September 2009 Archives
09/27/09 5:56 PM
The Psychology of Stimulus
Anyone who still thinks that stimulus expenditures in the second quarter of this year increased GDP or employment would do well to read John F. Cogan, John B. Taylor, and Volker Wieland, "The Stimulus Didn't Work," in the September 17 issue of the Wall Street Journal. They note that, consistent with theory, the transfer payments (the major component of the stimulus that was actually executed in the second quarter) appear not to have resulted in any measurable increase in personal consumption expenditures, as they constituted transitory income and therefore were largely saved; and that the modest stimulus spending on investment in that quarter probably had no effect. Rather, they attribute the reduction in the rate of decline of GDP in the second quarter to military spending unrelated to the stimulus and to a decline in the rate at which business investment was declining that began in January, before the enactment of the stimulus law in February.
Their argument, if understood as I think the authors intended it to be understood as a root-and-branch criticism of Keynesian deficit spending as an anti-depression weapon, is not as compelling as it may appear to be. The fact that personal consumption expenditures didn't increase after the stimulus program was enacted is inconclusive, because, had it not been for the transfers, they might have fallen (though as I have emphasized in previous blog entries the initial stimulus spending was so limited that it is doubtful that it could have had much effect on consumer expenditures). The fact that the increase in military spending was unrelated to the stimulus law doesn't mean it wasn't an effective form of stimulus. And the fact that the rate of decline in business investment slowed in January may have been in anticipation of the stimulus, as it was certain by then that there would be a stimulus program.
The narrow criticism of the Administration's touting the successes of the stimulus program is that it emphasizes actual expenditures, which have been as yet (and certainly during the second quarter, when the rate of decline of GDP fell markedly) both modest and heavily weighted to transfers; and that criticism, which I have emphasized in my blog entries, I continue to believe is sound. The program may, however, still have had an important positive effect on business and consumer psychology. Economists both left and right systematically neglect the psychological dimensions of a depression, properly emphasized by Keynes.
An exception, however is Daniel Indiviglio, who is not an academic economist, and who in his blog entry argues that:
"Perhaps knowing that the government was throwing $787 billion at the economy in order try to reduce the pain of the recession helped the sentiment of business as well. Maybe businesses decided that the economy can't possibly continue to suffer given such extraordinary government intervention, so built more plants, ordered more equipment and ramped up inventories in the hopes of imminent recovery built on that government action."
In the same vein, with regard to the transfer payments, he argues that the "money must be going somewhere, so where is it going? Maybe it's being used to pay down debt; maybe it's being used for investment; or maybe it's just being saved. I would argue that, though not consumption, those are still actions that ultimately help a stumbling economy get a little healthier. Having more money in your pocket certainly makes you feel better, and consumer sentiment matters a lot during a recession, even if that doesn't translate to immediate consumption. Maybe people would have saved even more and spent even less without the payments, for example."
Those are excellent points.
09/20/09 8:06 PM
Financial Regulatory Reform: The Politics of Denial
Two bad recent signs concerning the movement to reform financial regulation: The first is the first public meeting of the Financial Crisis Inquiry Commission, created by Congress four months ago to investigate the causes of the financial crisis and report back at the end of next year. The commission has gotten off to a slow start, and even though only one member of the commission could (I believe, though I am not certain, and welcome correction) be described as a professional economist (Keith Hennessey), and even he is more a political operative, the commission has appointed as its executive director not an economist but a lawyer--a prosecutor in the California attorney general's office. And at its first public meeting members of the commission made statements which suggest that they will divide along the predictable political lines (six of the members are Democrats, four Republicans).
One can hope; but it seems unlikely that the commission will do a good job. It will look for crooks and frauds rather than for underlying causes, unless an underlying cause can be pinned to the tail of the politically party to which the pinner does not belong.
Meanwhile the Administration and the Fed plow ahead with their own programs of regulatory reform, without waiting for the commission's report--which may indicate how the commission is regarded by the government's economic leaders. The latest proposal, this one from inside the Fed, is that the Fed should issue regulations empowering it to regulate the compensation practices of all banks that belong to the Federal Reserve System and thus are under the Fed's regulatory aegis--and not just the compensation of senior executives but of all bank executives. The proposal goes beyond the Treasury Department's June 17 white paper, which proposed regulation of compensation only of executives of "Tier 1 Financial Holding Companies," which is to say the handful of major banks and other major financial institutions whose failure might trigger a general collapse of the financial system. The Fed proposal is more ambitious--and highly dubious. Where will the Fed find staff for such regulatory oversight? What is the need to regulate the compensation practices of small banks? And given Lucian Bebchuk's sensible suggestion (about which I have blogged) that if senior executives are compelled to be compensated in ways that would penalize them if their company got into trouble and needed a bailout they will be motivated to prevent their subordinates from taking risks that might trigger such consequences, why does the Fed think it has to reach down and review the methods by which banks compensate traders, loan officers, and other non-senior executives? Why can't that be left to properly incentivized senior management?
It seems that the Fed, and the government more broadly (including Congress), is in the psychological state known as "denial." Or that it is behaving like the drunk who, criticized for looking for his lost change under a lamppost far from where he had dropped it, explained that he was looking for it there because the light was better. Congress, and much of the public and media, can understand the financial crisis only in populist terms, as the product of the machinations of greedy, reckless, overpaid, perhaps criminal denizens of "Wall Street." Systemic causes of the financial crisis, such as unsound monetary policy, deregulation, lax regulation, regulators asleep at the switch, unsound economic theories, complacency, quirks of the tax code, deficits, Chinese trade policy, mindless governmental promotion of home ownership, and so forth, are beyond them. The government is willing to play to the ignorant partly because in a democracy popular views must always be treated deferentially; partly because (in all likelihood) it doesn't think that the people, the Congress, and the media (except for the most sophisticated financial journalists) can understand a serious economic analysis; and partly because the populist account conveniently deflects attention from the failures in which the current economic leaders of the nation were complicit in the run up to the crisis--unsound trade policy, excessive financial deregulation, lax regulation, complacency, lack of foresight, lack of contingency planning.
Of course if the officials who screwed up said they'd screwed up, the people and the Congress would be reluctant to entrust them with responsibility for redesigning the regulatory system. So they must find scapegoats, and where better than on "Wall Street"?
(Photo: Flickr User eflon)
09/16/09 4:04 PM
The Politics of Taking Credit
One can imagine, though with difficulty, an Administration spokesman explaining the nation's recent economic history as follows:
"Because of serious errors of monetary policy, excessive deregulation of the banking industry, a belief there would never be another depression, a failure to understand the full significance of the bursting of the housing bubble, and mistakes in responding to the financial collapse of last September (such as allowing Lehman Brothers to collapse and thinking the banks' problem was one merely of liquidity, rather than of solvency) by the troika that managed U.S. economic policy in the final two years of the Bush presidency--Ben Bernanke, Timothy Geithner, and Hank Paulson--the economy took a disastrous dive.
"Still, by the end of October, the members of the troika had regained their composure and taken a series of measures that avoided a complete collapse of the banking industry and a liquidation of General Motors and Chrysler.
"When the new Administration took office in January, the troika remained in charge of economic policy but with the substitution of Lawrence Summers for Paulson. Economic policy since then has been largely continuous with the policy of the previous Administration, not surprisingly given the continuity of the economic leadership. The stress tests and other measures relating to the financial sector taken by the new Administration would undoubtedly have been undertaken by the previous one had its time in office not expired. Even a large stimulus program might well have been launched by the previous Administration, despite vociferous Republican opposition to the program when it was proposed by a Democratic President and Congress. That opposition reminds me of the dog who barks ferociously at passersby when he is behind a fence, but take away the fence and he quickly becomes quiet. When the stimulus program was proposed, the economy was in dire straits and the bank bailouts and related measures focused on the financial sector (such as pushing down the federal funds rate almost to zero) had not arrested the decline. And it's not as if the Bush Administration had been averse to spending and deficits.
"On the whole the measures taken by the two Administrations have probably contributed to the bottoming out of the economic downturn, though it is impossible to measure their impact relative to the impact of natural economic forces, such as the depletion of inventories, the modest expansion in exports, the wearing out of some durable goods, and falling prices, which have lured timid consumers out of their burrows. It is impossible to separate out the effects of the different recovery measures or determine which Administration did more to save the economy--a meaningless question since it is uncertain whether either Administration did anything important that the other would not have done."
But this of course is not how politicians speak. President Obama in his speech of September 14 on the economic crisis acknowledged that "Congress and the previous administration took necessary action in the days and months that followed. Nevertheless, when this administration walked thorugh the door in January, the situation remained urgent." And so "this administration...moved quickly on all fronts, initializing a financial stability plan to rescue the system." (I assume "initializing" is a misprint for "initiating.") The implication is that, the previous Administration having failed to stop the rot, the new Administration had to move quickly to create a financial stability plan. In fact all the new Administration did, apart from the stimulus and an ambitious but not terribly successful mortgage-relief plan, was to continue the policies of the previous Administration.
The speech goes on to describe the recovery program, and while acknowledging that "the work of recovery continues" states that"we can be confident that the storms of the past two years are beginning to break." The implication is that they are beginning to break because of the Administration's recovery program, but actually they are beginning to break as the result of the natural recuperative strengths of the economy plus the combined efforts of successive administrations.
The speech then turns to the causes of the economic crisis, and naturally there is nothing there about failures of government policy, in which Bernanke and to a lesser extent Geithner and Summers were implicated. Such an acknowledgment would strike a discordant note, and not only because the President has announced that he is reappointing Bernanke as chairman of the Federal Reserve and because Geithner is his Secretary of the Treasury (not only held over, but promoted from his job as president of the Federal Reserve Bank of New York.) The Administration wants to enlarge the powers of the Fed, yet the Fed under Alan Greenspan was a major cause of the economic crisis because of its bubble-blowing monetary policy, and the Fed under Bernanke failed to detect or arrest the crisis until it was almost too late; acknowledgment of these errors would raise questions about the appropriateness of rewarding the Fed for its failures by giving it enhanced powers.
Blame has to fall somewhere so in the President's speech it falls on the "reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kill and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall." But of course American taxpayers will be there next time to break their fall, because according to Bernanke the bank bailouts were necessary to avert a second Great Depression and will be necessary to do the same thing the next time we're in the same fix. And nobody in a position of authority on "Wall Street" takes risks without regard for consequences. The problem is that they do not have regard for consequences for the economy as a whole, because that is not the business of business. That is the business of government. But rich people are the natural scapegoats for economic distress.
The rest of the speech is a summary of the Administration's program of financial regulatory reform, announced in the Treasury report of June 17. One thing that is new, however, is a confusing discussion of "resolution" authority. The term refers to the streamlined bankruptcy process that the Federal Deposit Insurance Corporation uses on insolvent commercial banks and thrifts. The big "nonbank banks" like Lehman Brothers that got into such serious trouble last year were not commercial banks, so that when the government refused to save Lehman Brothers it had to declare bankruptcy. Since its assets were scattered all over the world, it found itself in separate bankruptcy proceedings in different countries, causing severe problems of coordination that have yet to be overcome.
That is a pity, but the suggestion in the speech that if only there had been authority to "resolve" the insolvency of the nonbank banks the taxpayer would have been spared having to bail them out doesn't make sense. Especially with regard to Lehman, because it received no taxpayer money. But it also doesn't make sense with regard to the nonbank banks that did receive bailouts. Broke is broke, whatever the mechanics of liquidation or reorganization; and if you don't want to have an insolvent banking system you have to bail out the broke banks. No one thinks bankruptcy a bad way to "resolve" a bankrupt auto manufacturer; the bankruptcies of GM and Chrysler were orderly and prompt--yet the government still poured in tens of billions of dollars to save them from liquidation.
Moreover, whatever changes we make in our procedures for winding up a bankrupt financial institution will not deprive foreign countries of control over the assets of such an institution that are located in foreign countries.
Another curious novelty in the speech (I think it's a novelty) is the suggestion that bonuses for senior executives should be subjected to a vote by the company's shareholders. What would that do? Probably the senior executives would substitute higher salary, more stock options, bigger severance packages, and other forms of compensation, for bonuses. And that would prevent the next financial crisis?
09/09/09 3:14 PM
The Politics and the Economics of Stimulus
My lefty critics don't believe me when I say I support the stimulus. But I do, and I advocated it in my book A Failure of Capitalism, completed before the stimulus was enacted. I am a Keynesian, and I have sharply criticized conservative economists who oppose Keynesian deficit spending. I simply do not believe that it is possible to attribute the improvement in the economy to the actual spending of stimulus money through the end of the second quarter, because I believe the actual spending was small and that the significance of the stimulus program is more psychological than (as yet) economic.
I attribute Christina Romer's August 6 speech, and Vice President Biden's speech of September 3 on the first 200 days of the stimulus program, to the political imperative of shorting up public support for the stimulus. Oddly, the program is unpopular, and not only among Republicans. The reason for its unpopularity I believe is the Administration's health care plan. The unfunded and probably unfundable cost of the plan has riveted public attention on the nation's huge deficits. $787 billion in deficit spending obviously adds a lot to the deficit. The stimulus program probably should have been adopted last fall rather than in February of this year, and expedited more vigorously than it has been. Romer has warned in her academic writing (which incidentally I admire) that Keynesian measures for spurring recovery from an economic downturn tend not to be implemented until the downturn has reached its bottom and thus they risk overheating the economy by adding public demand when private demand is again growing. This should worry Romer, although because of the continuing credit crunch, continued stimulus expenditures may not in fact overheat the economy. In the postwar recessions that she discusses (particularly in a 1994 article with David Romer in the NBER Macroeconomics Annual), fiscal recovery measures came on top of monetary measures, namely reducing interest rates. When a nation's banking system is in bad shape, monetary measures lose much of their efficacy. The Federal Reserve has pushed interest rates way down, without stimulating much lending. The economy may well have considerable slack for months or even years to come, in which event stimulus expenditures will not cause inflation.
My criticisms of Christina Romer's August 6 speech (most recently in my blog posting of August 25) continue to draw criticism, most recently (as far as I know) from the economist Menzie D. Chinn, in an August 27 posting on Econbrowser--an excellent blog. Professor Chinn makes a series of criticisms of my argument, starting with saying I have "given up on accusing Dr. Romer of lying about the $40 billion figure." The reference is to her estimate of the tax benefits authorized by the stimulus bill that were granted by the end of the second quarter of this year (June 30). I never accused her of lying about the figure; I do not even question the figure. My point was the difference between authorizing or disbursing money and spending it. No one seems to know how much of the $40 billion was actually received by taxpayers, as opposed to reducing their future tax payments; and of the amount actually received by them, no one seems to know how much they spent rather than saved. These distinctions have eluded Professor Chinn, though I had emphasized them in my August 25 blog posting--the target of his criticisms. He seems to think that it is possible that all the $40 billion took the form of rebates, but as far as I know none of it did. A rebate would be a check to the taxpayer, as distinct from a tax credit. Bush's spring 2008 stimulus package consisted entirely of tax rebates; the Obama stimulus does not.
Professor Chinn says that even if none of the $40 billion in tax relief was actually spent by recipients of the relief in the second quarter, the remaining $60 billion of Romer's "more than $100 billion" was ample to increase GDP that quarter by two percent. But that assumes that all of the $60 billion was spent, and no one seems to know how much was; Chinn assumes it all was, which is false. A neglected point is brought out in an article by Michael Cooper in the September 5 New York Times. The article points out that federal stimulus spending can be nullified by state cutbacks. For example, a federal grant of stimulus money for mass transit has been nullified by reductions in state expenditures on mass transit. The question then becomes what was the consequence of those reductions? Maybe they enabled a state to rescind a tax increase, in which event state taxpayers would have more money in their pockets. And then the questions would be: how long does this process take, and how much of the additional money do the taxpayers spend rather than save?
Photo Credit: Flickr User Tony the Misfit
Richard A. Posner
