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June 10, 2010

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"Why Economic Advisors Are Paid to Be Economic Advisors"

Posted: 10 Jun 2010 12:42 AM PDT

Robert Reich says there are two types of economic advisors, but only one of the two has any value to the president:

Why Economic Advisors Are Paid to Be Economic Advisors, by Robert Reich: Say you're a high government official with some responsibility for advising the President on what he should be doing and saying about the economy. You know the economy is still in a deep hole, the deepest since the Great Depression. The jobs report for May was dismal... 
You also know that consumers don't have the buying power to get it out of the hole... The housing market is still awful. You know businesses are reluctant to create new jobs if there are few customers... And you know export markets are drying up because of a high dollar..., and Europe has embarked on austerity measures to shrink its deficits.  You also know state revenues are way down because of the deep economic hole, and they're forced to raise taxes, cut services, and lay off large numbers of state workers, including teachers.
Oh, and one more thing: You know that all the boosters keeping the economy barely going now are coming to an end. The Fed can't keep interest rates near zero for long because it's starting to worry about inflation. ... The federal stimulus is 75 percent spent, and the money will be gone in a few months. Census workers will also be gone by the end of the summer. 
So what do you do?
A) Tell the President the economy will either go into a "double-dip" recession or, at best, suffer anemic growth over the next five years — creating enormous pain and suffering for millions of Americans, and imperiling his reelection — unless he immediately champions a $300 billion jobs bill, including zero-interest loans to states and locales to prevent them from having to raise taxes and cut services, public-service jobs (cleaning up the Gulf), and a one-year payroll tax holiday on the first $100,000 of income. To sell this, he'll need to explain to the American people why larger short-term deficits are necessary now, in order to get jobs back and the economy growing again so that long-term structural deficits (read health care and Medicare, mostly) can be tackled. 
B) Tell the President you understand the political pressures for deficit reduction are growing, and Republicans are making headway fooling the public into believing that this terrible recovery is due to to excessive government deficits. So so it's perfectly fine for the President to bend to those political pressures. Cut the budgets of most federal agencies by 5 percent, enforce "pay-go" rules that don't allow bigger deficits, build up expectations for the report of his "deficit commission" on December, and tell the American public that we now have to move toward fiscal austerity. 
If you choose B, you shouldn't be advising the President. 

I think political realities have to play a role in the advice that is given to the president. Staff time is valuable, and policy proposals take quite a bit of time to construct. No matter how good a proposal is, it doesn't do much good to spend a lot of time developing policy proposals that you know are dead in the water when they arrive, especially if a second best option exists that isn't perfect, but makes substantial progress. However, even when it's clear that a policy has not chance at all of passing, I'd hope the more attractive proposal is at least articulated to the president as an option.

But Robert Reich is talking about something different from operating within the feasible set of policies. He's objecting to economic advisors getting behind proposals that might could be harmful economically if they are enacted, but that are popular politically due to public misperceptions about the underlying economics. Hard to disagree with that.

I'd go even further. When the president's political advisors decide to sell economic policies to the public based upon untrue statements, e.g. telling people that tax cuts pay for themselves, then I think the advisors have an obligation to either set the record straight, or resign.

links for 2010-06-09

Posted: 09 Jun 2010 11:04 PM PDT

Rodrik: Who Lost Europe?

Posted: 09 Jun 2010 03:33 PM PDT

Germany says it took the time and effort to build a solid house, just like the bric-house countries, and the pigs will have to fight the big bad financial wolves on their own. If Germany opens the its bric-house doors and lets the pigs in where they are safe, they'll never learn their lesson. They'll keep relying upon structures that collapse when the slightest financial wind blows against them.

What the bric house residents are forgetting, however, is the mutual dependence that exists. If the pigs perish, so will the source of income that pays for the bric house they live in. The other countries do need to build houses that are safe from the wolves, but that's a lesson that seems likely to be learned even if the bric-house residents open their doors and foot the bill required to provide safe shelter. Allowing the pigs to be completely destroyed is not in the bric-house country's best interest. (Or something like that, not sure if it's fair to characterize all of the pigs in this way -- some thought they had built strong houses -- the point is that it may not be in Germany's best long-run interest to refuse to help at all):

Who Lost Europe?, by Dani Rodrik, Commentary, Project Syndicate: ...Having suffered a deeper economic collapse in 2009 than the United States did, Europe's economy is poised for a much more sluggish recovery... European leaders have so far offered no solution to the growth conundrum other than belt tightening. The reasoning seems to be that growth requires market confidence, which in turn requires fiscal retrenchment. As Angela Merkel puts it, "growth can't come at the price of high state budget deficits." 
But trying to redress budget deficits in the midst of a collapse in domestic demand makes problems worse, not better. ... In fact, it sets in motion a vicious cycle. The poorer an economy's growth prospects, the larger the fiscal correction and deleveraging needed to convince markets of underlying solvency. But the greater the fiscal correction and private-sector deleveraging, the worse growth prospects become. The best way to get rid of debt (short of default) is to grow out of it.
So Europe needs a short-term growth strategy... The greatest obstacle to implementing such a strategy is the EU's largest economy and its putative leader: Germany. ... What makes this perverse is that Germany runs a huge current-account surplus..., 5.5% of GDP in 2010,... not far behind China's 6.2%. So Germany has to thank deficit countries like the US, or Spain and Greece in Europe, for propping up its industries and preventing its unemployment rate from rising further. ...Germany is not only failing to do its fair share, but is free-riding on other countries'...
Germany's refusal to boost domestic demand and reduce its external surplus, along with its insistence on conservative inflation targets for the ECB, severely undercuts prospects for European prosperity and unity. It virtually guarantees that Greece, Spain, and others with large private and public debts will be condemned to years of economic decline and high unemployment. At some point, these countries may well choose to default on their external obligations rather than endure the pain.
Germany's leaders may take comfort in lecturing other governments about their profligacy. And it is true that some, like the Greek government, ran too-high deficits during the good times and endangered their future. But what about Spain or Ireland, where the borrowers were not the government but the private sector? If others borrowed too much, doesn't it follow that Germans lent excessively?
If Germany wants the rest of Europe to swallow the bitter pill of fiscal retrenchment, it will eventually have to recognize the implicit quid pro quo. It must pledge to boost domestic expenditures, reduce its external surplus, and accept an increase in the ECB's inflation target. The sooner Germany fulfills its side of the bargain, the better it will be for everyone. 

[Kevin O'Rourke has also argued recently that a collapse in domestic demand makes problems worse, not better.]

Reconsidering the Rush to Reform the Financial Sector

Posted: 09 Jun 2010 10:44 AM PDT

This is a post that appeared on my MoneyWatch blog, but upon further reflection, I'm not so sure about this one -- maybe I was in too much of a rush. I was supposed to be traveling to a conference in Europe today, and I needed posts that I could set to appear automatically while I was traveling, so I figured I'd set this one for about the time I was taking off for Budapest. That way, I'd have a good reason to ignore the inevitable comments telling me what an idiot I am -- even if I tried, travel would make it hard to get to them. However, I had to cancel the trip at the last minute, and I thought about canceling this post too. But what the heck, I'm never satisfied with posts after the fact, so I'll post it anyway. Maybe it's OK after all.

The post argues that perhaps we were in too much of a rush to pass financial reform legislation, and that explains the disappointing outcome. But what made me reconsider was an argument I read somewhere along the lines that "it took all this time to get legislation done, and this is the best they could do?" I still think that in legislative time, this was undertaken relatively quickly, that more patience might have helped, but it has been several years since we knew their were big problems to solve so it's not as though the legislation was rushed from day one. In any case, the main question I want to take up now is the quality of the legislation we're likely to get:

Reconsidering the Rush to Reform the Financial Sector, Maximum Utility: I wish I could say that the financial reform legislation that is under consideration in Congress makes the best possible attempt to insulate the financial system from problems in the future, but I can't make that claim. The legislation still needs to go through reconciliation to bring the House and Senate versions together, but the reforms that appear set to be enacted feel like a hodgepodge of measures rather than a set of consistent laws and regulations designed to counteract the fundamental failures within the financial system. The policies that emerged seemed to depend on what was possible rather than an overriding sense of the fundamental issues that needed to be addressed.

I had hoped that financial legislation would proceed by first identifying the major problems that caused the crisis or amplified its effects, and then by putting specific measures into place designed to fix those problems. But that's not how it went. Instead, it seemed like it was a little bit of this and a little bit of that with no real sense of overall purpose.

Maybe we were in too much of a hurry. I was one of those who made the following argument:

Kashyap and Mishkin ... may be right that now is not the time to change regulations because it could create additional destabilizing uncertainty in financial markets, and that waiting will give us time to see how the crisis plays out and to consider the regulatory moves carefully. But as we wait, passions will fade, defenses will mount, the media will respond to the those opposed to regulation by making it a he said, she said issue that fogs things up and confuses the public as well as politicians. By the time it is all over there's every chance that legislation will pass that is nothing but a facade with no real teeth that can change the behaviors that go us into this mess.

I thought that if we didn't hurry up and do something, we wouldn't get anything done at all (as passions fade, etc.), so it was better to go forward and perhaps get imperfect legislation than to wait and get nothing at all.

I wanted to strike while the iron was hot, but what I underestimated is the ability of politicians to heat things up. That's what politicians do, they create the passions that allow legislation to go forward (or to block it as the case may be). I am not claiming that the timing of the announcement of the Goldman Sachs investigation was politically motivated, i.e. connected to the reform legislation that was being considered in Congress, but it did show how easily passions can be inflamed with the right triggers. Politicians and their allies in the media are experts at finding and exploiting those triggers, so perhaps I was in too much of a hurry to push financial regulation forward. Patience may not have been so costly in terms of waning support as I first thought, and it may have allowed us to better identify the problems in the financial sector and then find the solutions that are needed to insulate it from further problems.

We couldn't have waited too long. It's still true that things fade over time, including the ability of politicians to whip up passion on an issue, but perhaps a little more patience would have produced legislation that does a better job at first identifying the problems that need to be fixed, and then crafting specific, workable regulatory solutions to those problems. I'm still not fully convinced that waiting longer was the right thing to do. I still worry that it gives the opposition too much time to put up obstacles to reform -- the opposition can whip up the public's passion too -- and that the public's anger fades over time. But seeing the legislation that actually emerged, and having the sense that it is not as effective as it could be due to the somewhat ad hoc way it was put together, I'm much more open to arguments that patience would have produced a better outcome than I was before.

I'm clearly not all that impressed with the legislation. I don't think the leverage restrictions are tough enough, I don't understand why we allow firms with enough political and economic power to manipulate their environment to persist, the ratings agencies need reform (though there is some progress here), there are incentive problems throughout mortgage and financial markets that need to be fixed, and the legislation is not as focused, cohesive, and encompassing as it should be.

What's your view on the legislation that is likely to emerge from reconciliation? Is it as good as we can expect, or is it far short of what could and should have been accomplished?

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