January 29, 2009

More On Economics

Filed under: Politics — Bob Gifford @ 11:24 pm

In my last post I glossed over some important fine points of economics. Admittedly, I was recounting what I had told my son, and I did not get into any of these details with him. But some of these nuances are very relevant to the current debate on the stimulus bill. Hence, lest anyone think I’m just painfully ignorant of some of the complexities of economics, I will address them here.

First is the value of monetary policy. Hard-core Keynesians believed they had the keys to the kingdom back in the 60s and 70s. We all learned beginning in the 80s that monetary policy is perhaps more important than fiscal policy to the successful management of the economy. The distressing fact, though, is that monetary policy has run out of juice in our current financial crisis. Interest rates are about as low as they can go, and we are still seeing a massive contraction. We need another dial to turn besides interest rates if we are to turn around the current economy. That’s why everyone has discovered Keynes all over again.

Secondly, as Megan McCardle points out:

Though you wouldn’t think it from the really quite shocking incivility emanating from the pro-stimulus side, the empirical evidence that this [fiscal stimulus] works in a large industrial economy like ours is basically nonexistent. The problem is, we have very, very few examples to test on: America during the Great Depression, and Japan in the 1990s. And neither America nor Japan managed to stimulate their way out of their troubles. You can argue–and many do–that this is because we, and they, didn’t stimulate enough. That may be true. But unless you can forward test your theory, it’s a just so story . . . as we just painfully found out about the “It was all the Fed’s fault” narrative of the 1930s banking collapse. There is no excuse for calling people who question your highly theoretical model fools and charlatans.

I am not nearly as dismissive of the empirical evidence for fiscal stimulus as McCardle is, but it’s been almost 30 years since I took macroeconomics in business school. I would much rather leave teasing apart the data on this to the professionals.

Speaking of professionals, President Obama has some pretty damn smart ones working for him. The consensus of economists both within and without his administration seems to be that we need a good Keynesian fiscal stimulus, putting forward the argument I make in my previous post. So I appreciate and respect the nay-sayers like McCardle, Mankiw and others, but for now I’m rooting for Obama and the Dems. We elected them to solve this mess, and they are on the hook. We gave the Repubs a shot, and they ran us into a ditch. Let’s hope the Dems can get us out of it. And if Keynesian stimulus is the tool they choose to do it with, God bless ’em.

January 28, 2009

Economics a 15 Year-Old Can Understand

Filed under: Politics — Bob Gifford @ 10:52 pm

My younger son was asking me about the stimulus package, the criticism of it, and what I thought. I walked him through some basic economics and explained what kind of stimulus we need and why. Nothing I said was profound, or innovative, or insightful. It was very basic. But I can’t help wondering how many bloggers, television commentators, and even politicians know this much. Listening to the conservative critiques of the stimulus bill, it would seem not many. So herewith, the explanation I gave to my 15 year old son.

In the 19th century the US went through a regular series of panics. Demand, for whatever reason, would dip, so production would slow and workers would be laid off. This caused everyone to start saving more and spending less, either because they were unemployed or worried they soon would be. Lower spending meant decreased demand, which lowered production, caused more workers to be laid off, and the cycle continued spiraling down.

The same thing happened in the Depression, triggered in that case by the collapse of a stock market bubble, which froze credit and caused banks to fail. People lost their savings, so they stopped spending, which lowered demand, which slowed production, put people out of work, and we were into the same old vicious cycle, but on steroids.

This is eerily similar to what we are seeing today, except that our bubble is in housing prices and investments backed by home mortgages.

Mainstream economists, following Keynes, understand that something has to break this cycle to stop a recession from becoming a depression. So the spender of last resort is the government, the one entity able to borrow lots of money and with incentives to do something to benefit the economy as a whole. Paraphrasing Lincoln, government allows us to do together what none of us can do individually. During a recession, the government spends more than it takes in, which compensates for the drop in consumer spending, prevents production from dropping and workers from being laid off, and thereby stops the vicious cycle. This is the classic Keynsian stimulus.

Cutting taxes doesn’t have the same affect as increasing spending. If you cut personal taxes, you put more money in the pockets of consumers, but in the middle of a recession they will likely save most or all of the tax cut, and hence not increase demand. Similarly, cutting business taxes puts more money in business owners’ hands, but if no one is buying, businesses can’t spend that money to expand, increase production, and hire workers.

What we need is spending, and 100% of government spending gets, well, spent.

If the government is going to spend more to stimulate the economy, then it should spend money on things that are worthwhile. Since we’re in a recession, it would be even better if government spent money on things that would boost productivity, which in the long term increases economic growth. Infrastructure. During the Depression it was dams, water projects and power lines. Today it’s much of the same, plus things like electronic medical records and high-speed rail.

But then the government debt is increasing, and that’s bad, right? Of course. During good times we should be paying down the debt, saving up for a rainy day when the government needs to engage in deficit spending. Unfortunately, Bush magically turned a budget surplus into a deficit. Instead of saving for a rainy day, we’ve been running up more debt. But now we have no choice — we are in a deep recession, and have to deficit spend to keep it from getting a lot worse. Once the economy turns around, we need to go back to fiscal responsibility — running surpluses in good times to make up for deficits in bad times.

So this is why all the mainstream economists agree on the shape of the stimulus bill. Which isn’t to say that the political process isn’t throwing some garbage into the bill. We need to hold Congress accountable for focusing spending on things we really need and that will stimulate the economy. But for the most part, the need for a bill and its general outlines are not in doubt.

Except by, apparently, Republicans.

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