Penny wise and pound foolish

Posted on November 1, 2011 by Richard S. Grossman

The institutions of government and the politicians who run them have–rightly–been criticized for many mistakes during the past few years.   The Congressional budget deadlock this past summer is a case in point.  The mismanagement at Walter Reed Army Medical Center, first publicized by the Washington Post in 2007, is another.

No wonder why Gallup reports that trust in the government is low–so low that the national mood can probably be summed up by paraphrasing the Robin Williams’ character in Good Morning, Vietnam: “If it is being done correctly, here or abroad, it’s probably not being done by the government.”

The government actually does a number of things quite well.  Among the things it does superbly well is collect economic data.

Is hard to overstate the importance of accurate and comprehensive data for conducting economic analysis.

Without good data, it is impossible to assess where the economy has been, how it is currently doing, and to make concrete recommendations for economic policy.

Which is why it was so disappointing to read in yesterday’s Wall Street Journal that cuts to the Census Bureau budget proposed by House Republicans may endanger the Bureau’s Economic Census.

The Economic Census, which takes place every five years, is scheduled to survey five million US firms starting in late 2012.  This survey provides a gold mine of data on the size, location, and competitiveness of US business.  It provides, in the Census Department’s words, “consistent, comparable, and comprehensive measures” of business activity by region and industry.

It also provides important benchmark data for constructing a host of important indices of economic activity, including GDP.  According to Steve Landefeld, director of the Bureau of Economic Analysis, without the census, “You would find that the GDP estimates would get progressively off.”

Economists have been rightly criticized for our performance during the financial and economic meltdown of the past few years.

We won’t do any better if the data get worse.

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Alan Meltzer’s straw “Keynesian”

Posted on October 29, 2011 by Richard S. Grossman

Remember when “liberal” became the insult of choice among Republicans?

Apparently, “Keynesian” has now taken on that status for Republican economists.  Never mind that Keynesian is ill-defined (old Keynesian?  new Keynesian?  the Keynesian part of the neoclassical synthesis?)–making Keynesian a dirty word and applying it to those with whom you disagree has become the tactic of choice among Republican economists.

Take Friday’s Wall Street Journal opinion piece by Alan Meltzer of Carnegie Mellon University and–because WSJ‘s op-ed page seems to require that a quota of their opinion piece be penned by someone from it–the Hoover Institution.

A couple of  this op-ed’s shakier assertions:

“Those who heaped high praise on Keynesian policies have grown silent as government spending has failed to bring an economic recovery.  Except for a few diehards who want still more government spending, and those who make the unverifiable claim that the economy would have collapsed without it, most now recognize that more than a trillion dollars of spending by the Bush and Obama administrations has left the economy in a slump and unemployment hovering above 9%.”

In fact, there is a considerable body of evidence to suggest that the fiscal stimulus did have a positive effect on the economy.  Fellow Hoover Institution denizen Ed Lazear is willing to credit the stimulus with boosting GDP by 3 percent–and if you can get 3 percent further away from the edge of a cliff, I am all for it.  Even the fiscally conservative Economist magazine seems to think that there is room for additional stimulus.

Meltzer continues: “…Keynesian models totally ignore the negative effects of the stream of costly new regulations that pour out of the Obama bureaucracy…”  The solution?  “…announce a five-year moratorium on new regulations.”

Talk about unverifiable claims! The author is railing against reforms that have not yet been fully implemented (health care and Dodd-Frank).

Although we do have a number of silly and costly regulations (my personal favorite is Florida’s licensing requirements for interior designers) which should be eliminated, many make valuable contributions to societal welfare.  If the government had done a better job of using regulation to moderate some of the excesses of the financial industry, we might have mitigated some of the worst consequences of the financial crisis.

According to the World Bank the US ranked fourth out of 183 countries in ease of doing business.  Claiming that America’s businessmen suffer from the burdens of over-regulation–and erroneously blaming it on Keynesian economics–is a mistake.

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See no evil, hear no evil, and, if you are a ratings agency, speak no evil

Posted on October 25, 2011 by Richard S. Grossman

You don’t have to look too far to find nutty policy proposals.

One of my favorites is  Herman Cain’s suggestion that Congressional bills be limited to no more than three pages.

Another, reported in recent days by both the Financial Times (which claims to have seen an actual draft) and the Wall Street Journal, is the European Union’s suggestion that regulators would be given powers to suspend credit ratings of countries undergoing bail-outs.

According to the FT, the proposal would give the European Securities and Markets Authority (ESMA) the right to: “suspend ratings of countries in bail-out programmes so that adverse ratings are not issued at “inappropriate moments”.”

I would love to be able to ask a Finance Minister when he or she thinks an appropriate moment would be to downgrade his or her country’s credit rating.

According to the FT, the draft continues: “In order to prevent that credit rating agencies issue sovereign ratings which do not accurately reflect the situation of the country concerned and would cause negative spillover effects to other countries, Esma should be granted the power to temporarily restrict the issuance of credit ratings in exceptional, precicely defined situations.”

Actually, I think the objective is to prevent the ratings agencies from issuing sovereign ratings that accurately reflect the situation in the country.

The Journal correctly points out two flaws with the proposed policy: (1) ratings agencies seldom lead the markets (recall that S&P downgraded the US when it was hours away from a default); (2) investors will just use other metrics, such as bond yields and spreads.

Of course, the EU might want to think about banning newspapers or web sites that publish such subversive data….

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Prize (for a) failure

Posted on October 24, 2011 by Richard S. Grossman

British clothing retailer Simon Wolfson (known to his friends in the House of Lords as Baron Wolfson of Aspley Guise) announced several days ago the establishment of the Wolfson Economics Prize (read the press release here).   The prize, worth a cool £250,000 (about $400,000)–second only to the Nobel Prize in Economics, in terms of cash value– “…will be awarded to the person who is able to articulate how best to manage the orderly exit of one of more member states from the European Monetary Union.”

Talk about your high-stakes essay contest!

According to Lord Wolfson: “There is now a real possibility that political or economic pressure may force one or more states to leave the euro.  If this process is mismanaged it could threaten European savings, employment and the stability of the international banking system.  This prize aims to ensure that high quality economic thought is given to how the euro might be restructured into more stable currencies.”

I’ve got nothing against contingency planning.  Nor do I begrudge an enterprising economist a quarter of a million quid for a well argued essay.  But the euro is here to stay and it is unlikely that any of the members will be leaving soon.

Sure, there are a number of practical obstacles to withdrawing from the eurozone: everything from reprogramming computers and ATMs, to legal questions surrounding redenomination of debts, to political questions about exactly how to withdraw from a treaty that has no exit clause.

But the most serious obstacles have do to with the incentives to exit.

Writing in the Financial Times last month, Ian Bremmer, argues that Greece is not leaving the eurozone, “not now, not ever.”  Even if the technical and legal barriers could be overcome, he argues that Greece’s limited (relative to the rest of the eurozone) exposure to foreign trade, large euro-denominated debts, and competition from lower-cost non-euro neighbors (e.g., Turkey), would limit the benefits of a euro-exit.

On the other end of the eurozone, Germany’s exit seems equally unlikely.  Chancellor Angela Merkel is committed to saving the euro (with as little cost to the German taxpayer as possible).  And why shouldn’t she be? If Germany were to leave the euro, the new mark would be so expensive that German exporters would be priced out of world markets.

So, although Greece appears to be on its way to some sort of debt default/rescheduling, it is unlikely that it–or any other country is about to leave the eurozone.

But, just in case I’m wrong, entries for the Wolfson Prize are due by January 31st, 2012.

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John Cogan and John Taylor confuse temporary and permanent

Posted on October 4, 2011 by Richard S. Grossman

In a recently published op-ed piece in the Wall Street Journal, Stanford economists John Cogan and John Taylor argue that:

“Temporary, targeted tax reductions and increases in government spending are not good economics. They have repeatedly failed to increase economic growth on a sustainable basis. What may come as a surprise is that such policies are not good politics either. Their inability to deliver promised economic benefits has invariably led disappointed voters to turn against those politicians, Democratic and Republican, who have supported them.”

There is so much wrong with this article that it is hard to know where to start.

  • Their assertion that temporary fiscal measures always fail to deliver a macroeconomic boost is just plain wrong.  War, for example, which is almost always temporary, typically generates greater economic growth in its wake.  Of course, the benefits are usually greatest and the costs the lowest if you are not involved directly in the fighting, but do business with the warring parties.  For the record, I am not endorsing war for economic purposes, but am just making a point about temporary targeted spending.
  • Their distinction between temporary and permanent is simplistic.  Very little accomplished (if that is the right word for it) in Washington is permanent.  It is only permanent until your political opponents are able to overturn it.  And sometimes even “permanent” measures do not purport to be permanent.  The tax cuts enacted under George W. Bush came with an expiration date.
  • The assertion that Gerald Ford and Jimmy Carter were voted out of office because of harmful fiscal legislation passed during their terms is also dubious.  Both of these presidents had major baggage which made a second term a long-shot in any case: Ford had Nixon; Carter had an oil shock, the Iran hostage crisis, and tight monetary policy pursued by Paul Volcker starting in 1979.

The authors offer a paean–sadly misguided–to Ronald Reagan.  They write:  “President Reagan rejected temporary stimulus measures and instead proposed permanent income-tax rate reductions. His tax program, in conjunction with steady monetary policy begun by Paul Volcker, produced the promised results.”

They continue: “By late 1982 the recession was over and in early 1983 employment and investment began to rise rapidly. In 1984, it was “Morning in America” and Reagan was overwhelmingly re-elected. Nearly two decades of strong, steady, noninflationary economic growth ensued.”

First, please stop giving credit to Reagan for Paul Volcker.  Carter appointed Volcker; Reagan merely benefited–both politically and economically–from Volcker. Second, given the authors’ interest in “permanent” versus “temporary” policies, they should concentrate on permanent, rather than temporary results.  As a result of Reagan’s tax (and spending, particularly on defense) policies, America’s debt-to-GDP ratio rose from more than 32 percent in the first year of his term to nearly 52 percent in the last (by the end of George H.W. Bush’s four years the figure stood at 64 percent).  Reagan didn’t pursue a temporary stimulus, he pursued a fiscally irresponsible permanent stimulus.  We already have enough budgetary woes in this country–we should not make them worse by emulating Ronald Reagan.

The best example of the authors’ economic myopia is in their description of the effects of George W. Bush’s tax cuts.  They wrote: “Within four months, employment began to rise and the unemployment rate began to fall. By 2004, the economic recovery was in full swing. President Bush was re-elected, along with Republican majorities in both the House and Senate.”

What they forgot to add is that four years later, the–very temporary–macroeconomic boom set off by the Bush tax cuts and spending increases led to the worst financial and economic crisis since the Great Depression.  Surely Messrs. Cogan and Taylor can find better role models for economic policy making.

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The long run and short run of it

Posted on September 25, 2011 by Richard S. Grossman

When you teach economics, you spend a fair amount of time dwelling on the distinctions between the short run and the long run.

If a firm is not making a profit but is meeting its short-run costs (e.g., wages, utilities), microeconomic theory says that the firm should continue in business rather than shut down.

In macroeconomics, we distinguish between the short and long run (and in some textbooks, the medium run) on the basis of what aspects of the economy are fixed and what are variable.  For example, if all workers received a 50 % wage increase tomorrow, they would all be about 50%  better off….for a very short time (how short depends on a variety of factors).  Once those higher wages were translated into higher prices, workers would have to pay about 50% more for everything that they consume and they would no longer be better off.  Thus, we say that the price level is “fixed” in the short run, but is variable in the medium run.  Things like the state of technology, on the other hand, are fixed for a much longer period.

Policy makers in the US and Europe have clearly demonstrated their confusion over this relatively straightforward concept, particularly in the fiscal arena.

  • Spanish lawmakers have taken steps toward enacting a constitutional amendment mandating a balanced budget.  Balancing the budget is a good idea; instituting a rule in the midst of a severe economic slowdownmandating that the budget be balanced  is not.
  • Europeans are pressing the Greek government to enact ever more severe austerity measures, even thought it is clear that there is little more that Greece can do to meet their demands without causing civil unrest.
  • In the US, Republican lawmakers–particularly Tea Party-affiliated Republicans–have prevented the enactment of necessary spending (e.g., extension of unemployment insurance benefits) on the grounds that this is fiscally irresponsible.  Achieving fiscal balance over a longer term is a good idea; forcing tight fiscal policies when we may be about to fall back into recession is foolhardy.

Most economists would agree that government budget policies in the US and Europe require substantial adjustment.  However, those who press for immediate resolution of those long term issues do so at the peril of ignoring the very real possibility of another severe recession.

The English economist John Maynard Keynes famously observed “in the long run, we are all dead.”  By confusing short-term and long-term problems–and remedies–budget hard-liners in Europe and the US are only making matters worse.

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Gary Becker and the law of the jungle

Posted on September 3, 2011 by Richard S. Grossman

The sub-prime crisis and the ensuing economic slowdown have led many to question some widely held economic tenets, particularly the belief that unfettered markets inevitably lead to the best of all possible outcomes.

Writing in yesterday’s Wall Street Journal, University of Chicago economics professor and Nobel laureate Gary Becker whines about this assault on the unconditional faith in completely free markets (sometimes equated with “the Chicago School of Economics”), by saying, in essence, “Sure, the market performed badly–but the government was even worse.”  He concludes his article with: “…when the performance of markets is compared systematically to government alternatives, markets usually come out looking pretty darn good.”

Professor Becker is attacking a straw man.  Mainstream economists and politicians are not proposing a statist or socialist system in which the government owns the means of production and directs economic activity.  On the contrary, some are arguing that government spending should be increased by a few percent of gross domestic product in the short-to-medium term in hopes of reviving the economy.

Professor Becker’s article contains a number of other misleading features.  Although correctly citing the fact that the Federal Reserve kept interest rates too low for too long, he ignores the irresponsible fiscal policy of the Bush administration in both cutting taxes and increasing spending.  I agree with Prof. Becker that Medicare, Medicaid, and Social Security are in need of attention, but if the Bush Administration had not spent away the surplus built up during the Clinton years, these programs could have been dealt with on something less than an emergency basis.

Prof. Becker also alleges that the fiscal stimulus had no positive effect on the economy.  In fact, there is a substantial body of opinion among economists that the stimulus prevented the economy from falling off a cliff.  Unfortunately, Prof. Becker does not share his alternative scenario with us.  In his ideal world–a world without government intervention–what would have happened to the US economy?  How much higher would unemployment have risen?  How much more frozen would capital markets have become?

Finally, Prof. Becker dismisses regulatory reform as “badly designed,” without sating anything about what aspects of it he finds most objectionable.  Is there no element of financial reform he can support?  Does he have any positive recommendations?  Or should all regulations and regulators be dismissed? Do we really want our financial system to be ruled by the law of the jungle?  Didn’t such a jungle regime contribute to our financial problems in the first place?

It would be reckless to argue that effective regulation can completely insulate the financial system from crises  Profit seekers will always be more nimble than the regulators who attempt to constrain them.  Nonetheless, these constraints make a vital contribution to financial stability.  Prof. Becker’s desire to eradicate them is a recipe for disaster.

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A policy worth considering

Posted on August 28, 2011 by Richard S. Grossman

The White House has already given some indication of the sort of proposals it will put forward after Labor Day to help boost the economy.  These include extending payroll tax cuts for another year, extending unemployment benefits, and speeding the approval of free trade agreements with Colombia, South Korea, and Panama.  These are all worthwhile proposals and should be adopted.

Rumor has it that the President will also propose an infrastructure bank that will promote public-private partnerships to improve some of our nation’s admittedly crumbling roads, rails, bridges, and other parts of our infrastructure.  This is an attractive idea (depending on the specifics), although it does not sound like something that Congressional Republicans will agree to, especially in an election year.

One proposal the Republicans might agree to is a temporary investment tax credit (ITC), offering corporations generous tax deductions on investments in plant and equipment for such investments made in the coming calendar year.  The advantages of such a program include the fact that because it is explicitly temporary, firms would be encouraged to undertake such investments quickly in order to take advantage of the time-limited tax credit.  Further, it would likely have a large effect, relative to other sorts of fiscal policies, encouraging job-creating investment in building new factories and/or producing new equipment.

A disadvantage is that it would force firms to come up with investment plans that could be implemented quickly–making and implementing investment projects in haste may not be a recipe for well thought-out plans.  Additionally, economic studies suggest that the positive effects of increasing the ITC might not be seen for several quarters.  Hence, it is in no way a quick and easy solution to the current economic sluggishness.

A temporary reduction in the ITC makes economic sense.  More importantly, given the dysfunction in Congress, it makes political sense.

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WSJ op-ed board member: The unemployed prefer sitting on their duffs to working

Posted on August 19, 2011 by Richard S. Grossman

Writing in today’s Wall Street Journal, WSJ op-ed board member Stephen Moore offers a variety of dubious–and at least one outrageous–opinion on the economy and eocnomic policy.

(1) The economy would be in better shape today in the absence of the economic stimulus.  No, it wouldn’t.  Even fellow WSJ contributor Ed Lazear believes that the stimulus had some effect.

(2) Dismissing an Administration view, he writes: “Only someone with a PhD in economics from an elite university would believe this.” This is just one of those populist throw-away lines that makes no sense. John Taylor (PhD, Stanford), Michael Boskin (PhD, University of California, Berkeley), Glenn Hubbard (PhD, Harvard) all make regular appearances on the Journal’s op-ed page.  I think what Mr. Moore (BA, University of Illinois; MA George Mason University, according to the Journal’s  web site) really means, is that anyone he disagrees with is not to be trusted.

(3) “How did modern economics fly off the rails? The answer is that the “invisible hand” of the free enterprise system, first explained in 1776 by Adam Smith, got tossed aside for the new “macroeconomics,” a witchcraft that began to flourish in the 1930s during the rise of Keynes.”  The invisible hand flourished during the boom-bust of the 1920s, which led to the worst economic downturn in our nation’s history.  It also flourished during the Administrations of Ronald Reagan and George W. Bush.  Taxes were lowered, spending–particularly military spending–was increased, and regulation–especially financial regulation–was gutted.  And from this we reaped bloated deficits and financial crises–including the worst since the Great Depression.

Perhaps the nuttiest part of the op-ed is his policy recommendation on unemployment insurance:

“I have two teenage sons. One worked all summer and the other sat on his duff. To stimulate the economy, the White House wants to take more money from the son who works and give it to the one who doesn’t work. I can say with 100% certainty as a parent that in the Moore household this will lead to less work.”

Economists with PhD’s from elite universities take note! Painstaking construction of comprehensive databases on the employment situation are a waste of time.  Sophisticated empirical techniques for making sense of the data  are equally worthless.  All we need to do to make sound economic policy is to observe the behavior of a couple of teenagers.

Moore’s conclusion that unemployed are lazy layabouts who are coddled by the unemployment insurance system is outrageous.  To anyone who is struggling to find work so that they can feed and house their families in the worst labor market in more than 20 years, his op-ed is offensive.

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The monetary musings of Gov. Rick Perry

Posted on August 16, 2011 by Richard S. Grossman

Texas Governor and Republican presidential candidate Rick Perry, “…brought the Fed directly into the campaign debate Monday night by saying it would be ‘almost … treasonous’ for the central bank to play politics by expanding the money supply.

“‘If this guy prints more money between now and the election,’ Mr. Perry said in Cedar Rapids Monday night, without naming Mr. Bernanke, ‘I don’t know what y’all would do to him in Iowa, but we—we would treat him pretty ugly down in Texas.’”

Just a couple of notes for Gov. Perry.  I’ll keep this polite, since the governor carries a weapon when he jogs and has already threatened to treat one economist “real ugly.”

The governor seems to be saying that the Fed shouldn’t engage in any extraordinary measures to help the economy between now and the election.

Let me make sure I’ve got this right.  The Fed should do nothing to help the economy because it might alter the election results?  Specifically, it should do nothing to help the economy because it might increase likelihood that Barack Obama is reelected?

At this point, Governor, I’m pretty sure that the American people will welcome any policy action that improves the economy’s prospects, wherever it comes form and whatever its effect on the 2012 presidential election.

Now, if Governor Perry wants to prevent any meaningful economic policy from being enacted in order to enhance his electoral prospects, all he has to do is talk to his friends in Congress. They have already demonstrated that they are pretty good at that.

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