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August 13, 2011

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GOP on Defensive over Fiscal Policy

Posted: 13 Aug 2011 12:24 AM PDT

I wish I could believe that the tide is starting to turn against Republicans:

GOP on Defensive as Analysts Question Party's Fiscal Policy, by Jackie Calmes, NY Times: The boasts of Congressional Republicans about their cost-cutting victories are ringing hollow to some well-known economists, financial analysts and corporate leaders, including some Republicans, who are expressing increasing alarm over Washington's new austerity and anti-tax orthodoxy.
Their critiques have grown sharper since last week, when President Obama signed his deficit reduction deal with Republicans and, a few days later, when Standard & Poor's downgraded the credit rating of the United States.
But even before that, macroeconomists and private sector forecasters were warning that the direction in which the new House Republican majority had pushed the White House and Congress this year — for immediate spending cuts, no further stimulus measures and no tax increases, ever — was wrong for addressing the nation's two main ills, a weak economy now and projections of unsustainably high federal debt in coming years.
Instead, these critics say, Washington should be focusing on stimulating the economy in the near term to induce people to spend money and create jobs, while settling on a long-term plan for spending cuts and tax increases to take effect only after the economy recovers. ...
S.& P. based its downgrade ... partly on the assumption that Bush-era tax cuts for high incomes would be extended past their 2012 expiration, "because the majority of Republicans in Congress continue to resist any measure that would raise revenues." S.& P. said it could change its outlook to stable if the tax cuts ended.
Yet Republicans insist that taxes will not be on the table for the bipartisan Congressional committee created by the deficit deal. ... The prospect of further reductions worries forecasters. ...
Low borrowing costs, analysts say, are more reason to bolster the economy now. "At the very least," said Mark Zandi..., Congress should renew for another year two measures that expire after 2011 — payroll tax relief for employees and extended unemployment compensation — as Mr. Obama has proposed. If either expired, Mr. Zandi said, that could shave roughly a half-percentage point from economic growth next year.
Republicans are resistant. And Democrats are too cowed to counter much, given polls that show many Americans believe Mr. Obama's 2009-10 stimulus package did not work, despite studies to the contrary.
A Democratic Congressional adviser, granted anonymity to discuss party deliberations, said: "We're at a loss to figure out a way to articulate the argument in a way that doesn't get us pegged as tax-and-spenders." ...

This isn't my preferred way of doing it, I'd rather simply run deficits in the short-run and put a plan in place to address long-run issues, but one option is to raise taxes on upper incomes and use the money to finance infrastructure and job creation on a dollar for dollar basis for two years (three would be better), and not a day more. After that, the spending on the projects ends and the tax increase goes solely to deficit reduction. That is, in the short-run build a fixed number of infrastructure projects financed by the tax increase on upper incomes and chosen in part based on the project's ability to create jobs -- once the number of the projects is set it cannot be increased -- and when that ends, that's it. But the higher taxes persist. That should yield a net budget reduction over ten years without harming the economy or making the deficit worse in the short-run, and help with growth in the long-run. Job-and-growth-creating-tax-and-reduce-the-deficit liberals seems like a decent label to me.

links for 2011-08-12

Posted: 12 Aug 2011 10:04 PM PDT

Clarida on Monetary and Fiscal Policy

Posted: 12 Aug 2011 07:38 PM PDT

This is from an old post (March 2009, Clarida and DeLong on Fiscal Policy). It should give you a bit of perspective on potential Fed Governor Richard Clarida's views on monetary and fiscal policy:

A lot of bucks, but how much bang?, by Richard Clarida, Vox EU: "We have involved ourselves in a colossal muddle, having blundered in control of a delicate machine, the workings of which we do not understand" - John Maynard Keynes, "The Great Slump of 1930", published December 1930.

I recently had the privilege of participating on a panel that was part of the Russia Forum, an annual conference held in Moscow that brings together market makers, policymakers, and academic experts... The topic assigned to our panel, not surprisingly, was the global financial crisis – causes, consequences, and policy responses. Although each speaker had his own, unique perspective, a cohesive, urgent theme did emerge, or so it seemed to me...

That theme suggests the title I've chosen for this column; there are, at last, a 'lot of bucks' now committed by policymakers to address the global recession and the global financial crisis, but there is real doubt about how much 'bang' we can expect from these bucks.

In the US, President Obama has just signed a nearly 800 billion dollar stimulus package and the Fed has cut the Federal Funds rate to zero. Monetary policy in the rest of the G7, while lagging behind the US, will follow the US lead and soon come close to zero. (In the case of the ECB, the policy rate may end up at 1%, but the effective interbank rate has been trading well below the official policy rate in recent weeks so a policy rate of 1% could translate into an effective interbank rate of nearly zero). Likewise for fiscal deficits – they are rising globally and headed higher, propelled by a combination of discretionary actions and automatic stabilisers.

To date, however, these traditional policies have been insufficient for the scale and scope of the task. Recall that the Obama stimulus package is actually the second such US effort in the last 12 months. The 2008 edition was deemed to be a failure because a big chunk of the rebate checks were saved or used to pay down debt and not spent. The Obama package includes tax cuts and credits that will provide a boost to disposable income, but how much of these will be spent rather than saved or used to pay down debt? The package also includes a substantial increase in infrastructure spending, as well as transfers to the states, but the infrastructure spending is back-loaded to 2010 and later, and the transfers to states will most likely just enable states to maintain public employment, not expand it appreciably.

Bucks without bang

What is the source of this concern that the US fiscal package will not deliver a lot of 'bang' for the 'bucks' committed? Because of the severe damage to the system of credit intermediation through banks and securitisation, policy multipliers are likely to be disappointingly small compared with historical estimates of their importance. Recall the Econ 101 idea of the Keynesian multiplier – the impact traditional macro policies are 'multiplied' by boosting private consumption by households and capital investment by firms as they receive income from the initial round of stimulus. It important to remember why and how policy multipliers actually come about. Policy multipliers are greater than 1 to the extent the direct impact of the policy on GDP is multiplied as households and companies increase their spending from the increased income flow they earn from the debt-financed purchase of goods and services sold to meet the demand from the initial round of stimulus.

Historically, multipliers on government spending are estimated to be in the range of 1.5 to 2, while multipliers for tax cuts can be much smaller, say 0.5 to 1. But these estimates are from periods when households could – and did – use tax cuts as a down payment on a car or to cover the closing costs on a mortgage refinance. For example, in 2001, the economy was in recession, but households took advantage of zero-rate financing promotions – as well as ready access to home equity withdrawal from mortgage refinancings – to lever up their tax cut checks to buy cars and boost overall consumption. With the credit markets impaired, tax cuts and income earned from government spending on goods and services will not be leveraged by the financial system to nearly such an extent, resulting in (much) smaller multipliers.

There is a second reason while the bang of the fiscal package will likely lag behind the bucks. Even if the global financial system soon restores some semblance of order and function, the collapse in global equity and housing market values has so impaired household wealth that private consumption (which represents 60% to 70% of GDP in G7 countries) is likely to lag – not lead – economic growth for some time, as households rebuild their balance sheets the old-fashioned way – by boosting their saving rates. Just in 2008 alone, I estimate that the net worth of US households fell by some 10 trillion dollars, with much of this concentrated in older demographic groups who, in our defined contribution world, must now be focused on building back up their wealth to finance retirement, which is not that far away. This means more saving, less consumption, and smaller multipliers. ...

Will the Fed pull it off?

So where does this leave us? A LOT is riding on the efforts of the Fed and other central banks to stabilise the financial system and restore the flow of credit.

Officials recognising these challenges are now seriously considering "non-traditional" policies that combine monetary and fiscal elements. Cutting rates to (near) zero has not been a mistake, but it has been ineffective – really the most striking example of 'pushing on a string' I have witnessed in my lifetime. The reason, again, is the impaired credit intermediation system. The private securitisation channel, which at its peak was intermediating nearly 50% of household credit in the US, has been destroyed. Banks are hunkering down in the bunker, hoarding capital as a cushion against massive losses yet to be recognised on the trillions of dollars of 'legacy' assets that they have been unable or unwilling to sell at the deep discount required to attract private investors. For this reason, the Fed and Bank of England – with many other central banks likely to follow suit in some form or fashion – are filling the vacuum by directly lending to the private sector. The Fed aims to purchase 600 billion dollars worth of mortgage-backed and agency securities this year and, via the soon to be launched Term Asset-Backed Securities Loan Facility (TALF), to finance without recourse up to one trillion dollars worth of private purchases of credit cards, auto loans, and student loans. Since last fall, the Fed has also been supporting the commercial paper market via the Commercial Paper Funding Facility (CPFF).

Altogether, between the MBS, CPFF, and TALF programs, the Fed is committing nearly 2 trillion dollars of financing to the private sector. While these sums may be necessary to prevent an outright economic collapse that extends and deepens into 2011 and beyond, it is not clear to me that they are sufficient to turn the economy around so that it returns to robust growth. Moreover, based on the Fed's just released economic forecast and Chairman Bernanke's recent testimony to the Senate Banking committee, the Fed is also not convinced that these policies are sufficient to turn the economy around. On 24 February, knowing that an 800 billion stimulus had passed, that the Fed has committed nearly 2 trillion dollars of lending to the private sector, and that the Treasury's Public Private Investment Fund will aim to support up to one trillion dollars of private purchases of bank legacy assets, Chairman Ben Bernanke said,

If actions taken by the administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability – and only if that is the case, in my view – there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery,

As I said in my remarks at the conference, I think of myself as an optimist, and that outlook on life has served me well. However, the last nine months have severely tested that mindset, at least as it pertains to my professional endeavours. But old habits are hard to break, so I am casting aside the contrary evidence and putting my 'bucks' on the Fed. But it is a close call.

Jeremy Stein and Richard Clarida Identified as Potential Nominees to Fed

Posted: 12 Aug 2011 01:44 PM PDT

Some news:

The Obama administration has identified two economists, one Democrat and one Republican, for two empty seats on the seven-member Federal Reserve Board, according to several people familiar with administration deliberations.
The two are Jeremy Stein, a Harvard University specialist in finance, and Richard Clarida, an executive vice president at money manager Pimco and professor of economics and international affairs at Columbia University.
Mr. Stein did a stint in the White House at the beginning of Barack Obama's presidency. Mr. Clarida was a Treasury official in the early years of the George W. Bush administration.
The administration coalesced around the two names a few months ago, hoping that pairing a Republican with a Democrat would smooth the way for Senate confirmation. But the White House has yet to nominate either formally and could change course depending on the political environment and the individuals' circumstances.
Although the two men have different political views, both are well-credentialed economists who have done scholarly work on central banking and would bolster the economic expertise on the Fed board. Only two of the five current Fed governors are Ph.D. economists, Mr. Bernanke and Vice Chairwoman Janet Yellen.

More here and here. Clarida is a good choice. I know less about Stein, so I'll withhold judgment for the moment.

What Was Kocherlakota Thinking When He Dissented on Monetary Policy?

Posted: 12 Aug 2011 09:36 AM PDT

Narayana Kocherlakota makes it clear that the rate at which the recovery is proceeding is just fine with him. No more accommodation from the Fed is necessary given that "Since November, inflation has risen and unemployment has fallen."

But he doesn't acknowledge that the November date is cherry-picked to some extent. Since January -- just two months from when he starts his measurement -- unemployment has actually risen. He's happy with that? As for inflation -- the worry that is stopping him from endorsing a more aggressive policy -- using his preferred time period from last November until now, core PCE has risen from 1.0% to 1.3%. And it didn't move at all between May and June, it was 1.3% in both months. Uh oh, hyperinflation! Assuming a target of 2.0%, at this rate the Fed will reach it's inflation target in about a year and a half. Sounds kind of like the guidance they issued (and there is a good argument that the Fed should overshoot its target in the short-run). Perhaps lag effects can explain his response, if we tighten now we may not feel it until a year later, but that doesn't seem to be his argument:

In its August 9 meeting, the Committee changed this "extended period" language to say instead that it "currently anticipates economic conditions … are likely to warrant extraordinarily low levels of the federal funds rate through mid-2013." This statement is designed to let the public know that the fed funds rate is likely to stay between 0 and 25 basis points over the next two years, not just over the next three to six months. Hence, the new language is intended to provide more monetary accommodation than before.
I dissented from this change in language because the evolution of macroeconomic data did not reflect a need to make monetary policy more accommodative than in November 2010. In particular, personal consumption expenditure (PCE) inflation rose notably in the first half of 2011, whether or not one includes food and energy. At the same time, while unemployment does remain disturbingly high, it has fallen since November. I can summarize my reasoning as follows. I believe that in November, the Committee judiciously chose a level of accommodation that was well calibrated for the prevailing economic conditions. Since November, inflation has risen and unemployment has fallen. I do not believe that providing more accommodation—easing monetary policy—is the appropriate response to these changes in the economy.

Again, "well-calibrated" should include both the direction and pace of change. Even if the direction is correct, is he satisfied with the pace of change for employment? I realize he thinks we will have to tighten in 3-6 months, but it's hard to see how a data-based projection takes you to this outcome (even more so if you believe, as I do, that the risks are asymmetric, i.e. that unemployment is more costly than inflation).

Finally, this is not a rock solid commitment from the Fed. This is their view of the most likely path for the federal funds rate, they have not said this is what they will do independent of how the data evolve. All they have said is that economic conditions are likely to warrant this outcome. The dissenters seem to believe that another outcome is more likely, the view is that economic conditions will force the Fed into a different posture -- you know, that high inflation and rapid recovery we've been seeing to date -- in as soon as 3-6 months. Anything is possible, but again, it's hard to see how recent data point to this outcome.

Update: See Matt Rognlie: Macroeconomics in Action (I've made this point several times in the past, and should have mentioned it here as well).

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