Tag: the continuing crisis

Davies on the Disorder in Europe

My friend Jen writes about informal labor markets in South Africa. She was telling me the other day about street vendors who make their living buying packs of a dozen pairs of socks and selling them pair by pair. In that same spirit of finding a niche in the very last step of the distribution network, I thought I would pass on some material from a talk I attended last week by Sir Howard Davies. It’s below the fold, with occasional comments from me in brackets. A lot may seem familiar, but enough was new to me — and Davies is high enough up in this world; he’d had dinner the night before with Charles Dallara — that I think it’s worthwhile to put down my notes in full.

There are six and half questions to ask about the Euro system. Is the crisis over? Why did anyone think it would work? Why did it take so long to fall apart? Are the responses to date sufficient? What more is needed? Why even bother? And the half question, what’s it all mean for the UK?

To question 1, no surprise, the answer is No.  “The ECB has been making really good policy for a country that doesn’t exist.” The fundamental problem of pan-European banks with no pan-European regulator or lender of last resort is no closer to being resolved; “some sticking-plaster has been applied,” that’s all.

On question 2, there were three reasons:

Some people said, “Yes, you will need a fiscal authority, but it will happen.” Europe policy in general has developed through a process of leap forward, then retrofit. And after all, it says right in the treaty “Ever closer union.”

Other people thought the stability and growth pact would ensure appropriate policy.

A third group of people, including Davies, believed something like, “Yes, these economies are very different, with different labor market institutions and so on, but without the option of devaluation they will be forced to converge.” Periodic devaluations had allowed southern European countries to avoid structural reform, but now everyone would have to behave like the Germans.

Well, all these views were wrong. Why? Three reasons:

– Maastricht turned out to be the high point of enthusiasm for federalism. Every single vote on additional federalism has said, No.

– The SGP turned out to be both too tight, in that it didn’t leave enough space for countercyclical fiscal policy, and too loose, in that it had no enforcement mechanism. [So it sounds like Davies would be on board with John Quiggin’s “hard Keynesianism.”]

– Lower interest rates were not used for fiscal consolidation. [This seems wrong to me, at least for Italy and Spain.] And there was no convergence to German levels of productivity.

On question 3, the first answer was that the first decade of the euro was, in Mervyn King’s unfelicitous coinage, NICE — Non-Inflationary with Consistent Expansion. And the ECB, while prohibited from buying government bonds directly, bought them in secondary markets at equal rates, meaning there was no pressure for fiscal discipline on member states. [Again, I’m resistant to this story, except for Greece and maybe Portugal.] Davies recalls talking to a Morgan Stanley bond dude, explaining how he marketed Greek debt: “A Greek bond is just like a German bund, except with an extra three points of interest.” There was a real market failure here, says Davies, and the banks that ended up holding this stuff (all European, by the way, American institutions have successfully elimianted almost all their exposure) deserve their haircuts.

[It would be interesting to explore the idea that an unsustainable current account deficit is precisely one that can only be financed with an interest rate premium.]

Question 4, the adequacy of the response. “The problem is that they are focused on the last crisis and the next crisis, but not on the current crisis.” By which he means that they are putting in place rules that would have helped if they’d already been in place years ago, while ignoring the ways in which “responsible” fiscal policy will exacerbate the current downturn. The problem right now is that austerity just makes the growth picture worse, and that the European “rescue capacity” is too small.

Question 5, what more is needed. In the short run, a better firewall is needed to prevent contagion from the worst-hit countries and institutions. In the longer run, Europe needs (a) some system for Europe-wide public borrowing (one idea would be for debt up to, but not above, the SGP levels to be backed by the community as a whole); and (b) a pan-European bank regulator and lender of last resort. But the Germans won’t go for it.

Which brings us to Question 6. Wouldn’t some countries be better off leaving? Greece’s departure is probably inevitable, he said. But it poses major challenges — even if you had an agreed-on procedure for converting Greek euros to the new Greek currency, which euros are the Greek ones? “If the coin says Greece, no problem. Greek government bonds, ok, those are Greek. And if you are living in Greece and have an account in a Greek bank, then that is probably a Greek euro. But, I have a boat in Greece and an account at Barclay’s in Athens. Are those Greek euros? I hope not. How about someone living in Athens but with a bank account in London, is that a Greek euro?” And beyond those technical problems, there are even worse political problems, that should make exit the last possible resort. Because, who will benefit from the failure of the euro, politically? In France, the fascists — Marie le Pen based her whole campaign around it. “In Greece, it would be the anarchists and the communists, they’re the only ones who have been against the euro.” [OH NOES the anarchists.] The communists in Hungary, Sinn Fein in Ireland, etc. “Only in the UK can you say that the Euro-skeptics are not mad people.”

Nonetheless, Greek exit is probably unavoidable. “My hunch is that Greece will not make it,” because they lack social capital. The Irish are stoic, they will accept lower pay and higher taxes. They say, ah well, we had a good few years but it had to end. Not the Greeks, they won’t pay taxes. [There was a shaggy-dog story in here about local officials in Spain and Greece competing to see who can waste more EU money.] Gas costs $6 a gallon in Greece because it’s almost the only thing the government can reliably tax. “Latvia could make austerity work because they’d been in the USSR for 50 years, they were used to unpleasant and dramatic things happening. The population would accept incredible privation.” The Greek population, sadly, will not.

And on the last half question: If the solution is “more Europe,” that will be a big problem for the UK. Cameron is a Euro-skeptic; it’s not just because he’s responding to popular opinion, but nonetheless popular opinion is heading that way. The UK is going to face increasing pressure to detach itself from the EU.

And a few other observations, from the Q&A:

“You can’t imagine Italy having an unelected government for long, but they are urgently engaged in some necessary reforms that would otherwise be impossible.”

There has never been a referendum in favor of the euro.

German wages have not gone up, German property values have not gone up, why should ordinary Germans feel like they are the beneficiaries of the euro and want to do more to save it? [Sounds like an argument for Thomas Jørgensen’s “Drink finer wines, drive nicer cars, and party harder!” platform.]

Most likely, Greece will have a disorderly exit, and that will concentrate the minds of European policymakers to take the necessary steps to prevent a repeat. Avoiding future defaults will require some kind of collective guarantee of Euro-area bonds, but Germans won’t accept that until it’s clear that the altenrative is catastrophe. So, “Greece may have to perform this service.”

The alternative is for Greece to do what Latvia did, structural reforms, get rid of anti-competitive policies. The problem is, you don’t have a full technocratic government in Greece, you still have elected officials with real power. [And that, I think, is what it all comes down to.]

What We Talk About When We Don’t Talk About Demand

There sure are a lot of ways to not say aggregate demand.

Here’s the estimable Joseph Stiglitz, not saying aggregate demand in Vanity Fair:

The parallels between the story of the origin of the Great Depression and that of our Long Slump are strong. Back then we were moving from agriculture to manufacturing. Today we are moving from manufacturing to a service economy. The decline in manufacturing jobs has been dramatic—from about a third of the workforce 60 years ago to less than a tenth of it today. … There are two reasons for the decline. One is greater productivity—the same dynamic that revolutionized agriculture and forced a majority of American farmers to look for work elsewhere. The other is globalization… (As Greenwald has pointed out, most of the job loss in the 1990s was related to productivity increases, not to globalization.) Whatever the specific cause, the inevitable result is precisely the same as it was 80 years ago: a decline in income and jobs. The millions of jobless former factory workers once employed in cities such as Youngstown and Birmingham and Gary and Detroit are the modern-day equivalent of the Depression’s doomed farmers.

This sounds reasonable, but is it? Nick Rowe doesn’t think so. Let’s leave aside globalization for another post — as Stieglitz says, it’s less important anyway. It’s certainly true that manufacturing employment has fallen steeply, even while the US — despite what you sometimes here — continues to produce plenty of manufactured goods. But does it make sense to say that the rise in manufacturing productivity be responsible for mass unemployment in the country as a whole?

There’s certainly an argument in principle for the existence of technological unemployment, caused by rapid productivity growth. Lance Taylor has a good discussion in chapter 5 of his superb new book Maynard’s Revenge (and a more technical version in Reconstructing Macroeconomics.) The idea is that with the real wage fixed, an increase in labor productivity will have two effects. First, it reduces the amount of labor required to produce a given level of output, and second, it redistributes income from labor to capital. Insofar as the marginal propensity to consume out of profit income is lower than the marginal propensity to consume out of wage income, this redistribution tends to reduce consumption demand. But insofar as investment demand is driven by profitability, it tends to increase investment demand. There’s no a priori reason to think that one of these effects is stronger than the other. If the former is stronger — if demand is wage-led — then yes, productivity increases will tend to lower demand. But if the latter is stronger — if demand is profit-led — then productivity increases will tend to raise demand, though perhaps not by enough to offset the reduced labor input required for a given level of output. For what it’s worth, Taylor thinks the US economy has profit-led demand, but not necessarily enough so to avoid a Luddite outcome.

Taylor is a structuralist. (The label I think I’m going to start wearing myself.) You would be unlikely to find this story in the mainstream because technological unemployment is impossible if wages equal the marginal product of labor, and because it requires that output to be normally, and not just exceptionally, demand-constrained.

It’s a good story but I have trouble seeing it having much to do with the current situation. Because, where’s the productivity acceleration? Underlying hourly labor productivity growth just keeps bumping along at 2 percent and change a year. Over the whole postwar period, it averages 2.3 percent. Over the past twenty years, 2.2 percent. Over the past decade, 2.3 percent. Where’s the technological revolution?

Just do the math. If underlying productivity rises at 2 percent a year, and demand constraints cause output to stay flat for four years [1], then we would expect employment to fall by 8 percent. In other words, lack of demand explains the whole fall in employment. [2] There’s no need to bring in structural shifts or anything else happening on the supply side. A fall in demand, plus a stable rate of productivity increase, gets you exactly what we’ve seen.

It’s important to understand why demand fell, but from a policy standpoint, no actually it isn’t. As the saying goes, you don’t refill a flat tire through the hole. The important point is that we don’t need to know anything about the composition of output to understand why unemployment is so high, because the relationship between the level of output and employment is no different than it’s always been.

But isn’t it true that since the end of the recession we’ve seen a recovery in output but no recovery in employment? Yes, it is. So doesn’t that suggest there’s something different happening in the labor market this time? No, it doesn’t. Here’s why.

There’s a well-established empirical relationship in macroeconomics called Okun’s law, which says that, roughly, a one percentage point change in output relative to potential changes employment by one a third to a half a percentage point. There are two straightforward reasons for this: first, a significant fraction of employment is overhead labor, which firms need an equal amount of whether their current production levels are high or low. And second, if hiring and training employees is costly, firms will be reluctant to lay off workers in the face of declines in output that are believe to be temporary. For both these reasons (and directly contrary to the predictions of a “sticky wages” theory of recessions) employment invariably falls by less than output in recessions. Let’s look at some pictures.

These graphs show the quarter by quarter annualized change in output (vertical axis) and employment (horizontal axis) over recent US business cycles. The diagonal line is the regression line for the postwar period as a whole; as you would expect, it passes through zero employment growth around two percent output growth, corresponding to the long-run rate of labor productivity growth.

1960 recession

1969 recession

1980 and 1981 recessions
1990 recession

2001 recession
2007 recession

What you see is that in every case, there’s the same clockwise motion. The initial phase of the recession (1960:2 to 1961:1, 1969:1 to 1970:4, etc.) is below the line, meaning growth has fallen more than employment. This is the period when firms are reducing output but not reducing employment proportionately. Then there’s a vertical upward movement at the left, when growth is accelerating and employment is not; this is the period when, because of their excess staffing at the bottom of the recession, firms are able to increase output without much new hiring. Finally there’s a movement toward the right as labor hoards are exhausted and overhead employment starts to increase, which brings the economy back to the long-term relationship between employment and output. [3] As the figures show, this cycle is found in every recession; it’s the inevitable outcome when an economy experiences negative demand shocks and employment is costly to adjust. (It’s a bit harder to see in the 1980-1981 graph because of the double-dip recession of 1980-1981; the first cycle is only halfway finished in 1981:2 when the second cycle begins.)

There’s nothing exceptional, in these pictures, about the most recent recession. Indeed, the accumulated deviations to the right of the long-term trend (i.e., higher employment than one would expect based on output) are somewhat greater than the accumulated deviations to the left of it. Nothing exceptional, that is, except how big it is, and how far it lies to the lower-left. In terms of the labor market, in other words, the Great Recession was qualitatively no different from other postwar recessions; it was just much deeper.

I understand the intellectual temptation to look for a more interesting story. And of course there are obviously structural explanations for why demand fell so far in 2007, and why conventional remedies have been relatively ineffective in boosting it. (Tho I suspect those explanations have more to do with the absence of major technological change, than an excess of it.) But if you want to know the proximate reason why unemployment is so high today, there’s a recession on still looks like a sufficiently good working hypothesis.

[1] Real GDP is currently less than 0.1 percent above its level at the end of 2007.

[2] Actually employment is down by only about 5 percent, suggesting that if anything we need a structural story for why it hasn’t fallen more. But there’s no real mystery here, productivity growth is not really independent of demand conditions and always decelerates in recessions.

[3] Changes in hours worked per employee are also part of the story, in both downturn and recovery.

Stimulus Around the World

Interesting new working paper out from the NBER today, on Net Fiscal Stimulus During the Great Recession. It purports to compare the level of fiscal stimulus across 28 rich and developing countries, with results that are decidely gratifying for a Keynesian.

Purports, I say, because unfortunately their chosen measure of fiscal stance makes it hard to know how seriously to take their results. They look only at final expenditures by government, ignoring both transfers and taxes. While there are certainly contexts in which this is the right approach — where the alternative would be double-counting with private expenditures — it’s not at all clear that it’s right for the questions they are trying to answer. From the stimulus side, in theory one would expect the demand effect of final government purchases to be qualitatively greater than the effect of transfers or tax cuts only if the recipients of the latter don’t face credit constraints, so that temporary changes operate only through wealth effects. And while I do think that the importance of credit constraints in the Great Recession may be overstated for businesses, they’re clearly very important for households, especially the ones most likely to receive transfers like UI. On the debt burden side, obviously deficits add the same whatever their source. On the other hand, it may well be that changes in final expenditure by government is a good proxy for the fiscal stance in general, and perhaps a better one for discretionary stimulus spending. It would be nice to see the paper redone with other measures of stimulus, but let’s tentatively accept their findings. What do they show?

First, as Krugman says, if stimulus didn’t work in the US, it’s because it wasn’t tried. The US ranks 9th from the bottom of the 28 countries in the growth of government spending, and even that is only thanks to spending in 2007-08; taking all levels of government together public consumption and investment didn’t rise at all in 2009. Of course we knew that already (And we also knew, as Aizenman and Pasricha seem not to, that the earlier increase was almost all military spending.) But it’s useful to see it in comparative perspective.

Second, the most interesting finding, that countries with the biggest increases in public spending did not see any larger increase in real interest rates on public debt, either contemporaneously or in the following year, but they did see faster growth. This means the real debt burden – measured as (r – g) * d, where r is the real interest rate on public debt, g is the real GDP growth rate, and d is the debt-to-GDP ratio – fell in those countries where public spending rose the most. If it holds up, this is obviously a very interesting result.

Finally, there’s a point they don’t make. They observe, correctly, that the US is far from any objective financial constraint on public spending. And they observe; also correctly, that the most aggressively countercyclical fiscal policy is found in middle-income countries like Korea, in sharp contrast to previous downturns, especially the late 90s. But they don’t offer any explanation for this change except a vague suggestion that countries chastened by the Asian crisis got their fiscal houses in order, leaving them plenty of space for stimulus. But that’s obviously not right. As they themselves note, there’s no correlation between the public debt burden prior to the crisis and the trajectory of government spending over the past few years. As I’ve pointed out before, what’s different in countries like Korea in the period before this crisis compared with the Asian Crisis isn’t the fiscal balance, but the external balance. They were running external deficits then, external surpluses this time. That’s what created the extra space for stimulus. (Same thing in Europe: public-sector surpluses in Spain and Ireland didn’t matter because the countries had big current account deficits. It was the corresponding private liabilities thy ended up on public balance sheets in the crisis and created the pressure for spending reductions.) Which brings me to the punchline: If the US had had a smaller trade deficit with,say, Korea in the past few years, that would have had a negligible direct effect on US demand and there’s no reason to believe that it would have created space for more expansionary fiscal policy, since we’re using nowhere near the space we have. But it very well might have forced Korea to adopt a more contractionary policy, just as other not-exorbitantly-privileged countries without external surpluses have had to. In that sense, though they certainly don’t draw this conclusion, I think this paper supports the view that global imbalances have moderated rather than exacerbated the crisis.

What’s Going On With Inventories?

One of the weirdly under-discussed features of the current macroeconomic situation is the huge role of inventories in the recovery. I read a lot of economics blogs — there are a lot more I don’t read — and at least sporadically the business press, and I’ve hardly seen this discussed at all. But check it out:


The orange line is the change in GDP, the blue line is the contribution of inventory changes. (Sorry it’s fuzzy. I’m technologically hopeless.) Since the end of the recession, 62 percent of GDP growth has been accounted for by inventories. Inventories have accounted for the majority of GDP growth in four of the five post-recession quarters; in the fifth, they were 48 percent. There’s really no precedent for this. It’s not unusual for inventories to be the main source of growth in one post-recession quarter, but never in the past 50 years have they accounted for half of GDP growth for two quarters in a row, let alone for five. [1]

The question then is, what’s it mean. Honestly? I don’t know.

The natural theory is that it’s supply chain risk and credit risk. When you’re not confident you’re regular suppliers will still be in business a few months from now, you want to keep a stash of whatever inputs you depend on them for on hand. And as transactions move toward a cash-on-the-barrelhead basis, everyone has to hold more goods in stock (along with more cash, but that’s happening too.)

But I suspect there are better answers, if one understood the concrete realities underlying the BEA statistics. Any of you hypothetical readers have ideas?

[1] The first post-war recovery in 1947-48 saw inventories play a similarly large role. I doubt the reasons were the same.

Is There Really a European Sovereign Debt Crisis?

The past few months have seen a flurry of articles warning that the next stage of the financial crisis will be a flight from sovereign debt, specifically in the European periphery. Even people who don’t believe in confidence fairies when it comes to the US or the UK accept the conventional wisdom that financing the deficit of the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) is a problem — that there is simply no way to convince the public to hold the amount of debt these countries will have to issue in the absence of austerity. For these countries, it’s sadly conceded, in the absence of the option of devaluation the hard exigencies of the bond market leaves them no choice but slash spending and force down wages. But is it true? Here are the relevant debts and deficits, in billions of euros (not percent of GDP, for reasons that will be clear in a moment.)
General Government Debt and Net Borrowing

2010 2009 2008
Greece Net debt 259 230 199
Net borrowing 19 32 18
Ireland Net debt 86 58 41
Net borrowing 28 23 13
Italy Net debt 1542 1473 1395
Net borrowing 80 80 42
Portugal Net debt 135 121 105
Net borrowing 12 16 5
Spain Net debt 1051 1054 1088
Net borrowing 97 118 44
PIIGS Net debt 3073 2936 2828
Net borrowing 236 269 122

Source: IMF, World Economic Outlook (General government here includes all levels of government; “net” means that intra-government borrowing is excluded.) As we can see, deficits approximately doubled in the PIIGS countries between 2008 and 2009, and stabilized in 2010. But how big are these deficits? Are they, for example, big compared with the balance sheet of the European Central Bank?
ECB Assets (billions of euros)

4th week of October of…
2010 2009 2008 2007 2006 2005
Euro-area bank loans 547 701 831 451 444 389
Euro-area securities 471 361 153 133 121 133
Total assets 1878 1786 1958 1249 1119 999

Source: ECB, Weekly Financial Statements In passing, it’s interesting how different the balance sheet of the ECB looks from the Fed’s especially before the crisis. While the asset side of the Fed’s balance sheet, at least until three years ago, consists almost entirely of treasury bills, the ECB has more lending to banks, much more foreign exchange reserves, much more gold (about 10 percent of its pre-crisis assets!) and relatively little in the way of securities. For present purposes, though, two points stand out. First, the ECB increased its security holdings by E320 billion over the past two years, or E160 billion a year. This is equal to two-thirds of the total annual borrowing of the PIIGS countries. So in principle the ECB would only have to increase its current rate of securities purchases by 50 percent to meet the entire borrowing needs of the five threatened countries. Second, looking now at stocks rather than flows, the ECB increased its balance sheet about about 1 trillion euros between 2005 and 2008. Another similar increase would allow the ECB to purchase one-third of the entire outstanding debt of the PIIGS countries. Interestingly, this is very similar to the increase in the Fed’s balance sheet over the same period. More to the point, it’s well within the range that has been suggested as an appropriate size for a second round of quantitative easing (QE2). Now, I’m not suggesting that the ECB should actually finance all new borrowing by ECB countries facing crises, or try to monetize a substantial portion of their existing debt. For one thing, there’s no need to; presumably even modest additional purchases would be enough to convince private actors to hold the debt at a reasonable price, if the ECB made it clear it stood ready to do more. I’m just saying that the frequently-heard argument that the governments of Southern Europe are “too big to save” isn’t obviously true. It seems more likely that any European QE2 — quantitative easing in its current use, remember, just means big central bank purchases of long-dated government debt — that had appreciable macroeconomic effects would be more than enough to solve the sovereign debt problem as well. Of course people (or their equivalents in the world of respectable business opinion) get very upset when you suggest that a government debt problem can be solved by just monetizing it. Oh, they say, but that’s inflationary. Maybe; but in the current context that’s an argument for it, rather than against it. And given that the 2005-2008 expansion of the ECB balance sheet didn’t produce any noticeable upward pressure on prices, it;s hard to see why another comparable one would. OK, they say, but what about the incentives? Why should governments ever show fiscal discipline if they know the ECB will just bail them out when they get in trouble? And there’s the heart of the matter, I think. It’s not that Greece, Spain, and the rest need tough austerity because they can’t be bailed out; rather, they won’t be bailed out in order to force them to implement austerity. The metaphor you sometimes see for the European sovereign debt situation is of mountain climbers roped together above a cliff. If one falls, it goes, the others can hold him up. But if they don’t act quickly and more fall, then the ones still holding on may be pulled down themselves if they don’t cut their companions loose. Maybe a more apt analogy would be that the climbers up top have a powerful winch, securely bolted to the rock; they could pull up the danglers just by turning a crank. But they wonder, wouldn’t it be better to leave them hanging, to teach them a lesson?

EDIT: The counterargument is that, while there is no technical problem with the ECB guaranteeing the financing of budget gaps in peripheral Europe, this would exacerbate the anti-democratic character of Euorpean institutions by giving the ECB a quasi-fiscal role. This is a trickier question.

Abject Patience

Aldous Huxley says, “The abject patience of the oppressed is perhaps the most inexplicable, as it is also the most important, fact in all history.”

I thought of that today when I came across this story, which really must be read to be believed. And if you read the fantastic work that Mike Konczal and a few other left bloggers are doing on the foreclosure crisis, it’s clear that what happened here is shocking and horrifying but not especially unusual. All over the country, people’s homes are quite simply being stolen from them by banks and other creatures from the financial sector.

But the most disturbing part isn’t the mortgage servicers evicting people from their homes with no clear title or other legal basis. It is the homeowners themselves. The “good” ones most of all.

Tina Kimmel was told by Citi, her lender, that she qualified for a trial loan modification under HAMP. Then after seven months of paying the lower amount as instructed, she was told without explanation she did not qualify and would be considered in default if she didn’t make all the back payments with interest and penalties. She paid them. Then Citi said they wouldn’t accept her money, she was being foreclosed. She kept paying. Without informing her they sold her mortgage to Carrington Mortgage Services, which told her that all they knew was she was in foreclosure and it was up to her, not Citi, to give them documentation on anything else regarding her loan. She gave it. And that while they were deciding whether to evict her, she’d have to keep paying. She paid. Next thing she heard was a sheriff’s notice on her door, announcing the house would be auctioned in three weeks. At the last minute, she paid the $13,000 — borrowed from family and friends — that Carrington was demanding for her nonexistent missed payments, and was allowed to keep her house.

She did everything the banks told her to. She’s proud of that. Shouldn’t she be ashamed?

I don’t know that much about mortgages or mortgage fraud. But one thing I do know is that the Citis and the Carringtons will keep stealing houses as long as the victims think it’s their duty to do whatever it takes to satisfy them, and to peacefully move out if they fail.

One can’t help wondering how many houses would have to end up mysteriously burned a few days after an eviction, to make the banks find loan modifications suddenly quite attractive. But instead we get Tina Kimmel, stakhanovite bill-payer.

Roubini, Deflationist

Last week, Nouriel Roubini wrote a somewhat puzzling op-ed in the Washington Post, in support of a payroll tax cut as a stimulus measure.

It’s a rather strange argument, or mix of arguments, since he’s never clear whether it’s a demand-side or supply-side policy. For example, he argues both that the cut should be higher for low-income workers (since they have a higher propensity to consume), and that “to maximize the incentives for private-sector hiring, there should be sharper reductions to the payroll taxes paid by employers than for those paid by employees.”

But let’s take the supply-side half of Roubini’s argument at face value. Suppose a payroll tax cut lowered the cost of labor to employers. Is it so obvious that would increase employment?

The implicit model Roubini is using is the one every undergraduate learns, of a firm in a perfectly competitive market with increasing marginal costs. But in the real world firms face downward-sloping demand curves, especially in recessions. So the only way a reduction of labor costs can increase hiring is if it allows firms to lower costs, i.e. contributes to deflation. Does Roubini really think that more deflation is what the economy needs? (Does he even realize that’s what he’s arguing?)

This, anyway, was my reaction when I read the piece. But it wouldn’t be worth dragging out a week-old op-ed to take shots at, if my friend Arin hadn’t pointed out a recent NY Fed working paper by Gauti Eggerston making exactly this point. From the abstract: “Tax cuts can deepen a recession if the short term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures.” The paper itself involves building up a complicated model from microfoundations (that’s why Eggerston gets paid the big bucks) but the underlying intuition is the same: The only way a decrease in labor costs can lead to increased hiring is by lowering prices, and under current conditions lower prices can only mean lower aggregate demand.

As Arin points out, the incoherence of the argument for payroll tax cuts may be precisely their appeal. People who think unemployment is the result of inadequate demand and people who think it’s the result of lazy, overpaid workers (i.e. it’s “structural”) can both support them, even though the arguments are incompatible. (People who don’t scruple too much over consistency can even make both arguments at once.) But if macroeconomic policy is limited to stuff that can be supported with bad arguments, we shouldn’t be surprised if the results are disappointing. That lower labor costs don’t help in a recession is, I guess, another lesson from the Great Depression that will have to be learned again.

As for Roubini, it’s hard to improve on Jamie Galbraith’s very diplomatic judgment: I cannot discern his methods.

Does fiscal policy need to be paid for in advance?

Let’s be clear: Paul Krugman is a national treasure. On fiscal policy – and politics generally – he has been saying exactly what should be said, clearly and forcefully, and just as important, from a platform that people can’t ignore. No one of remotely his stature has been as clear or consistent a critic of the Administration from the left. That said, his economics can be … problematic. I don’t know if it’s just because I’m interested in trade, or if, ironically but perhaps more likely, it’s because it’s where he made most of his own contributions, but it’s on international economics that Krugman seems most committed to orthodoxy, and correspondingly out of tune with reality. Case in point: This blog post, where he notes, correctly, that the most consistent expansionary response to the crisis has been in Asia, and then goes on to endorse the suggestion of David Pilling (in the Financial Times) that today’s Asian stimulus is the reward for fiscal rectitude in previous years:

Deficit spending is what you should do only when the economy is depressed and interest rates are at or near the zero lower bound. When times are good, you should be paying debt down. Pilling: “The scale of Asia’s stimulus may have matched, even surpassed, the west. But the context has been entirely different. Asian governments had plumped-up their fiscal cushions after the 1997 crisis, building a formidable pool of reserves. … when the crunch came, they had the wherewithal to spend.”

I’m sorry, but this is just wrong. First of all, let’s look at stimulus spending and earlier fiscal stances in various Asian countries:

Country Fiscal stimulus 2008 Average fiscal surplus, 1998-2007 Average fiscal surplus, 2003-2007
Malaysia 0.9 -1.72 -1.72
India 1.5 -5.50 -2.93
Indonesia 2.7 10.04 10.04
Australia 4.4 -3.00 -1.65
Philippines 4.5 -0.69 -0.69
Korea, Rep. of 5.4 0.98 1.20
New Zealand 5.9 -2.10 -2.23
Thailand 7.7 -4.80

n/a

Singapore 8 -1.34 -1.93
China 13.5 2.70 4.69
Japan 14.6 -0.80 -0.95

See that striking correlation between prior surpluses and stimulus spending? Yeah, me neither. It’s true that some countries, like China and Korea, show prior surpluses and big stimulus. But others that are pursuing expansionary policy have had fiscal deficits for years, like Japan (as Krugman should know as well as anyone.) Empirically, the Krugman-Pilling argument that in Asia, fiscal surpluses paved the way for fiscal stimulus just does not hold up.
No, what’s allowed Asian countries to respond aggressively to the crisis is not their (mostly nonexistent) fiscal surpluses, but their current account surpluses. Unlike in past crises (or lots of countries in the current crisis, especially on the periphery of Europe) they are not dependent on private capital inflows, so they are under no pressure to undertake contractionary policy to maintain external balance. The case of Korea is exemplary. True, it was running a fiscal surplus prior to the crisis — but it was also running a fiscal surplus in the mid-1990s prior to the Asian Crisis, to which it responded with brutal austerity. The difference was that the current account was in deficit then, and in surplus this time. The fiscal position was irrelevant.(Incidentally, Pilling literally does not seem to realize there is a difference between a current account surplus and a fiscal surplus. That’s why he’s able to write something like “Asian governments had plumped-up their fiscal cushions after the 1997 crisis, building a formidable pool of reserves,” without realizing it’s a non sequitur.)What about the larger argument, that good Keynesian governments should engage in the precautionary accumulation of financial assets in good times to finance demand-boosting spending in bad times? Krugman himself admits that the Bush deficits are not a binding constraint on fiscal policy today, which is rather a blow to his argument. More broadly, it’s far from clear that there is any meaningful sense in which the existing level of public debt affects the space for fiscal policy. The argument for prudential saving might apply to the government of a premodern or underdeveloped country, which rests on a narrow fiscal base; but if substantial excess capacity exists in an industrialized country the government always can mobilize it. (Matt Yglesias gets this, even if Krugman does not.) As for the traditional Keynesian argument for federal surpluses in boom times, it has nothing to do with precautionary accumulation of financial assets, and everything to do with preventing aggregate demand from running ahead of aggregate supply.In the end, I suspect this idea of paid-in-advance Keynesianism says less about his intellectual weaknesses than about his institutional commitments. As a certified big-name economist, you have to make some concessions to orthodoxy if you don’t want to see your intellectual capital devalued. And what orthodoxy demands now — above all from those who want more expansionary policy — is gestures of somber concern with future deficits. (If not austerity today, at least austerity tomorrow.) With a few honorable exceptions, even left-leaning economists seem happy to comply.