They thought that budget deficits would stimulate growth under all circumstances, not just those of a deflationary depression.

From Mark Thoma:

"Does Stimulus Stimulate?"

Bruce Bartlett:

Does Stimulus Stimulate?, by Bruce Bartlett, Forbes.com: ...The [Great Depression] didn't really end until both monetary and fiscal policy became expansive with the onset of World War II. At that point, no one worried any more about budget deficits, and the Fed pegged interest rates to ensure that they stayed low, increasing the money supply as necessary to achieve this goal.

It was then and only then that the Great Depression truly ended. As a consequence, economists concluded that an expansive monetary and fiscal policy, which had been advocated by economist John Maynard Keynes throughout the 1930s, was the key to getting out of a depression.

Keynes was right, but many of his followers weren't. They thought that budget deficits would stimulate growth under all circumstances, not just those of a deflationary depression( I AGREE WITH BARTLETT HERE, AS I'VE POSTED. BARRO DOESN'T SEEM TO GET THE NATURE OF A CALLING RUN, ALTHOUGH HE SAYS HE DOES. ). When this medicine was applied inappropriately, as it was in the 1960s and 1970s, the result was inflation.( NOT HERE. NOT YET. )

Economists then concluded that it was a mistake to pursue countercyclical fiscal policy, and the idea of "fine-tuning" became a derogatory term. ...

In the 1980s and 1990s, economists came around to the view that only monetary policy could act quickly enough to reverse or moderate a recession. ... [But...] As we have seen, the Fed could not prevent the greatest financial downturn the world has seen since 1929. This has revived the idea that fiscal policy must be the engine that pulls us out.

Somewhat surprisingly, there has been rather heated opposition to the very principle of fiscal stimulus... We have now had several tests of the Keynesian idea--most recently with last year's $300 tax rebate... According to a new paper by University of Michigan economists Matthew Shapiro and Joel Slemrod, only a third of the money was spent, thus providing very little "bang for the buck."( TRUE )

The failure of rebates has shifted the focus to public works and other direct spending measures as a means of stimulating aggregate spending. A study by Obama administration economists Christina Romer and Jared Bernstein predicts that the stimulus plan being debated in Congress will raise the gross domestic product by $1.57 for every $1 spent.

Such a multiplier effect has been heavily criticized by a number of top economists, including John Taylor of Stanford, Gary Becker and Eugene Fama of the University of Chicago and Greg Mankiw and Robert Barro of Harvard.( I LIKE ALL OF THESE PEOPLE ) The gist of their argument is that the government cannot expand the economy through deficit spending because it has to borrow the funds in the first place, thus displacing other economic activities( THIS IS WRONG ). In the end, the government has simply moved around economic activity without increasing it in the aggregate.( WRONG )

Other reputable economists have criticized this position as being no different from the pre-Keynesian view that helped make the Great Depression so long and deep. Paul Krugman of Princeton, Brad DeLong of the University of California at Berkeley and Mark Thoma of the University of Oregon have been outspoken in their belief that theory and experience show that government spending can expand the economy under conditions such as we are experiencing today( I AGREE WITH THEM IN THIS CASE. ).

I think the critics of an activist fiscal policy are forgetting the essential role of monetary policy as it relates to fiscal policy. As Keynes was very clear about, the whole point of fiscal stimulus is to mobilize monetary policy and inject liquidity into the economy. This is necessary when nominal interest rates get very low, as they are now, because Fed policy becomes impotent. Keynes called this a liquidity trap, and I think there is strong evidence that we are in one right now.( ZIRP )

The problem is that fiscal stimulus needs to be injected right now to counter the liquidity trap. If that were the case, I think we might well get a very high multiplier effect this year( I AGREE ). But if much of the stimulus doesn't come online until next year, when we are likely to be past the worst of the slowdown, then crowding out will greatly diminish the effectiveness of the stimulus, just as the critics argue. ... Thus the argument really boils down to a question of timing. ...( I AGREE COMPLETELY )

For this reason, I think there is a better case for stimulating the economy through tax policy than has been made. Congress can change incentives instantly by, for example, saying that new investments in machinery and equipment made after today would qualify for a 10% Investment Tax Credit...( MY IDEA )

Stimulus based on private investment also has the added virtue of establishing a foundation for future growth, whereas consumption spending( OFTEN ) does not. As economist Hal Varian of the University of California at Berkeley recently put it, "Private investment is what makes possible future increases in production and consumption. Investment tax credits or other subsidies for private sector investment are not as politically appealing as tax cuts for consumers or increases in government expenditure. But if private investment doesn't increase, where will the extra consumption come from in the future?"

I don't agree with all of this, e.g. the "government is always the problem" emphasis in the analysis, and casting the debate as a tradeoff between private investment and private consumption rather than between private sector activity (consumption or investment) and public investment overstates the case for private sector solutions. [These arguments from yesterday apply as well.]

I've never objected to tax cuts being part of the package -- I have also argued that the desire for an immediate impact may necessitate some tax cut components in order to maximize the prospects for a faster recovery. And as tax cuts go, there are far worse choices than an investment tax credit( GOOD. THEN JOIN US. ). But just as there's a limit to the number of public sector projects that are shovel ready, there's also a limit to the number of private sector projects that are ready to go (though the planning stage does involve some spending, just not as much as when the public or private sector investment projects are going full throttle)( YES ). There's also a question about how strong the reaction will be to a tax credit when the economic outlook is so gloomy( TRUE. IT MIGHT ONLY MARGINALLY HELP. BUT WE NEED TO TRY. ), a question that doesn't arise when government is making the investments. So, sure, let's get as much out of the private sector as we can, but we shouldn't rely solely upon the private sector response to a tax credit to turn things around( AGREED ). It's very unlikely to be enough on its own, and it may not provide much help at all, Thus, even with tax credits, the public sector response - government spending in particular - still needs to be aggressive."

I agree. Infrastructure investment also sends a positive message. Oh my God. I actually resorted to talking about how people might behave in the real world. A real benefit of the stimulus in Infrastructure ( I said $100 Billion ) would be emotional. I will spend more money if I FEEL LIKE IT. Crowding out, a purely mechanistic explanation, is a fairly useful model, no more, under normal circumstances. Using math to describe correlations between various economic factors doesn't make you a scientist. All that the math does, or any correlative reasoning, is give you some useful guides to understanding how people might react in various circumstances. Crowding out is NOT a law of nature. Adam Smith understood philosophy, politics, economics, history, etc. What education do many of these economists receive? They have a philosophy of math that is hilarious. Of course, so do many mathematicians and philosophers, so let's not go there.

Let me repeat my plan:
1) $100 Billion on infrastructure, to be built only when benefits exceed the costs.
2) Sales tax cut $200 Billion
3) Investment incentives $100 Billion
4) Social safety net spending is not included in my stimulus. It is simply money that needs to be spent as part of the social contract.

"Create the incentive for people to take more risk and move their savings from government bonds to risky assets"

Here's the kind of proposal that I agree with for attacking the fear and aversion to risk. From Growthology:

"Stimulate Private Risk Taking

So how do we stimulate the economy without increasing the already large current-account deficit? It's not easy, but here is an idea: Create the incentive for people to take more risk and move their savings from government bonds to risky assets( I AGREE ). There is no better way to encourage this than a temporary elimination of the capital-gains tax for all the investments begun during 2009 and held for at least two years.( FINE )

So say ALBERTO ALESINA and LUIGI ZINGALES. Anyone reading the news knows that the idea of a traditional fiscal stimulus is losing its appeal among those wise enough to know. The CBO announced that most infrastructure spending could not be spent for years -- far too late to matter.

The challenge is whether the new President will focus on what is broken - the financial system - or play the traditional game of big government pork-barreling. The capital gains tax argument will run right into the maw of the liberal trench lines of class warfare. They don't hear "entrepreneur" when you say capital gains, they hear "Wall Street." And I'm afriad they would counter any argument for heart surgery with a counter argument for rebuilding the entire arterial system."

It is a good proposal.

"now we must make our congress the direct investors of last resort."

From Notes on Credit Spreads:

"Why Infrastructure Spending is Preferential to Tax Cuts

by David Levy

Much concern exists over Obama’s proposal to make tax cuts a major portion of fiscal stimulus. Through a tax cut, we (the government) are increasing the income of those still employed( NOT IF THEY'RE DIRECTED AT INVESTMENT AND CREATING JOBS. ). Hopefully, tax savings will buy goods and services, increasing GDP. In today’s environment, we’re not enacting a stimulus to buy goods, we’re enacting a stimulus to buy jobs.

GDP = government spending + investment + consumption + net exports. The marginal dollars in a tax cut will either be saved or spent.

While savings should be encouraged in the long term, a savings glut currently exists. Fed Funds rate trades near zero, while cash reserves within the Fed have ballooned.

More damaging, marginal spending could be directed at imported goods. From Martin Wolf to Warren Buffet, many shudder at no improvement in our trade balances. Dollars used for imports are either locked up as foreign reserves or exchanged for investments in future US cash flows. Those future cash flows are either US tax receipts or profits distributed as interest or dividends. Those tax receipts could have put new teachers in the class room. Those profits could have built new factories. Those cash flows will never to be re-invested in the US.

By definition then, an increasing current account deficit means the same standard of living - GDP - costs more. If this is not the purest form of inflation( WE WANT INFLATION ), I do not know what is.

Many believe too great a mismatch exists between jobs lost and jobs needed for “shovel ready”. Cokie Roberts on “This Week” opined on finance professionals helping on infrastructure: “Well maybe instead of going to their personal trainers, they can actually get out there and start digging.”

The purchase of infrastructure projects buys jobs across the food chain. Almost every project will go out for private competitive tender. Forget defunct residential home construction (shovel ready employees), companies bidding will require talent to prepare bids, obtain financing, manage payroll, and review costs. Every contract guarantied by the government (state or federal) will give lenders the confidence to finance, spurring new growth.( THAT'S THE POINT OF THE STIMULUS. TO ATTACK THE FEAR AND AVERSION TO RISK. )

The long term benefits (aside from jobs) are then improved transportation, reduced energy costs and reduction of barriers to education( MAYBE YOU COULD LOOK INTO THE BIG DIG AND THE BAY BRIDGE AS RECENT EXAMPLES OF INFRASTRUCTURE. THEY CERTAINLY COST A LOT OF MONEY. ). Thus reduction of risks for future runaway inflation - those risks prevalent in increasing current account deficits. Faith in government is presently difficult yet now we must make our congress the direct investors of last resort( I CALL THEM THE SPENDERS OF LAST RESORT. )."

I agree with the need for a stimulus, and that the government needs to be a SOLR, but I don't understand the problem with tax cuts targeted towards encouraging investment and jobs. What am I missing?

"So if stimulus is partly a game of psychology"

Barbara Kiviat finds someone on my side:

"Obama talks stimulus. He hopes you are listening

Posted by Barbara Kiviat | Comments (6) | Permalink | Trackbacks (0) | Email This

The spate of retailers reporting devastating December sales this morning provided a nice backdrop for President-elect Obama's speech in Virginia about why we need to spend another $775 billion to fix the economy. About 40% of that sum comes in the form of tax cuts, but the bulk of the fiscal stimulus would go to pay for new programs and projects—everything from the greening of federal buildings to the computerization of medical records.

The idea, just to be really basic about it, is that American consumers and companies aren't spending enough, so the government has to. There was a great article in the New York Times yesterday about how pretty much all most economists now agree that it's go-time on this count. Even Marty Feldstein, the champion of conservative economic thought who was a top adviser to President Reagan, has noted that lower interest rates aren't getting the job done because credit markets are screwy and that tax cuts only get you so far, so the "heavy lifting" will have to be done by increased government spending. (Quick historical recap: this hasn't been the consensus in the field of economics since the 1960s.)

But most economists also agree that fiscal stimulus shouldn't be an open-ended thing. This morning I was chatting with Andrew Dilnot, an economist at Oxford University who used to run the U.K's Institute for Fiscal Studies—what he described as a cross between the Congressional Budget Office, the National Bureau of Economic Research and the Brookings Institution. He argued that fiscal stimulus should be geared toward priming the pump—that is, getting private players to start spending again. "The strongest argument for doing these sorts of things is that it's a way of the government demonstrating that they're not going to allow the economy to slide into a depression, that they'll spend the money necessary ( THAT'S MY POSITION. IT'S THE EQUIVALENT OF THE GOVERNMENT GUARANTEES NEEDED TO STOP A CALLING RUN, ONLY THIS IS A PROACTIVITY RUN. HERE, THE GOVERNMENT NEEDS TO BE A SPENDER OF LAST RESORT, AND, ONCE AGAIN, ONLY THE GOVERNMENT HAS THE RESOURCES TO BE BELIEVED AS A SOLR. IT SHOULD ALSO BE CLEAR THAT I BELIEVE THAT HAVING THESE GUARANTEES WILL STOP CALLING AND PROACTIVITY RUNS IN THE FUTURE. THE POINT OF THE GOVERNMENT GUARANTEES SHOULD BE TO KEEP PEOPLE FROM PANICKING, THEREBY KEEPING THE NEED FOR GOVERNMENT ASSISTANCE TO A MINIMUM. )," he said. "If people believe it's going to be okay, then people who are putting off buying a new car or house will instead say, I shan't lose my job, I'll go ahead and do that( THAT'S THE WHOLE POINT. I AGREE. A HUMAN AGENCY EXPLANATION. )."

So if stimulus is partly( COMPLETELY. OTHERWISE, IT'S SIMPLY GOVERNMENT SPENDING AS OPPOSED TO PRIVATE SPENDING. ) a game of psychology, then it would make sense to ease off the extra spending once the economy picks back up( YES ). Get consumers and businesses confident enough to spend again, and then let them take over( YES ). In an interview on Wednesday, Obama nodded at that logic. "I'm not out to increase the size of the government long-term," he said. "My preference would be that the private sector was doing this all on their own( MY POSITION AS WELL. )."

I'm guessing that sounds pretty nice to most folks, especially considering the amount of money we've already spent on fixing the economy. But is it true? Jay Newton-Small has a piece up on Time.com that considers how Obama's stimulus package gives him a running start on a bunch of items on his long-term agenda. If we head down this road and GDP rebounds, do we suddenly cut funding? I know a lot more about economics than I do politics, but I'm guessing most legislation doesn't come with an easy on-off switch( THAT IS A CONCERN ).

Though that's not to say I'm against spending money to increase the energy efficiency of two million homes or to build broadband access to all corners of America so that small businesses, no matter where they're located, can be globally competitive. These are good ideas as far as I'm concerned.( GOOD IDEAS. I AGREE. )

All I'm saying is when we start buying computers for schools and paying people to put up windmills let's be clear about whether we're doing these things to save the economy—or if we'd be trying to do them in the long-term anyway.( FOR THE INFRASTRUCTURE PART OF THE STIMULUS, THIS IS ESSENTIAL. )

Here's one of my favorite parts of Obama's speech:

Instead of politicians doling out money behind a veil of secrecy, decisions about where we invest will be made transparently, and informed by independent experts wherever possible. Every American will be able to hold Washington accountable for these decisions by going online to see how and where their tax dollars are being spent. ( WONDERFUL )

I can't wait.

Barbara!"

My view of the importance and use of a stimulus is exactly the same, which is why I don't believe that we need to do as Paul Krugman says:

"More stimulus notes

Mind the gap

1. The new CBO budget and economic outlook is out. Above is its forecast( BS ) for the GDP gap — the hole stimulus has to fill( WHY DOES IT NEED TO FILL THE HOLE BY ITSELF? ). I’d guess( THAT'S WHAT IT IS ) that the CBO estimate, which has unemployment averaging 8.3 percent in 2009 and 9 percent in 2010, is actually too optimistic (see 3, below), but even so it puts the Obama plan in perspective: a 3% of GDP plan, with a significant share going to ineffective tax cuts( NOT CLEAR AT ALL ), to fill an 8% or more gap.

2. How ineffective? Howard Gleckman of the Tax Policy Center says Lots of Buck, not Much Bang.:

Here's his point:

"Refundable tax credits for hiring new workers promise to be an administrative nightmare and won't create many new jobs. It is tough to see how a company that is seeing its sales slaughtered in today’s recession is going to hire just because it gets a few thousand dollars per new worker from the government. Profitable firms would merely take the credit for bringing on workers they were already planning on hiring. ( IT'S AMAZING HOW PEOPLE CAN INTUITIVELY DIVINE WHETHER OR NOT AN ECONOMIC INCENTIVE WILL WORK. I HAVE NO IDEA WHAT HE'S BASING THIS VIEW ON. IT SEEMS LIKE A POSITIVE MOVE TO ME. )

I can’t begin to imagine how the variation on this idea--credits for not laying someone off--would work( HERE I AGREE ). My head throbs at the concept of the IRS trying to administer a rebate based on intentions. Worse, these breaks would never work unless they are refundable and, to be honest, giving such credits to failing business makes my skin crawl. In reality, it would become yet one more bailout—only this time taxpayers wouldn't even get stock for their trouble."

Back to Krugman:

3. The official BLS numbers won’t be out until Friday, but the ADP jobs estimate, based on private payroll data, is spectacularly grim. "( AND ACCORDING TO THE BIG PICTURE, NOT VERY USEFUL. )

Krugman's view is Mechanistic. The economy is like an engine. It needs a lot of oil. I don't credit this view at all. If there's one view that always wastes money, it's a mechanistic view of human behavior.

I would prefer an incentive for investment, but adding workers isn't a bad alternative. Let me explain something: We're fighting the fear and aversion to risk. One way to attack that is to target incentives to minimally effect this. The alternative is much more than spectacularly grim. There's no proof that any of these measures will be effective, least of all picking an enormous figure based on a graph of useful but inexact numbers. The idea that overspending poses no risk is beyond belief. It is itself a panicked reaction to our crisis. We've had a number of those recently, and, as of now, the record is mixed at best.

"In fact, the investment/net worth ratio is currently at a postwar low."

Bad news for another of my proposals. Namely, targeted tax cuts for investment. From Macroblog:

"Will tax stimulus stimulate investment?

On Monday, the form of potential fiscal stimulus, 2009-style, took a step forward detail-wise. From the Wall Street Journal:

“President-elect Barack Obama and congressional Democrats are crafting a plan to offer about $300 billion of tax cuts to individuals and businesses(ODDLY, THAT'S THE SAME AMOUNT AS MY PROPOSAL FOR THESE TWO TAX CUTS ), a move aimed at attracting Republican support for an economic-stimulus package and prodding companies to create jobs( I WANT TO USE IT AS AN INCENTIVE TO ATTACK THE FEAR AND AVERSION TO RISK, WHICH I BELIEVE TO BE THE MAIN PROBLEM NOW.).

“The size of the proposed tax cuts—which would account for about 40% of a stimulus package that could reach $775 billion over two years( MY FIGURE IS $700 Billion )—is greater than many on both sides of the aisle in Congress had anticipated.”

The plan appears to make concessions to both economic theory—which suggests that consumers will save a relatively large fraction of temporary increases in disposable income—and recent experience—which seems to suggest that what works in theory sometimes works in practice. Again, from the Wall Street Journal:

“Economists of all political stripes widely agree the checks sent out last spring were ineffective in stemming the economic slide, partly because many strapped consumers paid bills( ISN'T THAT SPENDING? ) or saved the cash( I HOPE SOME PEOPLE DO. JUST NOT EVERYBODY. ) rather than spend it. But Obama aides wanted a provision that could get money into consumers’ hands fast, and hope they will be persuaded to spend money this time if the credit is made a permanent feature of the tax code.”( I THINK THAT THE TAX HAS TO BE PHASED OUT TO ENCOURAGE SPENDING SOONER RATHER THAN LATER.)

As for the business tax package:

“… a key provision would allow companies to write off huge losses incurred last year, as well as any losses from 2009, to retroactively reduce tax bills dating back five years. Obama aides note that businesses would have been able to claim most of the tax write-offs on future tax returns, and the proposal simply accelerates those write-offs to make them available in the current tax season, when a lack of available credit is leaving many companies short of cash.

“A second provision would entice firms to plow that money back into new investment( THIS IS WHAT I WOULD FAVOR ). The write-offs would be retroactive to expenditures made as of Jan. 1, 2009, to ensure that companies don’t sit on their money until after Congress passes the measure.”

A relevant question here is really quite similar to the one we ask when the tax cuts are aimed at households: Will the extra cash be spent? This graph provides some interesting perspective:

Relative to net worth (of nonfarm nonfinancial corporate businesses), private fixed investment has been in consistent decline since the second quarter of 2006. (The level of fixed investment has declined in each quarter, save one.) In fact, the investment/net worth ratio is currently at a postwar low. ( IS HOUSING INCLUDED? )

Why? A couple of hypotheses come to mind. (1) Firms are extremely pessimistic about the outlook and see relatively few worthwhile projects in which to commit funds.( TRUE ) (2) Credit markets are so impaired that the net worth of firms—a critical variable in mainstream models of the so-called “credit channel” of monetary policy—is supporting increasingly smaller levels of lending.( TRUE ) (3) Nonfinancial firms, like financial firms, are deleveraging and hence not expanding( TRUE ). ALL OF THESE ARE PROBABLY TRUE TO SOME EXTENT, BUT WHEN I LOOK AT THE GRAPH, IT SEEMS THAT INVESTMENT STARTED GOING DOWN DURING THE TECH BUBBLE YEARS AND CONTINUED IN THE HOUSING BUBBLE YEARS. I'M WONDERING IF THERE HASN'T BEEN A MASSIVE AMOUNT OF MONEY INVESTED IN STOCKS AND HOUSING AS OPPOSED TO, SAY, MANUFACTURING. SEE BELOW.

Of course, even if one of these hypotheses is true, it need not be the case that marginal dollars sent in the direction of businesses will go uninvested. But it makes you wonder.( I STILL FAVOR MY IDEA. THE GRAPH ISN'T CONCLUSIVE. )

By David Altig, senior vice president and research director at the Atlanta Fed"

Here's Casey Mulligan:

"TESTING THE THEORY WITH DATA FROM 2008

Another application of this logic is to the residential sector: does residential spending increase or decrease nonresidential spending? Here it is easy to see the importance of supply -- see the figure below.

When housing boomed, nonresidential construction spending fell (despite the fact that the housing boom was increasing the prices of construction labor and materials) -- almost dollar for dollar!

When housing crashed, nonresidential construction spending ROSE (despite the fact that the housing crash was reducing the prices of construction labor and materials), about 15 cents on the dollar. Note that, according to the NBER, some of the nonresidential increase occur ed during a recession.

Another fascinating property of this episode is that the shocks to spending are on the order of magnitude (100s of billions of dollars) of the kinds of fiscal stimuli being recommended by some economists.

When interpreting what is above, we need to recognize that a large sector is omitted -- the non-construction sector. For this reason, the calculations above underestimate of the aggegate supply effect of housing spending on nonresidential spending (Take, for example, accountants. A housing boom pulls accountants into work for construction businesses, which leaves fewer accountants to work for non-construction businesses.). But they also underestimate the aggregate demand effect, because the housing construction workers are taking their paychecks and spending some of it on non-construction items. In any case, the supply effect is easy to see -- the housing construction boom did not take place with resources that would have otherwise been unemployed and the housing bust did not release resources entirely into unemployment."

So, I'm wondering if the Tech and Housing Bubbles diverted money away from other types of investment. If so, we might want to rethink subsidizing the purchases of houses ( I'm for a general housing subsidy for low-income people. ) It would seem to me, interpreting Mulligan's points for my own purposes, that now would be an especially felicitous time to encourage investment in sectors that have been recently shunned.

"But many of the critics of mass fiscal stimulus have an alternative frame in mind, namely, that "employment increases spending."

Alex Tabarrok on Marginal Revolution makes a good point:

"Macroeconomics without Supply

Alex Tabarrok

Paul Krugman writes:

...if you believe that a surge in private spending would raise employment — and even the critics agree on that — it’s very hard to explain why a surge of public spending wouldn’t have the same effect.

Brad DeLong writes:

But surely we believe that if the U.S. government were to follow the Countrywide plan--to send its representatives out onto the streets to have them walk up to people and say: "Here's $500,000. You can have it if you go buy a house"--then that would drive a recovery, right?

What's interesting about these statements is not so much whether they are right or wrong (let's just say that it depends) but that Krugman and DeLong are so immersed in the Keynesian viewpoint that they cannot even see any other way of looking at the issue. Thus "even the critics" and "but surely we believe," as if no other view were conceivable.

Well if the only frame you can see is the "spending increases employment" frame then whether the spending is private or public may seem like a niggle. But many of the critics of mass fiscal stimulus have an alternative frame in mind, namely, that "employment increases spending."

Frame the issue this way and it becomes clear that the choice between private employment and public employment as a driver of spending is crucial. Moreover, when we remember that employment drives spending we focus attention on the real allocation of labor and capital across sectors of the economy, on internal and external fiscal balance, on investment as well as on consumption and on time paths of development. The "spending drives employment" frame misses all this."

These are good points. The government needs to spend money on:
1) The social safety net
2) Infrastructure
I have no good numbers on these, because, even if I were an expert, I still wouldn't know how much 1 will turn out to cost us, and 2 depends upon how many truly useful and cost efficient infrastructure projects we will be able to develop.

Otherwise, we should focus on the Fear and Aversion To Risk, which is the main problem that we are facing. The way to do that is to try and offer incentives for risk, such as tax reductions. Oddly, greater risk will lead to more jobs as lending and investment unfreeze.

One could also target consumption with a sales tax decrease or payroll tax decrease, which will be for a limited time only. This would offer some disincentive to saving, but not enough to stop all saving, since we need some increase in saving as well. Going forward, we should look into incentives for saving as well. But not right now.

"The installation of infrastructure increases economic growth in the future"

Mark Thoma answers some of my questions about Woodward and Hall's post:

"Romer and Romer do not look at government spending multipliers, so we don't know if the government spending multiplier is smaller/larger than the tax multiplier if they are estimated in the same model (note, though, the the confidence band for Romer and Romer's tax multiplier is 1.3 to 4.7, so a multiplier smaller than Ramey's estimated value of 1.4 for government spending - though not strictly comparable since it comes from a different model - is within the confidence bounds of these estimates; confidence bounds for Ramey's estimates are not reported). I should also note that Romer and Romer isolate different types of tax cuts, the multiplier of 3.0 (plus or minus about 1.7) is for exogenous tax changes intended to promote economic growth, not tax changes intended to stabilize the economy. Their results for tax cuts used for stabilization purposes are not encouraging:

The behavior of output following countercyclical tax changes ... suggests that policymakers' efforts to adjust taxes to offset anticipated changes in private economic activity have been largely unsuccessful.

Finally, many estimates of the Keynesian government spending multiplier can be criticized on the same grounds that the tax cut advocates like to cite. The installation of infrastructure increases economic growth in the future, but these dynamic effects are missing from the standard Keynesian analysis (and using history as a guide is not very helpful since we have had very few surges in government spending devoted to infrastructure spending, and we have little data on the effects of fiscal policy - or any policy - in severe downturns since they are so unusual). If the dynamic effects were to be included in the infrastructure spending mulitplier, the multiplier would be larger."

This would explain my belief that infrastructure spending does have positive benefits, and that tax cuts don't necessarily do a great job as a stimulus.

But he doesn't discuss targeted tax cuts in order to help move the fear and aversion to risk in investment. I still think that's an obvious move, and don't understand what's so controversial about them.

"A similar result might obtain if the tax cut included, say, an investment tax credit."

Greg Mankiw on the stimulus:

"A key issue facing the new Obama administration is to what extent the economic stimulus should take the form of spending increases versus tax reduction. One way to think about the issue is the size of the fiscal policy multipliers. The multipliers measure bang for the buck--the amount of short-run GDP expansion one gets from a dollar of spending hikes or tax cuts.

So what are these multipliers? In their new blog, Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government spending multiplier is about one: A dollar of government spending raises GDP by about a dollar. Similarly, the results in Valerie Ramey's research suggest a government spending multiplier of about 1.4. (Valerie does not present her results in multiplier form, but she emails me this translation: "The right column of figure 5A of my paper shows that for a log change of government spending of 1, log GDP rises by 0.28, implying an elasticity of 0.28. To back out the implied multiplier, we can use the fact that government spending averages around 20% of GDP. This implies a multiplier of 1.4.")"

Well there is a difference between 1 and 1.4. I'm wondering how they can be different, since they relied on the same research.

"By contrast, recent research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars. The puzzle is that, taken together, these findings are inconsistent with the conventional Keynesian model. According to that model, taught even in my favorite textbook, spending multipliers necessarily exceed tax multipliers."

This is interesting. Couldn't people just save the tax cut? Also, I though that the tax cut earlier this year didn't do much for the economy?

"How can these empirical results be reconciled? One hypothesis is that that compared with spending increases, tax cuts produce a bigger boost in investment demand. This might work through changing relative prices in a direction favorable to capital investment--a mechanism absent in the textbook Keynesian model.

Suppose, for example, that tax cuts are not lump-sum but instead take the form of cuts in payroll taxes (as suggested by Bils and Klenow). This tax cut would reduce the cost of labor and, if labor and capital are complements, increase the demand for capital goods. Thus, the tax cut stimulates demand not only by increasing disposable income and consumption spending (the textbook Keynesian channel) but also by incentivizing more investment spending. A similar result might obtain if the tax cut included, say, an investment tax credit."

I am for, and have said so a number of times, incentivizing more investment income to try and overcome this fear and aversion to risk through targeted tax breaks. I would accept either attempt, but frankly prefer the investment tax credit as more focused on the immediate necessity. It might also be easier to assess, which is something I find essential with any tax proposal.

"This hypothesized channel seems broadly consistent with the empirical findings of Blanchard and Perotti, Mountford and Uhlig, Alesina and Ardagna, and Alesina, Ardagna, Perotti, and Schiantarelli. The results of all these authors suggest you need to go beyond the standard Keynesian model to understand the short-run effects of fiscal policy."

I still insist on social safety net spending. Some infrastructure spending also seems advisable to me, but only on projects clearly warranted on their own. The tax breaks mentioned above, especially the investment tax credit, actually try and attack the main problem from my point of view, namely, the fear and aversion to risk.

"My advice to Team Obama: Do not be intellectually bound by the textbook Keynesian model. Be prepared to recognize that the world is vastly more complicated than the one we describe in ec 10. In particular, empirical studies that do not impose the restrictions of Keynesian theory suggest that you might get more bang for the buck with tax cuts than spending hikes."

I believe that targeted tax cuts would work better to alleviate our main problem.

"The industry wants a temporary change in tax laws that would allow companies to receive a rebate upfront"

There does seem to be no end to this tune. I don't see a paucity of supplicants for some stimulus money or tax breaks:

"By David Olmos

Dec. 10 (Bloomberg) -- U.S. biotechnology executives are lobbying Congress to change a tax law and provide millions of dollars in government money to small, cash-starved drugmakers that comprise most of the industry.

The industry wants a temporary change in tax laws that would allow companies to receive a rebate upfront in exchange for giving up a portion of net operating losses deductions they are eligible to take once they begin to make a profit, Matt Gardner, president and chief executive of BayBio, an industry group in South San Francisco, California, said yesterday in a telephone interview.

Although its troubles are not as high profile as those of carmakers and banks, the biotechnology industry is facing one of its worst cash shortages in years. The crisis is being felt most severely by smaller companies, which require big infusions of money for costly drug research though they often have no sales. New drugs require hundreds of millions of dollars and more than a decade to develop.

“Most of these companies have not yet had their first product approved” by regulators, said Gardner. “They don’t have any revenue, and they are accumulating these operating losses. This change would allow them to convert some of these losses back into future research spending, which is a very good thing for the economy.”

The effort in Congress is being led by the Biotechnology Industry Organization, or BIO, a Washington, D.C.-based trade group. According to the group’s figures, 25 percent of the 370 publicly traded U.S. biotechnology companies have less than six months of cash on hand. The industry also has been hit by hundreds of layoffs and some bankruptcies.

Under the proposal, a company with $100 million in net operating losses would be entitled to $35 million in lower federal taxes when it becomes profitable, Alan Eisenberg, executive vice president of BIO, told the New York Times. Such a company might receive $20 million now under the proposal, he said.

Gardner said executives from the lobbying group and biotechnology companies would be talking today with lawmakers on Capitol Hill seeking the change."

I'm for it. I just believe in developing new drugs, and I don't mind targeted tax breaks in a downturn to keep

"downturns of the current magnitude in the LCrI have never occurred except before recessions."

From BusinessCycle the following chart:

"Credit Woes Ahead(Full report received by Pro clients on 15-Jul-08)

Since the epicenter of this recession continues to be the housing-related credit crisis, it is worth examining the outlook for credit growth in the context of the Fed easing that has already occurred. For this purpose, we look at the Leading Credit Index which is designed to anticipate cyclical turns in Nonfinancial Corporate Debt growth.

As the chart shows, downturns of the current magnitude in the LCrI have never occurred except before recessions. However, the downturn in corporate debt growth has only recently begun, suggesting that it has some way to go since, typically, corporate debt growth bottoms out shortly after the recovery begins.

I take this to mean that corporations ( non-financial ) are borrowing less money. Given the rates of interest on corporate bonds, this makes sense. This is one reason I've advocated cutting taxes on corporations. We need to give them incentives to fight against the fear and aversion to risk that is a major problem today.

"Then a stimulus of about 4 ppts of GDP -- roughly $580 billion -- will bring output up to about potential. "

Menzie Chinn on Econbrowser with some thoughts about the stimulus:

"Then a stimulus of about 4 ppts of GDP -- roughly $580 billion -- will bring output up to about potential. The bigger the tax cut element skewed toward higher income deciles, the larger the required stimulus. (However, I'm optimistic that with the new economic team of Summers, Orszag, Romer and Geithner that's been selected, the package will indeed hew to the idea of maximizing the stimulative impact, which is consistent with targeting the lowest and middle income groups for tax cuts/rebates [5], [6].)

And if stimulus across countries can be synchronized, then so much the better (especially since it would be hard to spend at $580 billion in one year).

By the way, the reason why I don't say "coordinated fiscal policy" is because, in the lexicon of academic economists, this would mean commitment to some sort of rules so that Nash outcomes can be avoided. See Frankel and Rockett (1986). In this discussion, I have in mind a more modest, one-shot, event, since I'm not sure a coordination is feasible over the longer term.

On a side note, I've just been watching Nancy Pfotenhauer on Larry King characterizing the new Obama economic team as "not change" because they are centrists. I think she misses the point entirely (not surprising). The "change" is not a matter of the economic ideology of the new team members -- rather the "change" is bringing in people who value expertise and evidence-based policymaking over ideology and dogma. That is, the end of PoMo Macro policymaking."

Her figure is probably close to what will be spent, over two years. At least, as of today.

"John Maynard Keynes called it the Paradox of Thrift, but most economists I know don't talk about it much for fear of being labeled a Keynesian."

I can think of worse things to be called. In fact, I've been called them. Repeatedly. Bob McTeer on The Paradox Of Thrift:

"The economy is facing quite a dilemma-or paradox. Actually, John Maynard Keynes called it the Paradox of Thrift, but most economists I know don't talk about it much for fear of being labeled a Keynesian. The paradox is this: most of us need to save more, i.e., consume less of our disposable income. Yet, if all or most of us try to save more at the same time, income will fall. The paradox comes in because out of the lower income we will likely end up saving less, not more.

The problem for the economy is this: consumption makes up about 70 percent of total spending, and consumption has been supporting the economy for years even though the personal saving rate is close to zero. The reason is that individual consumers who have experienced capital gains in their homes and in their stock or mutual fund portfolios (including those in their pension funds, 401Ks, IRAs, and the like) have thought of those capital gains as saving and thus have been willing to consume virtually all of their current income. (This is legit for individuals, but not for the nation as a whole since resources aren't being made available by capital gains.)"

Now, I see this as a problem of incentives for individuals, not a paradox. The incentives must be re-balanced to motivate individuals to spend and invest.

Here's my response:

Don the libertarian Democrat Says:

1. November 12th, 2008 at 9:29 pm

   “Second, and perhaps more important, “savings” represent loanable funds; an increase in the supply of loanable funds tends to lower interest rates and stimulate borrowing, so a decline in consumable goods with a short time horizon is offset by an increase in production in sectors with longer time horizons. For example, the demand for personal electronics might decline, but the demand for such things as real estate would be stimulated by favorable borrowing conditions.”

   I was going to write this, but Wikipedia says it better than I would have. During a recession, one can pass laws to increase long term investment and infrastructure spending, using tax breaks or government investment.

   As well, use loans and spending to help people start businesses. I actually started a business during a recession as I recall. I got a great deal on my rent at the time.

   By giving benefits to people who aren’t able to spend, with targeted tax cuts and investment, saving can be a good thing at all times. Of course, as a follower of Maimonides, moderation in most things is the wise course.

   The Paradox of Thrift seems more a problem of group versus individual behavior, which can be overcome with countervailing incentives for individuals.

"Where will the Treasury find the money? "

Via Crunchy Con, a post on Asia Times about the deficit and it's funding by David P. Goldman:

"The United States government needs to borrow US$1 trillion a year, before a new stimulus package, or handouts for the auto industry, or healthcare reform, or a dozen other spending programs promised by the incoming administration of president-elect Barack Obama. Where will the Treasury find the money?

A bizarre jump in the US Treasury's real cost of borrowing points to severe market disruption if the Treasury deficit continues to rise. It appears that the Treasury market is also a victim of global de-leveraging. The new administration has far less budgetary flexibility that it seems to think."

So, it will get costlier to service our debt. This problem will occur sooner than later because people around the world are going to avoid risk and increase capital.

"Equity, commodity and Treasury bond markets all are registering a deflationary crash in precisely the same way. That seems clear enough. The dog that barked, but shouldn't have, is the "real" component of Treasury yields.

The answer to the mystery of tripled real Treasury yields is to be found in the collapse of leverage in the global financial system. Indirectly, the rapid expansion of leverage in the global banking system contributed to demand for Treasuries. When de-leveraging commenced in August, an important component of demand for Treasuries declined sharply. That is bad news for Washington, but even worse news is that it will continue to decline sharply, just when Washington most requires global support for the US government debt market.

Global leverage indirectly increased demand for Treasuries in three principal ways:
1. It fed the boom in raw materials prices, increasing demand for Treasuries on the part of central banks as well as financial institutions in commodity-producing countries.
2. It pushed up the value of emerging market currencies, prompting emerging market central banks to intervene in foreign exchange markets by purchasing dollars which then were invested in Treasuries.
3. It contributed to the rise in global equity prices, which prompted investors to diversify their portfolios and purchase safer assets including Treasuries.

The carry trade, in which investors borrow low-interest currencies (dollars or yen) and buy high-interest emerging market currencies, created demand for Treasuries by funneling money into emerging markets that ended up as dollar reserves in their central banks. "

Here he explains why the demand for our bonds rose and are falling.

"We do not have Treasury data past August, and it well may be the case that a similar exception will emerge during the second half of 2008, as foreign investors increase their net purchases of Treasuries while stock markets crash, and for a symmetrically opposite reason. Investors may prefer safer assets.

We cannot directly estimate the impact of de-leveraging on the Treasury market, but it seems clear that the explosion of leverage during the past five years had a profound, if temporary, impact on the world market's demand for US government securities."

Now he's explaining what, for him, is an anomaly; namely, when this crisis began, instead of not buying our bonds, investors bought them because they considered our bonds safer than other investments around the world. This happened even though our interest rates were low. Now he seems to be saying there's no direct relationship between de-leveraging and the demand for our debt, which I took to be his thesis.

"We can observe in the movement of market prices, though, a close relationship between the breakdown of the carry trade and the rise in real Treasury yields. Withdrawal of leverage from the system forced market participants to liquidate carry trade positions."

I would have thought this had to do with exchange rates, but maybe he's saying that de-leveraging caused their movement.

"The Treasury market benefited from the explosion of bank leverage during the past 10 years, as emerging market central banks became the most important new buyers of US government securities. De-leveraging and the collapse of commodity markets combine to destroy global demand for Treasuries, limiting the US government's capacity to borrow from overseas sources."

What goes up, must come down. People bought our debt during leverage, but they won't when they de-leverage.

" Other major holders of US Treasury securities are likely to wish to reduce their holdings rather than to increase them. China's accumulation of foreign reserves represented "rainy day" savings for the nation, and the severity of the present crisis shows how well-advised China was to accumulate a large volume of reserves. China has announced plans to spend the equivalent of 20% of gross domestic product in a stimulus program which is likely to increase the country's demand for foreign capital goods.

China's trade surplus is likely to diminish sharply, both due to falling export demand and import growth arising from the stimulus package. Chinese reserves are likely to cease growing and may even decline as a result. Oil-producing countries, moreover, may have to spend reserves in order to maintain import levels as a result of the collapse of oil prices. "

Not even China.

"It is far from clear from whom, and on what terms, the US Treasury will obtain $1 trillion a year, or even more, to finance its deficit. The overseas well has run dry, and domestic financing of the deficit would require a drastic increase in the savings rate at the expense of spending, or outright monetization of the debt by the Federal Reserve. "

Okay. We could buy our own bonds, basically save, in other words, but that would reduce consumption spending, deepening our recession. The Fed could also print money ( read inflation ) .

"One way to increase the government savings rate, of course, is to increase taxes

, but that is an unlikely course of action during a severe recession. "

We could reduce our need to borrow by increasing taxes, but that's bad in a recession, because it reduces consumption spending, causing the recession to deepen.

"If the deflation persists, the Federal Reserve may be compelled to purchase US government debt. "

The Fed can stop deflation by causing inflation.

"Another possibility is that risk appetite among investors at home and abroad will continue to fall, inducing a portfolio shift towards Treasury securities. In this case "crowding out" will occur through risk-preference. It will not be so much that competing borrowers are crowded out of the lending market, but that investors will stampede away from risk. In this scenario, even a very low federal funds rate will not help to restore economic activity. "

Investors won't invest in new businesses because they're afraid of risk, so they'll save. This is a version of the Paradox Of Thrift. Instead of spending money to get us out of a recession, people will hoard it by saving, deepening the recession. One way out of this so-called paradox, is that the savings go into banks where it gets loaned out cheaply and people can use that money to invest in long term projects like infrastructure, causing hiring and spending, therefore helping to get us out of the recession and making us wealthier because we've added infrastructure. This is my answer, by the way. He's postulating a version of Ricardian Equivalence by saying that even my theoretical investors will be too afraid to invest in infrastructure.

"The point of lowering the risk-free rate is to push investors towards riskier assets. In a normal business cycle, falling output leads to lower yields on low-risk bonds, which in turn encourages investors to add risk to their portfolios by investing in businesses. "

That's what I just said will happen.

"If the safest of all investments, namely US Treasuries, suddenly offer much higher real yields, comparable to the boom years of the late 1990s, why should investors take risk? "

Okay. If I'm an investor, and I can get a high rate of interest from safely investing in Treasuries, why would I bother to invest in riskier businesses in the real world.

"In any of these scenarios, the result of global de-leveraging is dire: the more the US government tries to bail out businesses and households, the more bailing out the economy will need. The Bush administration's response to the financial crisis, and the likely content of the Obama administration's economic program, will deepen and prolong the economic downturn. "

I guess he's positing a greater and greater aversion to spending and risk because we'll all be buying Treasuries, which won't do us any good.

"It is not generally remembered that the premise of the Reagan administration's tax cuts was Robert Mundell's work on the optimal level of government debt. Mundell, who won the Nobel Prize in 1991 for his work on international economics, observed that an increase in government debt might represent an improvement in market efficiency, if it corresponded to an increase in incomes. That might occur if a reduction in taxes caused an increase in the deficit, while stimulating economic growth. In that case, Mundell argued, a tax cut would increase efficiency if the additional revenues arising from the growth effect were larger than the interest on the bonds issued to cover the ensuing deficit. "

I just like explanations.

"The capacity of the US and the world to finance an increase in the federal deficit was much greater, and the incentives arising from reducing the top marginal tax rate from 70% to 40% were much greater than any incentives that might be envisioned from tax cuts from the present level. "

Back then, marginal tax rates were really high, but now they're not. I'm not sure why we couldn't cut other taxes or get some revenue back from tax cuts this time. Anyway, he's claiming that it won't be enough to help.

"Even the best-designed economic policy would be hard-put to provide growth incentives without a substantial increase in the savings rate and a corresponding reduction of consumption, implying a very sharp economic contraction. If the Treasury tries to spend its way out of recession, the results are likely to be very disappointing. "

As near as I can tell, this is the Paradox Of Thrift, which I don't see as a major problem. The way to shift the tendency to save is to offer incentives not to. He's claiming that this time it will do no good. I don't agree, and we should certainly try.

Okay. This scenario is around in different forms. One scenario uses the same info he does to argue simply that we shouldn't have a huge stimulus and vastly increase our deficit and debt. He's more dire than that. He's positing a kind of mechanical downward spiral that we can't get out of.

Anyway, all one really has to know is that to counter this downward spiral we simply have to offer incentives for people to alter their spending and investment choices. One way to do this is to fashion a tax cut aimed at encouraging investment instead of everyone just buying bonds over and over. See, I don't believe that risk taking is dead, or even that dormant. So, I basically don't agree with his analysis of the Paradox Of Thrift or the total death of risk taking, killed by high interest debt from the government. But he's interesting, and I loved the charts.

China:"A stimulus package estimated at 4 trillion yuan (about 570 billion U.S. dollars) will be spent over the next two years"

China goes stimulus, via Alphaville:

"China said on Sunday it will loosen credit conditions, cut taxes and embark on a massive infrastructure spending program in a wide-ranging effort to offset adverse global economic conditions by boosting domestic demand."

Stimulus plan is to increase domestic demand. It's going to:

1) Ease credit
2) Cut taxes
3) Spend on infrastructure

"A stimulus package estimated at 4 trillion yuan (about 570 billion U.S. dollars) will be spent over the next two years to finance programs in 10 major areas, such as low-income housing, rural infrastructure, water, electricity, transportation, the environment, technological innovation and rebuilding from several disasters, most notably the May 12 earthquake.

The policies include a comprehensive reform in value-added taxes, which would cut industry costs by 120 billion yuan.

Commercial banks' credit ceilings will be abolished to channel more lending to priority projects, rural areas, smaller enterprises, technical innovation and industrial rationalization through mergers and acquisitions."

$570 billion of two years. Wow

3) Spend on infrastructure:

A. Low-income housing

B. Rural infrastructure

C. Water

D. Electricity

E. Transportation

F. Environmental projects

G. Technology

H. Enhanced disaster relief

For 2) Cut taxes

A. Cut VAT

For 1) Ease credit

A. Lower capital requirements

And 4) Encourage mergers and acquisitions

"The meeting decided that credit expansion must be "rational" and "target spheres that would promote and consolidate the expansion of consumer credit."

"The most recent modification was in December, when the government resorted to a combination of "tight" monetary policy and "prudent" fiscal policy to fight inflation."

"in September -- the focal task of macro-economic control has shifted from beating inflation to sustaining economic growth."

So, moving from fighting inflation to encouraging growth.

"The past three months have seen a series of stimulus policies: interest rate cuts, lower bank reserve requirement ratios, tax changes, higher credit quotas and the injection of central government funds to infrastructure construction.

The meeting decided that higher investment must be able to facilitate economic restructuring, promote growth potential by channeling investment to where it's most needed and spur private consumption."

They tend to repeat things a lot in these press releases.

Here's Brad Setser earlier on the Chinese stimulus plan.

Try here as well.

From the WSJ, some analysis of the plan.