World War II, not the New Deal, is the model for COVID-19 macroeconomic policies

Central planning (Socialism?) in democratic societies

There is a lot being written on the causes and cures for the economic consequences of the Coronavirus (COVID-19). The predictable distinction is among those that think that this is essentially a demand shock, mostly to services, and those that are concerned with the disruption to supply chains. And to some extent both are correct. But that is not the more relevant problem here, which is whether we need just more government or a change in the nature of the governmental interventions.

Neil Irwin, from the New York Times, provides a suitable and simple explanation of the demand shock story. Note that a demand shock often goes together with significant financial implications, as agents with reduced revenue tend to default on loans or payment streams to any liabilities. The Economist noted the risk associated with excessive corporate debt, and the possibility that the virus might trigger a debt-deflation type crisis in financial markets. On the fragility of corporate balance sheets see also this insightful piece by Michalis Nikiforos. Many economists have talked in favor of this interpretation, and certainly there is a lot to be said about this view, which I tend to agree with, by the way.

The fiscal expansion plans put forward by the administration have been mostly seen through the lens of a regular demand shock version of the recession. They include things like a bailout of certain sectors hit hard by the sudden decline in demand, like the airlines, and checks to those that have lost their jobs, besides the Fed injecting liquidity to reduce the financial effects of the demand shock. In that sense, not very different from the fiscal package and financial rescue of the 2008 crisis.

Of course, macroeconomic policies in 2008, even though they did preclude a fall in unemployment of the magnitude that had occurred in the 1930s during the Great Depression, were flawed in many ways. They did rescue banks, but left many to lose their houses for one (and Obama's Justice Department did not prosecute in any significant way the many financial excesses of Wall St); it was also probably on the smaller side, leading to a prolonged, but very slow, recovery, in which labor market conditions remained relatively poor for many workers, even with low levels of unemployment by the end. All things that increased the problems at the bottom of the income distribution and helped explain Trump's political victory in 2016. Hence, there is reasonable fear that these policies might not work well this time around again. Besides, there is a case to be made that this crisis is not fundamentally a demand shock.

A prominent defender of the latter is Dean Baker. He says: "Our problem is not creating demand in the economy, the problem is keeping people more or less whole for a possibly extended period in which much of the economy is shut down." And as he notes, sending checks to people directly will fall short of a solution. Checks will be irrelevant for many, that have secure jobs, and insufficient for many, since it will be too little, or because some people might be directly excluded from such programs, like undocumented immigrants with US born children. Dean's alternative is to send money directly to companies that would keep workers employed and inactive, helping in the recovery too. Of course this solution deals fundamentally with those in the labor market, and not with those in more precarious situations.

I see the problem as being essentially a demand shock, note that the increase in unemployment insurance applications was marked last week, to a great extent associated to Coronavirus layoffs. Obviously nobody would deny the supply side effects of the crisis, even though these are less disruptive in the short run, in my view. Nobody is being laid off because the company is unable to obtain intermediary goods for production, or at least not on significant numbers. It is the sudden collapse of demand that matters. But that misses the point of the kind of demand and supply shocks that have hit the economy. These are localized, uneven shocks and an efficient policy reaction requires targeted interventions. The kind of intervention we need is one that one the demand side tries to maintain the ability of families with cash flows problems (the ones laid off and those that were already outside the formal job market), and on the supply side that redirects production to the sectors that would experiment a surge in demand.

The most typical analogy in times of macroeconomic crises is the Great Depression, and progressives, not incorrectly go searching for ideas in the New Deal tool box. However, the New Deal was mostly about regulation, in its first phase, and about spending, in particular after the Roosevelt Recession. The kind of intervention we need is more akin to World War II, one in which government agencies have ample powers to requisite, produce or fund private corporations to produce what is needed as vital effort for survival, as alluded by Jamie Galbraith in his recent piece on the virus. For example, we need to reconvert the economy to produce more ventilators, which are in short supply, and also to ration the ability of families to hoard certain key central consumer goods, to preclude localized scarcity of essential items like hand sanitizer. We need planning, not just more government spending. And, yes, that means Socialism (or Social Democracy). This was something that no US citizen would have been surprised about, in particular after the incredible collapse of the market economy in the early 1930s, and it should not be a surprise that Socialism is somewhat more popular now. COVID-19 makes it clear why markets cannot cope with global crisis like a pandemic.

Another central element of the World War II effort was the generous and strategic concern with the global impact of US policies. Lend-lease, even before the US entry in the war, was central for allowing the UK resist the Nazi onslaught, and the subsequent program with the Soviet Union was crucial for them to be able to resist, and eventually win the war in the European front. In order to defeat Nazism, the US authorities were willing to cooperate with a Communist government, and provide significant resources. A similar approach should be used to deal with nations that are not seen as allied (like the Soviets then), but that in a particular context should be helped, like Iran, and Venezuela, which are and will be under extreme duress during the pandemic. The negative effects on the US image associated to the tightening of the sanctions, and the impediments to IMF loans under these circumstances, will be hard to reverse.

Finally, some think that this would be a short lived V-shaped recession. Meaning that once the main social distancing policies are lifted, the economy will recover swiftly. Note, however, that the duration of the measures is contingent on its own success. The more successful we are at flattening the curve, meaning reducing the contagion rate, to avoid overwhelming the health system, the longer the economic disruption will be, and the more we would need a planned economy.

PS: Portuguese translation here.

The left and the return of protectionism

So if you believe a simplified version of conservative views on the economy, Trumponomics is pretty contradictory (and yes they are contradictory, even if one may doubts about why). Tax cuts should lead to growth, via supply side economics, and the recently proposed tariffs on steel and aluminum do exactly the opposite. Protectionism (not a very good name, I prefer managed trade, as I discussed here before) has made a come back, but while many heterodox economists have suggested that 'free trade' is not always beneficial to all, and those concerned with the fate of manufacturing and the working class in the United States have decried Free Trade Agreements (FTAs) over the years, it seems that the association of these ideas with Trumponomics has made them less keen on the recent tariff proposal.

A typical example is the recent op-ed by Jared Bernstein and Dean Baker in WAPO, and I cite them exactly for my respect for their economic views in general, and their commitment to progressive causes. In their view: "The bigger dangers to our economy are twofold. One, that our trading partners will retaliate by taxing our exports to them, thus hurting a broad swath of our exporting industries, and two, by leading an emboldened, reckless Trump administration to enact more bad trade policy." Essentially, they agree that tariffs would have a negative effect on employment, but perhaps not as big as some Cassandras have suggested, and that this 'bad protectionist' policies would continue. A similar argument can be found in Brad DeLong's op-ed, another progressive economist, in which he argues that the tariff is a tax hike for consumers. Brad, I should note, has recently published a very good book in which he praises the Hamiltonian system, that is,  the use of managed trade to promote industrial development (I discussed it here).*

It's worth remembering that while on other issues Trumponomics is essentially Reaganomics (low taxes for the wealthy and increased military spending), on trade his views are a break with more recent Republican positions (and hence the push back in his own party against the tariffs) and closer to what many Dems, particularly those connected with trade unions, often defended. He has not signed TPP, has really started renegotiating NAFTA (something Obama promised to do as a candidate, but did not deliver as president) and now has imposed some tariffs (like, btw, Bush, so I'm not suggesting this is unprecedented; just that he has been more consistent on this topic).

Don't get me wrong, I'm not a big fan of Trumponomics, or even in particular of these tariffs. And this will not work probably, but the reasons are not the ones adduced by progressives. Their basic argument is that retaliation by other countries will make them innocuous. In all fairness, the US is already more 'protectionism' (manages trade) than most people understand. The ability to use trade treaties and organizations for defending the country's own advantage is considerably tilted in favor of advanced economies and their corporations that can use loopholes to creatively avoid rules and continue to subsidize their industries (and agricultural sector). The US use of the defense department, again used by Trump, is typical. Poor countries some times lack the basic technical capabilities (lawyers and economists) to face the trade teams of advanced economies. The complexity of the WTO dispute settlement process, the geopolitical role of the US and the importance of US markets for many developing countries render it a very ineffective tool for the interests of less developed economies.

It should not be a surprise that American corporations continue to thrive in international trade (it's the American working class that is in trouble). Manufacturing is doing well, with the support of what Fred Block has termed the hidden developmental state in the US. So the problem is not that tariffs could not work. In all fairness, tariffs together with significant expansion of domestic spending on infrastructure (and more steel demand), with a vigorous defense of trade unions, with higher minimum wages, with policies to improve income distribution, like progressive taxes on the wealthy, to strengthen the domestic market might actually be part of a Hamiltonian strategy of economic growth. Note also that the whole point of imposing tariffs is to depend less on exports and more on domestic markets, so that to some extent retaliation should matter less. A more closed (not closed, but more so, like Keynes suggested in his National Self-Sufficiency piece of 1933) international economic order, to role back of some of the excesses of the neoliberal, pro-corporate globalization process, used to be be, and should be, on the agenda of the left.

The problem, then is less the tariffs per se, and more the fact that the Trumpian agenda is empty, and has nothing for the working class. That was my biggest concern reading the progressive economists complaints about Trump's trade views. Their solutions are to stop protecting patents and professionals, that is more 'free trade,' and a more depreciated currency (I'll leave my skepticism about this one for another post, at any rate I discussed this before). While I'm more sympathetic to the skepticism on property rights, note that China, in part, thrives, exactly because they do explicitly infringe the rules on patents (the first Geely car was a knock off of a Mercedes, and they bought Volvo to have access to foreign technology; there are many examples; it's worth noticing that the US did that in the past too). That would not necessarily be good for American corporations. To weaken doctors, lawyers and other middle (and upper middle) class professionals is certainly not the way out of the hole for the American working class.

The political danger of these views, which I think still dominate the liberal wing of the Democratic Party, is considerable. I think, that even if his policies turn out not to be very helpful (for the reasons I outlined, meaning lower wages and protections for workers, lower taxes for the wealthy and corporations and so on) his true dislike of globalization and free trade policies would strengthen his position with working people in the Rust Belt, which were central for his victory (maybe you think it was Russia... oh, well). As I noticed before the election, this would make things so much hard for Dems in elections. I said back in September 2016 that: "Note that this doesn't mean he [Trump] is going to win the election. Demographic changes make it harder for Republicans to win now, since Dems get more of the electoral college to start with. And I hope he doesn't, btw. But there are good reasons to be afraid. This is going to be way closer than it should be." And so it was.

I'm afraid that his trade policies, and the Dems position that effectively are to his right (like Hillary, but not Bernie) would make it more likely (hopefully not enough) for a longer period of Trumponomics than it is acceptable. This suggests that a good chunk of Dems are stuck in the model that Mark Lilla has referred to as identity liberalism (see his book here), and have become vulnerable to right wing populism. It's getting increasingly difficult to have hope in the dark.

PS: For discussions of trade policy see this two previous entries which provide a simple discussion of the Ricardian and neoclassical models of trade and its limitations. I would also recommend the paper by Robert Wade linked here.

* There are many others that have written on this in the last couple of days. Paul Krugman could, arguably enter the list of progressives here, but he has been consistently more of a free trade guy. Krugman complain is more macro than the others. In his view, the Fed would hike rates, since we are close enough to full employment and any additional gains from the tariffs will be eroded, even without retaliation from other countries. In part, that would happen because higher interest rates would lead to inflows and an appreciation of the dollar (see here).

On Volcker and Peterson's debt problem

In their recent NYTimes op-ed Paul Volcker and Peter Peterson say:

Yes, this country can handle the nearly $600 billion federal deficit estimated for 2016. But the deficit has grown sharply this year, and will keep the national debt at about 75 percent of the gross domestic product, a ratio not seen since 1950, after the budget ballooned during World War II.

The practical consequence of large deficits and debts, according to them is that:

Our current debt may be manageable at a time of unprecedentedly low interest rates. But if we let our debt grow, and interest rates normalize, the interest burden alone would choke our budget and squeeze out other essential spending. There would be no room for the infrastructure programs and the defense rebuilding that today have wide support. 

It’s not just federal spending that would be squeezed. The projected rise in federal deficits would compete for funds in our capital markets and far outrun the private sector’s capacity to save, to finance industry and home purchases, and to invest abroad.

In other words, large deficits and debt will compete with funds for other activities, the savings glut which a good chunk of the profession thinks causes low interest rates will vanish, and this, in turn, will increase interest rates, which not only will increase the interest rate burden, but also will reduce the fiscal space to spend on things we agree are fine, like infrastructure.

What should we do according to them? No surprise here, cut social spending. In their words: "A realistic approach toward the major entitlement programs is required, given that they are projected to account for all of the growth of future noninterest spending." They fall short of asking for privatization of Social Security, but you can bet that this is what they are going to push for in a Clinton administration. To finish the work they started in the previous Clintocracy (the system of government in which a Clinton holds power).

I discussed fiscal issues several times here, and the problem in their argument is with basic principles really. Below Gross Federal Debt, which stands at slightly more than 100% of GDP, and once the amounts of public held by the Fed and in the Social Security Trust Fund and other government accounts are accounted for, then this leaves us with the Net debt of about the size reported by Volcker and Peterson in their piece.

Looking at the figure you might be alarmed. It has increased significantly after the last crisis. However, there are important elements that suggest that the increase in public debt is not problematic. First of all, as noted by Dean Baker, the burden of debt service (interest payments) is tiny. And will most likely remain low, since the space for normalization of interest rates is much smaller than what Volcker and Peterson suggest. The idea that government spending will grow out of line with the ability to finance it (which has little to do with the "private's sector capacity to save," btw) is difficult to believe too. Note that government spending has been subdued as the graph below shows.

Government spending in real terms remains below the pre-crisis level, and after the fiscal package, Obama has essentially followed the Clintonomics rule book of fiscal conservatism. If anything spending is kind of small, for the needs of the economy (I would say spending, and not deficits, since the result is endogenous, but I agree in general terms with the argument here). There is no problem of runaway government spending, and certainly no danger, as Volcker and Peterson suggest that "we would risk returning with a vengeance to stagflation — the ugly combination of inflation and economic stagnation that we tasted in the 1970s" if we do not cut social spending. This is the old trick of creating fear of a fake fiscal crisis to force cuts on spending for social programs.

My fear is that Volcker and Peterson, and others like them, will have an outsized influence on a Clinton administration. The danger is not the high inflation of the 1970s, but the completion of the neoliberal project of the 1990s.

Trading Up: A Critical Perspective on Jobs, Governance and Security in US Trade Policy

This Tuesday June 28, 2016, the AFL-CIO is holding a conference titled “Trading Up: A Critical Perspective on Jobs, Governance & Security in U.S. Trade Policy,” from 9:00 am to 5:00 pm in Washington, DC. The full program is here. Participants include Joseph Stiglitz, Dean Baker, Tom Palley, Rob Scott, Jeff Faux, among others.

You can join online for what should be an lively and insightful debate—especially given recent developments around the Brexit and the Trans-Pacific Partnership (TPP).

You can watch the conference here and join in the discussion online using #BetterTrade. Please tweet any questions for panelists to conference organizer Celeste Drake (@cdrakefairtrade).

Revised GDP and the slow recovery

BEA released the second estimate of the first quarter GDP, and it's up from 0.5 to 0.8%. Not bad, not great. Note that federal government spending is a drag on the recovery (although local and state governments are positive force, and part of that is actually funded by the federal government anyway; so the actual negative impact of contractionary fiscal policy is smaller than what the numbers suggest). At any rate, this will be used to demand higher rates in the next meeting of the FOMC. You can bet about it. Listen to Dean Baker at the Rick Smith Show here, suggesting why this is a terrible idea.

Jamie Galbraith's response to the critics of Gerald Friedman's paper on the impact of Bernie Sanders policies

There has been a debate following the NYTimes piece on left of center economists against Bernie Sanders. Doug Henwood replied here and Dean Baker here. Henwood does not discuss the Gerald Friedman paper that led to the whole discussion. Now Jamie Galbraith provided a nice reply to the left of center economists that suggested that Bernie's plans are not realistic. He says:

"What the Friedman paper shows, is that under conventional assumptions, the projected impact of Senator Sanders' proposals stems from their scale and ambition. When you dare to do big things, big results should be expected. The Sanders program is big, and when you run it through a standard model, you get a big result.

That, by the way, is the lesson of the Reagan era – like it or not. It is a lesson that, among today's political leaders, only Senator Sanders has learned."

Read full letter here.

A comment on Dean Baker's comment on Paul Krugman's comment on Bernie Sander's Health Plan

Away for while, and back in full meta-post. I guess all posts are comment on another post, this one is just one more degree of separation. So Krugman sides with Hilary over Bernie. Let's extend Obamacare, rather than get Medicare for all. The reason is mainly political calculation. It would be impossible to get a single payer system covering everybody. The power of insurance companies, and pharmaceutical firms, combined with the insidious role of money in the political process, implies that Bernie's position is a non-starter. Also, Krugman cites the fact that the increase in taxes would be a problem with the middle class.

Dean Baker basically accepts Krugman's arguments (not sure if that means that he also thinks Hilary is right, but somehow I doubt it), but makes two caveats. On the political level, Dean says, correctly I believe, that you need Bernie, or others like him, to move us in the right direction, and perhaps at some point in the future the US will be like other advanced and civilized societies with health coverage for all. Second, Dean suggests that the government allows pharmaceutical firms to get away with exorbitant prices and that we should have an alternative for that, in his view, public financing of research and clinical trials.

Fair enough. I can live with both comments, but here are my caveats. Krugman suggests that higher taxes would be required, not only on the wealthy, but also on the middle class, and he correctly acknowledges the argument Bernie used to respond to Hilary in the debate. Namely, that the higher taxes would be more than compensated by the reduction or elimination of health care premiums charged by private insurance companies. But there is an important argument that was not raised by Bernie that also matters in this regard. More government spending on health (and Bernie wants that and more on  education, and more on infrastructure) does have, as far as the evidence suggests (at least most would agree that multipliers are positive, even if not huge), positive effects on the level of income, and, hence, on taxes. I haven't seen the dynamic scoring of such a health plan, but it seems reasonable to suggest that the increase in taxes wouldn't be confiscatory, and there should be no great middle class backlash against Medicare for all (in fact, the majority of the country still favors it).

On the same note, I might add, Krugman's argument that Medicare for all would be too disruptive is difficult to buy. One of the many arguments against Obamacare was that it was disruptive, particularly for small businesses, and that many people would prefer their previous plans. And even though Obamacare was badly launched, and created some disruptions, I think that Krugman would accept the notion that so far it is working, and that eventually (if we don't get Medicare for all) it's going to be particularly well regarded by the people that benefited from it (in the millions).

Dean is correct that pharmaceutical firms obtain incredible advantages in the US current system.* And I have nothing against public funding of research; quite the opposite. About one third, if private firms' numbers are correct, of research is already funded by the government, mostly by the National Institute of Health (NIH), the Department of Defense (DoD), and the National Science Foundation (NSF). But even if we maintain the system in which much of the research is funded by the private sector, there is no reason why we cannot regulate the pharmaceutical sector (btw, like the financial sector), control prices, and in cases of national health priority adopt generic medications.

That is why I would be for Bernie's solution, to strive for a single payer system, rather than accept that there is little that we can do about it. That was, as he reminded us, the plan of FDR and Truman. Remember also that if Hilary has moved to the left (and, arguably, she did) this is, in part, because she lost to Obama in 2008, and is getting heat from Bernie now. Bernie, even though he was not a Democrat (so what, Hilary was in high-school a Young Republican and "Goldwater Girl" in 1964, but she came to her senses later), is more representative of progressive Democratic values.

* On a different, and less relevant, note, I'm not sure I agree that the way firms get higher prices is from some sort of tariff like system that allows them to price above marginal costs. In his words:

"Ordinarily economists treat it as an absolute article of faith that we want all goods and services to sell at their marginal cost without interference from the government, like a trade tariff or quota. However in the case of prescription drugs, economists seem content to ignore the patent monopolies granted to the industry, which allow it to charge prices that are often ten or even a hundred times the free market price."

Note that the notion that firms price at marginal cost is a fantasy. From a practical point of view firms basically tend to add a mark up on full costs (and also, almost no firm has increasing costs; but that is another story). And what really allows for exorbitant prices above full costs is the barriers to entry, some of which are caused by regulation and patents (tariff like as Dean notes), but also from the advantages of incumbency and from increasing returns or economies of scale. More importantly, the argument for patents is that they generate more of an incentive for investment, since firms can keep the proceeds from their research, but the evidence for that is scant at best.

Dean Baker on the need for larger deficits and junk economic science on Chris Hayes

And of course on the slow recovery. In his words, "we are still bound by the Age of Austerity." It's worth insisting, since pressures for more contractionary monetary policy are mounting. Hayes bit is more generally about GOP's contradictory complain about inequality and the new Obama budget, which is more progressive than his previous ones. And yes they do talk about Big Government Republicans, but not enough in my view about small government (and pro-Wall Street) Dems. For more on that go here.

Last quarter growth not impressive, and slow recovery continues

I was writing about this Friday, but other post took precedence. As noted in my links to other blogs, Dean Baker dealt with this in the context of the NYTimes coverage of the news. According to the BEA last release:

"Real gross domestic product -- the value of the production of goods and services in the United States, adjusted for price changes -- increased at an annual rate of 2.6 percent in the fourth quarter of 2014, according to the "advance" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 5.0 percent."

In other words, after two quarters of faster growth at 4.6% and 5%, the last quarter has been less impressive, and the overall growth rate for 2014 was at 2.4%.  Note that even those two faster quarters have to be taken with a grain of salt, since the first quarter had negative growth, and the subsequent ones seem higher for that reason.

This should deflate the overly confident views on how fast the economy is recovering, and about the need to hike interest rates, since inflation is the danger now. Also, it should underscore how additional fiscal expansion is still needed. The labor market presents an even worse picture.

Most comments are on the unemployment rate, at 5.6%. But employment is a better measure often. Below the picture of total non-farm employment in the last three recoveries.

Note that the last recession was more profound than the previous too, as it is well known. Also, only last year the level of employment surpassed the previous peak, after six years of the beginning of the crisis. The recovery still looks pretty slow.

Dean Baker on The Paid Vacation Route to Full Employment

 

By Dean Baker:

The economics profession has hit a roadblock in terms of being able to design policies that can help the economy. On the one hand we have many prominent economists, like Paul Krugman and Larry Summers, who say the problem is that we don't have enough demand to get us back to full employment. There is a simple remedy in this story; get the government to spend more money on items like infrastructure, education, and clean energy. This is a simple story, but politically it is a non-starter. Few Democrats are prepared to push for anything more than nickels and dimes in terms of increased spending, nothing close to magnitudes that would be needed. As far as the Republicans in Congress, it would be easier to convert the Islamic State folks to Christianity. (We could also boost demand by lowering the dollar and thereby reducing the trade deficit, but economists don't talk about that one.) The other side of the professional divide in economics doesn't have much to offer on full employment because they say we are already there. The argument goes that people have dropped out of the labor force because they would rather not work at the wage their skills command in the market. In this story, we may want to find ways to educate or train people so they have more skills, but unemployment is not really a problem in today's economy. The notion that seven million people (the drop in population adjusted employment since the start of the recession) just decided they don't feel like working, doesn't pass the laugh test outside of economic departments and corporate boardrooms. This leaves us stuck with a policy prescription - more stimulus - that has zero political prospect any time in the foreseeable future. There is an alternative.

Read rest here. 

Rosnick & Baker on The Wealth of American Households

By David Rosnick and Dean Baker

From the Abstract:

This paper presents data on the wealth of households by age cohort based on new data from the 2013 Survey of Consumer Finances (SCF). It shows that the upward redistribution of wealth continued between 2010 and 2013. As a result, most households had less wealth in 2013 than they did in 2010 and much less than in 1989, the first year examined. This is in spite of the fact that households were much less likely to have traditional defined-benefit pensions than in prior decades.

Read rest here.

Baker & Bernstein on The Incipient Inflation Freak-out

By Dean Baker and Jared Bernstein 

As predictable as August vacations, numerous economists and Federal Reserve watchers are arguing that the nation’s central bank must raise interest rates or risk an outbreak of spiraling inflation. Their campaign has heated up a bit in recent months, as one can cherry pick an indicator or two showing slightly faster growth in prices or wages. But an objective analysis of the recent data, along with longer-term wage trends, reveals that the stakes of premature tightening are unacceptably high. The vast majority of the population depends on their paychecks, not their stock portfolios. If the Fed were to slam on the breaks by raising interest rates as soon as workers started to see some long-awaited real wage gains, it would be acting to prevent most of the country from seeing improvements in living standards. To understand why continued support from the Fed is unlikely to be inflationary, consider three factors: the current state of key variables, the mechanics of inflationary pressures and the sharp rise in profits as a share of national income in recent years, along with its corollary, the fall in the compensation share.

Read rest here.

Dean Baker on The Promotion of Waste & Inequality By US Finance

By Dean Baker

In the crazy years of the housing boom the financial sector was a gigantic cesspool of excess and corruption. There was big money in pushing and packaging fraudulent mortgages. The country paid a huge price for the financial sector's sleaze. Unfortunately, because of the Obama administration's soft on crime approach to the bankers who became rich in the process; the industry is still a cesspool of excess and greed. Just to be clear, knowingly issuing and packaging a fraudulent mortgage is a crime, the sort of thing for which people go to jail. But thanks to the political power of the Wall Street, none of them went to jail, and in fact they got to keep the money.

Read rest here.

For more on the long-run macroeconomic causes, implications, and effects of US financialization, see recent articles here, here (subscription required) , here, here, here (subscription required), and here (subscription required); for a pertinent sociological analysis, see here

CEPR | Stimulus and Fiscal Consolidation: The Evidence and Implications

In a previous post, see here, Matias provided a graph that displayed the fiscal results for the US as a share of GDP from 1993-2014, along with a discussion of the misconception that democrats are nothing but tax/spend liberals. I thought it would be pertinent to post this paper by Dean Baker and David Rosnick providing conclusive evidence on the effects of stimulus packages and fiscal consolidation during the recent economic crisis.

From the abstract:

The first part deals with the most important literature on the subject, the consensus in the research of the past decade attests a clear counter-cyclical effect of stimulus packages during a prolonged recession. The second part deals with the impact of changes in government consumption and investment to growth. For this data for developed countries in 1980 are analyzed. Consistent with much of the previous literature have increased government spending during a crisis has a positive effect on economic growth. In addition, the period is simulated after the crisis, the multiplier effect is around 1.5. The third part focuses on the production potential, which has declined sharply due to the economic crisis. This would have to include a comprehensive model that analyzes the effects of an economic stimulus package with, since the effect could turn out relative to the size of the stimulus package as significant.

Read rest here.

Cheap Talk at the Fed

By Dean Baker

Federal Reserve Board Chair Janet Yellen made waves in her Congressional testimony last week when she argued that social media and biotech stocks were over-valued. She also said that the price of junk bonds was out of line with historic experience. By making these assertions in a highly visible public forum, Yellen was using the power of the Fed’s megaphone to stem the growth of incipient bubbles. This is an approach that some of us have advocated for close to twenty years. Before examining the merits of this approach, it is worth noting the remarkable transformation in the Fed’s view on its role in containing bubbles. Just a decade ago, then Fed Chair Alan Greenspan told an adoring audience at the American Economic Association that the best thing the Fed could do with bubbles was to let them run their course and then pick up the pieces after they burst. He argued that the Fed’s approach to the stock bubble vindicated this route. Apparently it did not bother him, or most of the people in the audience, that the economy was at the time experiencing its longest period without net job growth since the Great Depression.

Read rest here.

Dean Baker - Housing & The Downturn: It's Really Not That Complicated

By Dean Baker

Neil Irwin has a piece noting housing's importance in the downturn, which gets things half right. First, housing is typically important in economic cycles, as he says, but the picture is quite different than Irwin implies. In a typical recession housing construction falls because it is very sensitive to interest rates. Most recessions are brought on by the Fed raising interest rates to slow the economy. In these cases the decline in housing is a deliberate outcome of Fed policy, not an accidental outcome to be avoided. In contrast, the most recent downturn was brought on by a collapse of a housing bubble. This made it qualitatively different from most prior downturns (the 2001 recession was also bubble induced) in several different ways. First, construction was proceeding at an extraordinary rate of more than 6.0 percent of GDP before the collapse, compared to an average rate of just over 4.0 percent of GDP. This meant that housing contracted far more than it would in a typical downturn. Furthermore, because of the overbuilding of the bubble years, housing fell further than normal, hitting levels just above 2.0 percent of GDP. And, because the downturn was not brought on by a rise of interest rates it could not be reversed by a drop in interest rates.

Read rest here.

Dean Baker: Bond Bubbles? Silly Season at the Fed

By Dean Baker

Throughout this [so-called] 'recovery' there have been a number of economists and policy types expressing concern about a “bond bubble.” This is the idea that bonds are overpriced and could take a sudden tumble giving financial markets and the economy the same sort of hits we saw from the collapse of the housing and stock bubbles. This is seriously misguided thinking from any conceivable perspective. At the most basic level the concern is misplaced because there is nowhere near as much money at stake. Former Fed economist Andrew Flowers put the amount of money at stake in the bond market as $40 trillion in a recent FiveThirtyEight column. This compares to a stock market valued at around $28 trillion and housing market at a bit over $20 trillion. While that may make the bond market seem more important, the $40 trillion number is hugely misleading. The $40 trillion figure refers to total debt, much of which is short-term. This is important because short-term debt doesn’t lose much value when interest rates rise. If we restrict our focus to debt that stands to lose substantial value when interest rates rise – remaining duration of five years or more – the volume of debt would be well under $20 trillion.

Read rest here.

Dean Baker on Obama's High Unemployment Budget

By Dean Baker

President Barack Obama’s proposed federal budget for 2015, which he sent to Congress on March 4, pushes the debate in a positive direction in several areas. For that, he should be given credit. However, on the most important issue, a budget that would get us back to full employment, his proposals fall way short. Let’s start with the positives. President Obama proposes a four-year infrastructure program that would cost just over $300 billion. This comes to $75 billion a year, or roughly 0.4 percent of GDP. This idea could go far toward improving and upgrading our infrastructure and is much needed for this purpose. It would also provide a boost to the economy. Assuming the typical multiplier of 1.5 times the amount spent for the expected stimulus, the program would create more than 800,000 jobs. A second item on Obama’s agenda is universal pre-kindergarten. This idea would provide a boost to many children from low- and moderate-income families, whose lack of early education can stunt their prospects for social mobility, according to several important studies. It would also make it much easier for their parents to work, since arranging for quality child care is often difficult and expensive. The price tag for this proposal is surprisingly low: only $76 billion over the next decade. That amount comes to 0.18 percent of projected spending over the period. The relatively small price tag for this program would be more widely known if reporters covered the budget in a way that was intended to inform their audience by contextualizing numbers in terms of overall spending.

Read rest here.

For an analysis by the Economic Policy Institute on the budget proposed by the Congressional Progressive Caucus, see here

CEPR: North Carolina Proves Cutting Unemployment Insurance Pushes People Out of the Labor Force

By John Quinterno and Dean Baker

Last year North Carolina undertook a radical overhaul of its unemployment insurance system. Among the changes, legislators sharply reduced the amount and length of regular unemployment insurance, cutting the maximum weekly insurance amount by 35 percent and reducing the maximum duration of compensation from 26 weeks to, currently, 17 weeks. By implementing the cuts in weekly benefit amounts in July, North Carolina forfeited  its ability to participate in the federally-funded Emergency Unemployment Compensation program, and consequently, an estimated 70,000 individuals immediately lost long-term unemployment insurance, while another 100,000 individuals who still would have been eligible through the fall saw their insurance lapse  sooner than would have happened.

According to the legislation’s elected supporters, the overhaul was a “difficult decision” needed to fix “a welfare-dependent program” and push unemployed workers to get serious about finding a job--any job.  

We’ve now had some time to test this view and the initial results do not look promising for proponents of the cuts. The statewide unemployment rate has in fact fallen sharply since the cuts were implemented, dropping from 8.8 percent in June to 6.9 percent in December.  

This drop, however, did not come about because people rushed out and found jobs. Employment as measured by the household survey used to determine the unemployment rate rose by 41,364 persons (1 percent) between June and December, far too little to explain the sharp drop in the unemployment rate. According to the household survey, only 13,414 more persons (0.3 percent) were at work in December 2013 compared to a year earlier.

Read rest here

Dean Baker on The Checkered Past of Ben Bernanke

By Dean Baker

The retrospectives of Ben Bernanke on his leaving the Fed seem to be coming in overly positive. While there is much that is positive about his tenure as Fed chair, many of these accounts have a rather selective view of history.
The part that is clearly wrong is treating Bernanke as a bookish academic who got plucked down in the middle of a financial crisis that was not his making. While Bernanke had a distinguished academic career, he had been in the middle of the action in Washington since 2002. That was when he was selected to be a governor of the Fed. He served as a governor at Greenspan’s side until he went to serve as head of President Bush’s Council of Economic Advisers in June of 2005. After a brief stint as the chief economist in the Bush administration he returned to take over as chair of the Fed in January of 2006.
It was during the period that Bernanke was at the Fed and his tenure in the Bush administration that the housing bubble grew to such dangerous levels. While Bernanke does not deserve as much blame for this as Greenspan, there were few people better positioned to try to deflate the housing bubble before it posed such a large risk to the economy. During this time Bernanke was dismissive of suggestions that the unprecedented run-up in house prices posed any problem. There is no evidence that he dissented in any important way from Greenspan’s view that the Fed need not be concerned about the housing bubble or the innovations in the financial industry that was supporting it.

Read rest here