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October 6, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View

"So, How'd That Trickle-Down Thing Work Out?"

Posted: 06 Oct 2011 12:33 AM PDT

Republican presidential candidates are peddling trickle-down tax policies, but as Jared Bernstein notes "it's hard to take seriously those who claim that "supply-side" tax cuts ... will deliver for the middle class":

A Few Pictures to Keep in Mind, by Jared Bernstein: As I mentioned earlier, I've been collecting stuff on kids and their economic well-being.  Here are a couple of figures that provide an intersection of a number of points I've tried to stress a lot in recent weeks.
It's just a simple plot of real median income for families with kids, 1989-2010, followed by two bars showing the trough to peak of income growth in the two recovery periods.
The difference between how middle-income families fared in these two periods is really quite remarkable..., you might want to keep these pictures in your mind when listening to the economic agendas of those who would be President.
That is, it's hard to take seriously those who claim that "supply-side" tax cuts, as in the Bush years—large breaks tilted toward the top that are supposed to trickle down to the middle—will deliver for the middle class, compared to the more progressive tax regime of the Clinton years.  It's even harder to imagine how "shuddering the EPA" will make the difference.
There were important, real differences between these periods: the job market was much tighter in the former decade, job growth was about four times as fast on an annualized basis—importantly, the 1990s recovery lasted longer than that of the 2000s, in part because the only way for many families to get ahead amidst the flat income growth of the latter period was through cheap, easy credit.  (In other words, there's a linkage here between flat middle class incomes, the debt bubble, and the big crash.)
But so far, the road map I'm hearing from the R's sounds like that of the 2000s, and that shouldn't inspire anyone in the middle class on down.


Jb3Source: US Census Bureau, Family Income Tbl F-9

I prefer trickle-up policies. Give working class households more money -- tax cuts, helicopter drops, whatever -- and then let the rich compete for it by offering quality, innovative products at a decent price.

Fed Watch: Don't Let Monetary Policy Off The Hook

Posted: 06 Oct 2011 12:24 AM PDT

Tim Duy:

Don't Let Monetary Policy Off The Hook, by Tim Duy: Re-reading Federal Reserve Chairman Ben Bernanke's latest testimony to Congress left me increasingly puzzled by his conclusion:

Monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the U.S. economy. Fostering healthy growth and job creation is a shared responsibility of all economic policymakers, in close cooperation with the private sector. Fiscal policy is of critical importance, as I have noted today, but a wide range of other policies--pertaining to labor markets, housing, trade, taxation, and regulation, for example--also have important roles to play. For our part, we at the Federal Reserve will continue to work to help create an environment that provides the greatest possible economic opportunity for all Americans.

This is a clear effort to shift the focus away from monetary policy onto the fiscal side of the equation. But I think there is a significant flaw in that position. Fiscal policymakers will be completely unable to address medium- or long-term budget issues as long as there exists a sizable output gap and high levels of unemployment. Persistently low levels of output will necessitate deficit spending, and low interest rates will justify that spending. That is the lesson of Japan. Nor will the economy naturally gravitate toward such any other outcome – we are stuck in a liquidity trap. That is also the lesson of Japan.

Assuming the proximate cause of the current US economic environment is indeed a liquidity trap, then a solution to that problem lays solely in the hands of monetary policymakers. In short, the primary economic challenge is to lift the US from the zero bound floor; until that happens fiscal policy will limp along like that of Japan, with ever-growing debt that does little than serve as a partial stopgap. The deficit spending becomes a long-run outcome rather than a short-run solution.

Simply put, the Federal Reserve needs to take responsibility for ending the liquidity trap. Instead, as Scott Sumner summarizes:

The Fed has plenty of credibility, that's not the problem. The problem is that they are using the credibility to assure investors that low inflation is here to stay. With the right target, there would probably be no need for massive quantitative easing, or other extraordinary policies.

First and foremost, low inflation is the primary objective of Fed policy. They have repeatedly set expectations that the increase in the balance sheet is only temporary, and will be reversed as soon as possible. On not one but two occasions this cycle they prematurely shifted gears to setting expectations for tighter policy, which is effectively the same thing as engaging in tighter policy. They have offered a half-hearted attempt to remedy this situation by announcing a commitment to low rates, but have made it remarkably clear it is not a real commitment. From the Fed minutes:

Most members, however, agreed that stating a conditional expectation for the level of the federal funds rate through mid-2013 provided useful guidance to the public, with some noting that such an indication did not remove the Committee's flexibility to adjust the policy rate earlier or later if economic conditions do not evolve as the Committee currently expects.

Fear of inflation prevents the Federal Reserve from making an unconditional commitment. And therein lies the stumbling block to real policy change. It is virtually impossible to imagine reestablishing the pre-recession nominal GDP trend, and entirely impossible to regain the pre-recession price trend, without accepting a temporary acceleration of inflation along the way.

More succinctly, we will not lift the economy off the zero-bound without accepting higher than 2% inflation. Since the Federal Reserve has made it clear they will not accept inflation greater than 2%, the economy will not clear the zero-bound. And if the economy does not clear the zero-bound, we will be faced with perpetual and unavoidable deficit spending.

Deficit spending is not accommodated by the Federal Reserve via low interest rates; it is made necessary because the Federal Reserve sees no urgency ending the lower bound challenge. Which means it is ridiculous to believe that the Fed can dump off this problem on fiscal policymakers. How can the state of monetary policy have deteriorated so much that now even Bernanke claims "regulation" is holding back the economy? Yet here we are.

Where should the Fed go from here? First and foremost, they need to make a commitment to pull away from the zero-bound. As Sumner suggests, they need this commitment clearly defined by a target such as reestablishing nominal GDP or price level. The need to implement open-ended action to achieve this target. My suggestion is to announce they will make permanent additions to their balance sheet by purchasing on the secondary market $5 billion of US Treasury securities every week until the target is reached. I think they need to make permanent additions to be credible – they have clearly expressed that previous balance sheet expansions should be viewed only as temporary.

Won't this amount to monetization of deficit spending? Yes, but if Sumner is correct, less than might be feared, as the commitment is more important than the size of the purchases. And I already arrived at the conclusion, aided by Bernanke's 2003 speech, that the situation requires a greater coordination of monetary and fiscal policy. Moreover, even if sizable purchases are required, there is no reason this needs to be a problem. As Bernanke has already explained, the Fed simply needs to make clear its target and once that target has been reached, they will adjust policy appropriately to maintain the nominal GDP or price level trend. In other words, purchases will be suspended and policy will by that point revert to traditional interest rate management, with the possible reduction of the portion of the balance-sheet expansion that to-date has been viewed as temporary.

Once the Fed achieves normal monetary conditions, the ball will be back in the hands of fiscal policymakers, who may then soon understand that policy is a lot different when interest rates create real constraints on spending and taxes. But that is a battle for another day.

Bottom Line: It is ludicrous for the Fed to declare the primary economic responsibility is now on fiscal policy. As long as we are in a liquidity trap, fiscal policy is stuck in a never-ending cycle of deficit spending. Absent that spending, the economy will simply slip backwards into recession again and again. The exit from the liquidity trap can only come from the monetary side of the equation. Try as he might Federal Reserve Chairman Ben Bernanke cannot escape his policy responsibilities. And we shouldn't let him.

links for 2011-10-06

Posted: 06 Oct 2011 12:06 AM PDT

"The Republican Consensus is Seriously Wrong"

Posted: 05 Oct 2011 10:53 AM PDT

I wish the GOP would listen to David Frum:

...On the most urgent economic issue of the day – recovery from the Great Recession – the Republican consensus is seriously wrong.

  • It is wrong in its call for monetary tightening.
  • It is wrong to demand immediate debt reduction rather than wait until after the economy recovers.
  • It is wrong to deny that "we have a revenue problem."
  • It is wrong in worrying too much about (non-existent) inflation and disregarding the (very real) threat of a second slump into recession and deflation.
  • It is wrong to blame government regulation and (as yet unimposed) tax increases for the severity of the recession.
  • It is wrong to oppose job-creating infrastructure programs.
  • It is wrong to hesitate to provide unemployment insurance, food stamps, and other forms of income maintenance to the unemployed.
  • It is wrong to fetishize the exchange value of the dollar against other currencies.
  • It is wrong to believe that cuts in marginal tax rates will suffice to generate job growth in today's circumstance.
  • It is wrong to blame minor and marginal government policies like the Community Reinvestment Act for the financial crisis while ignoring the much more important role of government inaction to police overall levels of leverage within the financial system.
  • It is wrong to dismiss the Euro crisis as something remote from American concerns.
  • It is wrong to resist US cooperation with European authorities in organizing a work-out of the debt problems of the Eurozone countries.
  • It is wrong above all in its dangerous combination of apocalyptic pessimism about the long-term future of the country with aloof indifference to unemployment.


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