Once the Stimulus Kicks In, the Real Fight Begins, by Robert B. Reich, Commentary, Washington Post: The real stimulus debate hasn't even started yet. Congress will pass President Obama's stimulus package in the next two weeks... But when the economy starts to turn up again, perhaps as early as next year, the president will have the real tough decisions to make. He'll have to choose which spending will continue -- or whether any of it will continue at all. ...
Those who support the stimulus as a desperate measure to arrest the downward plunge in the business cycle might be called cyclists. Others, including me, see the stimulus as the first step toward addressing deep structural flaws in the economy. We are the structuralists. These two camps are united behind the current stimulus, but may not be for long. Cyclists blame the current crisis on a speculative bubble that threw the economy's self-regulating mechanisms out of whack. They say that we can avoid future downturns if the Fed pops bubbles earlier by raising interest rates when speculation heats up.
But structuralists see it very differently. The bursting of the housing bubble caused the current crisis, but the underlying problem began much earlier -- in the late 1970s, when median U.S. incomes began to stall. Because wages got hit then by the double-whammy of global competition and new technologies, the typical American family was able to maintain its living standard only if women went into the workforce in larger numbers, and later, only if everyone worked longer hours.
When even these coping mechanisms were exhausted, families went into debt -- a strategy that was viable as long as home values continued to rise. But when the housing bubble burst, families were no longer able to easily refinance and take out home-equity loans. The result: Americans no longer have the money to keep consuming. When you consider that consumers make up 70 percent of the economy, the magnitude of the problem becomes apparent.
What happened to the money? According to researchers Thomas Piketty and Emmanuel Saez, since the late 1970s, a greater and greater share of national income has gone to people at the top of the earnings ladder. ... But the rich don't spend as much of their income as the middle class and the poor do... That's why the concentration of income at the top can lead to a big shortfall in overall demand and send the economy into a tailspin. ...
Other structural problems are growing as well. One is climate change and our dependence on oil. Another is the United States' growing reliance on foreign capital, mostly from China, Japan and the Middle East. Neither is sustainable.
Meanwhile, our broken health-care system drains more of our dollars yet delivers less care. ... Most cyclists acknowledge these problems, but they tend to think of them as separate from the current crisis -- issues to be tackled after the economy has recovered, and then only to the extent that we can afford to do so.
But structuralists like myself don't believe that the economy can fully recover unless these underlying problems are addressed. Without policies that put the nation on the path to higher median incomes, higher productivity, renewable energy and a more accessible and efficient health-care system, we'll face deeper and more prolonged recessions...
As early as next year, the business cycle may hit bottom and begin climbing. At that point, cyclists and structuralists will want two different things -- and which side the president chooses will be ... the "central drama" of the Obama administration. ...
There's also another type of structuralist found on the conservative side of debate who focuses almost exclusively on economic growth (though some see that as a facade for upward redistribution of income). Curiously, however, the only way to get growth is tax cuts, government investments in infrastructure - something the left sees as productive investment in public goods - are not generally favored by this group.
However, I want to make a different point that doesn't deal directly with Reich's arguments, but it's a point that is being overlooked too often in the debate about the recovery package. Most observers are marking the turnaround in the economy as the point where GDP begins to turn upward, i.e. after the trough in GDP, and expressing worry that the stimulus package might extend beyond that point.
But looking to the last two recessions for guidance, the trough in employment came much later than the trough in output, the traditional one quarter lag between the upturn in GDP and the upturn in employment was extended considerably, and once employment did turnaround, the recovery of employment was sluggish relative to the recovery in GDP (overall job growth during the Bush years was relatively weak).
So marking the turnaround in GDP as the turning point in the economy rather than looking at the behavior of GDP in conjunction with other measures such as the behavior of employment can lead policymakers to pull back on the recovery effort too fast. If employment follows same path it followed in the last two recessions and lags GDP considerably, the need for stimulus in employment will extend far beyond the point where GDP begins to recover. Thus, if some infrastructure projects cannot be completed before GDP turns upward, and instead take a year or longer to complete - something we're hearing a lot of worry about - that won't be a problem, just the opposite as it will provide a helpful and needed boost to employment.
Nick Rowe explains why the "buy American" provision of the economic recovery package "will not shift demand towards domestic goods":
"Buy domestic" policies are individually irrational too, by Nick Rowe: Most (all?) economists agree that in a global recession, when each country wants to boost demand for the goods it produces, policies which steer demand to domestically-produced goods are individually rational (provided other countries don't retaliate), but collectively irrational when all countries do the same.
I think most economists are wrong. It's not just collectively irrational, but individually irrational as well, at least for countries with flexible exchange rates.
I hear that the US fiscal stimulus contains restrictions on buying imported goods. One could perhaps argue that the Canadian fiscal stimulus also concentrates demand on non-traded goods, and so does sort of the same thing, but in a manner which is less provocative (or more devious, if you prefer). This is dangerous. ... I don't have anything new to say about the collective dangers if all countries end up restricting trade as they did in the 1930's.
But I do have something to say about the benefits to an individual country of following this policy. Even if no other country retaliates, it is irrational for an individual country with flexible exchange rates to follow this policy. ...
In normal times, outside of a liquidity trap, an expansionary fiscal policy will put upward pressure on interest rates... An increase in domestic interest rates will cause a capital account inflow, which causes the exchange rate to appreciate. The exchange rate appreciation will cause net exports to fall. The fall in net exports offsets the expansionary fiscal policy. Under imperfect capital mobility the offset will be partial. Under perfect capital mobility there will be full offset, for a small open economy. So in normal times, part or all of the increased demand from an expansionary fiscal policy will be lost due to a decline in net exports. Some or all of the extra demand just leaks out to foreign countries.
But these are NOT normal times. An expansionary fiscal policy will not cause an increase in the rate of interest. Central banks won't let it happen. The perfectly interest-elastic demand for money won't let it happen either.
An expansionary fiscal policy ... will cause total spending to increase, and some proportion of this increased total spending will be on imports. But an increased demand for imports will cause an excess demand for foreign exchange on the current account of the balance of payments. Nothing happens on the capital account, because interest rates don't change. The excess demand for foreign exchange causes the exchange rate to depreciate (the exact opposite of the normal case). The exchange rate depreciation causes net exports to rise. This will fully offset the increased imports from increased income and spending (it has to, if the capital account stays the same). So, in the new equilibrium, all of the increased spending goes to increased demand for domestic goods. None leaks out to increased demand for foreign goods.
A "buy domestic" policy will not shift demand towards domestic goods. If it did, so that imports fell and net exports increased, the current account surplus would merely cause the exchange rate to appreciate so that net exports fell to their original level. The current account must stay the same, because the capital account stays the same, because the interest rate differential stays the same, because interest rates stay the same.
My argument does not apply within the Eurozone of course. The countries share a common currency and so there are no exchange rates to adjust. ... And it does not apply to countries on fixed exchange rates, where the foreign country will intervene in the foreign exchange market to prevent its currency appreciating against our currency.
[Brad Delong: "Buy American": A Very Bad Move in the Stimulus Package.]
- Damnification - Paul Krugman
- The US and China: A grand bargain? - Eswar Prasad
- On Paul Krugman's Nobel Prize - voxeu.org
- Fingerprints Amplify Vibrations Optimally - Discover
- Republicans Need to Remember Hoover - washingtonpost.com
- GDP Declines in 4th Quarter - NYTimes.com
- Ex-Fed Official Poole Against Buying Treasurys - Real Time Economics
- Growth Confusion - Forbes.com
- Jeff Sachs is Right! (at least about one thing) - William Easterly
- The recession finally hits plant and equipment - Woodard and Hall
- The Geithner put - Paul Krugman
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