s the tyranny of arithmetic. Kind of like 2+2=4. Because this always holds, the public sector must run deficits if we are going to allow the public sector to further net save and de-lever, and the private sector MUST de-lever. The reality is, both the public sector and the private sector can not de-lever. Why is this concept so difficult to understand? This has nothing to do with “Keynesian "hair of the dog"”. This has to do with reality. They tyranny of arithmetic. So yes, its true, the government does not understand that credit fed booms are unsustainable. Otherwise, the deficit fear mongers would be ignored (as they should be). But it’s also pretty clear you do not understand how a credit fed booms must be remedied.

SirThinkALot said...

If the failure of the stimulous actually helps prevent further actions we might have reason to hope....

However I think more likely is that old adage 'When a government enterprise fails...its expanded.'

Bob Roddis said...

The reason that it is hard to understand what Keynesians are saying is because Keynesianism makes no sense whatsoever and is totally without any evidentiary, logical or historical basis. Keynesians employ the unintelligibility of their hoax to intimidate skeptics with the charge that the skeptics just aren’t very smart and that Keynesian economics is some hyper-complex counter-intuitive paradoxical form of quantum physics. Instead, it’s merely a load of crap.

The fact that “public deficits always equal private savings” is nothing but an accounting identify. The government owes the debt to someone on the other side of the ledger. But it is not algebra and is no indication of any cause and effect.

Because this always holds, the public sector must run deficits if we are going to allow the public sector to further net save and de-lever, and the private sector MUST de-lever. The reality is, both the public sector and the private sector can not de-lever. Why is this concept so difficult to understand?

Everything about that statement is difficult to understand because it is without any evidentiary, logical or historical basis. To cure the price and capital structure discoordination caused by the previous Keynesian money dilution, all that must be done is nothing. Prices must be allowed to reconfigure to what living-breathing human beings can and will pay for goods and services. People need to SAVE MORE to replenish the stock of savings, not purchase government debt. Government debt merely steals assets away from productive use by people and impedes the process of recovery. (Austrians are quite familiar with Keynesians’ phony attempts to employ accounting identities as the equivalent of physics formulae.)

This Austrian explanation is no different than what everyone normally experiences in business or with their family finances. The phony Keynesian hyper-complex counter-intuitive paradoxical form of quantum physics nonsense is finally being revealed for what it is: THE CAUSE OF OUR ECONOMIC PROBLEMS.

Finally, having read many of his excellent articles such as this one, I’ll vouch for the fact that Mr. Catalan understands “Keynesian stimulus”.

Jonathan M. F. Catalán said...

I think that AP Lerner is incorrect, even within the Keynesian framework. Even if government deficits add to private savings (in the form of holding t-bills), the fact is that one of the problems is an increase in saving (increase in the demand for money) without an increase in investment (i.e. the liquidity trap).

As such, I'm not sure why there is so much emphasis on the idea that more deficits will increase savings. While true, the problem does not lie around savings, as if there is an increase in demand for money there was already an increase in savings.

What deficit spending does is attempt to bring savings and investment back into equilibrium, through government spending.

Jonathan M. F. Catalán said...

To clarify,

Imagine that society's demand for money has increased to a value we will call X.

Now, imagine that government deficits increase. We will call the size of that deficit Y.

It does not hold that net savings are now X + Y, as some of that Y may have come from held money. Government debt represents a substitute for money. Usually, money and debt are not perfect substitutes, because money is less risky, but there is presumably no risk in holding government debt.

AP Lerner said...

Hi Jonathan M. F. Catalán – I think some of the confusion may be in the way I have used the term private savings. When I refer to public deficits = net private savings, I am referring to the financial balances in the two primary sectors of the economy. I am referring to a very simplified (too simplified) version of financial balances. If you frame it this way, it may be a bit clearer:

Household Financial Balance + Business Financial Balance +Government Financial Balance +External Financial Balance = 0

Where net private = households+business+external.

Graphically, it looks like this:

http://images.creditwritedowns.com/2010/01/financial-sector-balances.png

This is how financial balances flow through the economy. By working in this framework, it becomes apparent that in order for one sector of the economy to move from deficit to surplus, something else must give. Every sector cannot run a surplus simultaneously. Impossible. Arithmetic just doesn’t allow it. At the end of the day, the financial balances must sum to zero.

So why does any of this matter? Because Prof. Anderson and other Austrians would have you believe the US government is on the verge of bankruptcy unless we start cutting the public deficit now, now, now. But what’s clear is if the public deficit is cut aggressively, then all this does is pull much needed surpluses from the private sector. Surpluses that are in very high demand so the private sector can de-lever. When you look at financial balances in this framework (often referred to as MMT – modern money theory, although there is nothing modern about this..it’s been around forever) it should become pretty obvious that a move towards fiscal austerity will only steal surpluses from households, preventing the much needed deleveraging. In this context, Krugman is 100% correct – the deficit must be maintained to allow the private sector to de-lever. He may be wrong about the composition of the deficit, but he is 100% correct about the need to run a public deficit.

Think about two things. 1) why are yields on government securities so low despite massive ‘borrowing’ and printing? According to Austrians, rates should be through the moon, but those that follow Austrian ideology generally don’t understand how the monetary system works and assume there is credit risk associated with US government securities. This is incorrect. And anyone that tells you government securities crowd out other investment are still working in a gold standard framework and don't understand the monetary system of the US

2) Do you think it’s a coincidence that when the public sector cut it’s deficit and started generating a surplus in the late 90’s that a massive credit bubble formed the following decade?

“I'm not sure why there is so much emphasis on the idea that more deficits will increase savings”

Not savings as you are thinking in a savings/investment context. My guess is you are thinking in a Y=C+I+G+X frameork, and not the financial balances noted above. Deficits add to private financial balances. Surpluses. Savings is not the appropriate term. My apologies.

“What deficit spending does is attempt to bring savings and investment back into equilibrium”

It is incorrect to assume savings are required for investment.

“Usually, money and debt are not perfect substitutes, because money is less risky, but there is presumably no risk in holding government debt.”

Right. Again, Prof. Anderson and others have forgotten we are no longer on the gold standard, and the US is a monopoly issuer of a non convertible, free floating currency. Thus, US government securities represent zero credit risk. Inflation is the risk to holder of US government securities, not solvency. Many on this blog will go on and on about the horrors of deficit spending and claim hyperinflation is right around the corner. The claims are baseless, lack support, and represent an incorrect understanding of our monetary system.