"who represent competing strains of Democratic economic thought": I'm A Sort Of Non-Competative Strand

Yesterday Free Exchange commented on the post by Robert Rubin and Jared Bernstein about interest and debt, and how they are viewed in the Democratic Party. My party. Now, you might well ask where I fit in, but I've about 600 posts now trying to answer that, so let's move on:

"ROBERT RUBIN and Jared Bernstein are two left-leaning economists (both of which have advised Barack Obama) who represent competing strains of Democratic economic thought. Mr Rubin, Treasury secretary under Bill Clinton, was known as an economic centrist—pushing free trade and fiscal responsibility. Mr Bernstein is a more progressive economist, who has emphasised international labour standards and a robust social safety net.

Today, the New York Times published an opinion column co-written by Mr Rubin and Mr Bernstein. It lays out the broad areas of agreement between the two men which, one assumes, hints at what might emerge from an Obama administration. It's not particularly scary stuff—short-term stimulus, infrastructure investment, long-term fiscal discipline, sympathetic labour policies, and a trade policy that seeks to protect workers but not jobs or industries. A change in direction, to be sure, and one that deserves vigilant oversight, but not a new social democratic state."

Now, I didn't respond to this column because I also didn't see it as particularly scary or even interesting. It dealt at the level of nostrums. I'm more on Rubin's side, but I actually am concerned about Bernstein's concerns.

"What's most interesting to me are the areas where the two authors are forced to concede disagreement. One of these issues—the effect of long-run deficits on interest rates and economic growth—is one of the most contentious areas of debate for lefty economists. The authors write:

One of us (Mr. Rubin) views long-term fiscal deficits — in combination with a low national savings rate, large current account deficits and foreign portfolios that are heavily over-weighted in dollar-dominated assets — as a serious threat to long-term interest rates and our currency and, therefore, to our economic future. The other views these economic relationships as much weaker.

This is the view that shaped Clintonian deficit reduction. It also angered many Democrats, who would have preferred that increased revenues be used for a health insurance solution or public investments. Mr Rubin's position strikes me as fairly orthodox. The thing is, I'm not sure that it makes sense in light of recent events. A lot of people expected a dollar run to precipitate crisis. Instead, crisis precipitated a dollar boom."

Again, here I'm on Rubin's side. But I see the problem.

"And now, Calculated Risk is arguing that declining American deficits might result in higher long-term interest rates. Why? A reduction in the current account deficit would trim growth in foreign central bank investment in dollar-denominated assets, pushing up interest rates. In short, so long as Bretton Woods 2 held up, American deficits meant low interest rates. Only when that financial system comes apart can we expect Mr Rubin's conditions to obtain.

Mr Rubin was right about interest rates given that he was in a certain financial equilibrium, but he was wrong about which equilibrium he found himself in. Given Bretton Woods 2, and the resulting ability to borrow cheap, America should have borrowed heavily and ploughed Chinese capital into long-term domestic investments. By instead running a surplus, Mr Rubin simply made easy credit available to the private sector which, understandably, poured that credit into heavy consumption and investment in non-tradable sectors (like housing!) which weren't rendered comparatively unattractive by Chinese currency policies."

I saw the Calculated Risk post as well, and it bothered me. ( but see Setser here )

"So which should America choose moving forward? For the moment, the risk of a dollar collapse seems low, and the need for deficit spending appears high. Beyond that, we must see whether China will continue to finance American borrowing, or if China will allow domestic spending to flourish by letting the RMB appreciate. Increasingly America is learning that neither its monetary policy or its fiscal policy is as independent of international forces as it believed."

So, this really is food for thought. I agree with:

1) Risk of dollar collapse is low ( I also agree with 'seems' )

2) That's why I accept some deficit spending in the short term and a stimulus plan.

Where to go from here. Let me utter some nostrums:

1) A banking system based on Bagehot's Principles

2) Reducing government spending

3) Lower debt

4) A slight budget surplus or debt in normal times

5) Lower taxes, and fairer and more efficient taxes

I fear:

1) Inflation

But I have to admit, all these gyrations are making things hellishly complicated.

However, this post by Bob McTeer seems to echo more or less the same view, although I would disagree with him on some specifics:

"The most important near-term thing you could do to reassure financial markets and quell the turmoil is to announce early that you don't intend to eliminate President Bush's marginal tax-rate cuts. If you can't go that far, keep the adjustments as small as possible and announce your intentions to be moderate early. A little bad news early is better than great uncertainty and expecting the worse. ( I'm fine with small adjustments )

You have an education job to do. You must be able to articulate clearly how high tax rates on capital (capital gains, dividends, corporate taxes, the death tax, etc.) diminishes the demand for labor and keeps wages from rising. ( I agree )

While tax-rate increases are bad anytime, they are particularly bad in a recession. The timing couldn't be worse for a tax increase. ( I tend to agree, but the debt bothers me more )

Energy limitations must be attacked on all fronts: drill, drill, drill, nuclear, clean coal, wind, solar, and so forth. Don't push for energy independence; push for less energy dependence. ( I sort of agree, but have more environmental concerns )

Everyone knows that exports create jobs, but few focus on imports, which represent the gains from trade. Help educate people on the benefits of low prices via imports. ( I agree, basically )

Don't overdo the regulatory reaction to the current financial crisis. Another Sarbanes-Oxley is the last thing we need." ( I agree )

In other words, while things are in flux, let's stick to our general principles, while confronting reality and bending them where necessary. But like Becker and McTeer, I agree that we don't want to kill the goose that laid the golden egg.

As to Rubin and Bernstein, I'm not that bothered by either of them. I see them as sensible people. I've no fear of some massive economic shift. There will be tinkering, but tinkering can often be wise.