This post isn’t really fully fleshed out but I’m just going to blunder ahead and hope for the best. I have a question or, more correctly, a series of questions for those among my commenters who support a large fiscal stimulus. Here’s the question: why?
That may seem like a dumb question on my part but I think there’s more to it. First, the more recent articles by the model-makers like Moody’s Mark Zandi and Macroeconomic Advisers have cautioned that the effects of fiscal stimulus are temporary. Any increased GDP produced by fiscal stimulus in 2012 would be followed by GDP growth lower than it otherwise would be in 2013 and 2014. What this tells me is that either 1) any fiscal stimulus must be large enough to “jump start” the economy on its own or 2) fiscal stimulus merely provides the political space to undertake other necessary reforms that will help to produce sustained economic growth.
Second, we have a serious demographically-based cashflow problem which will continue for several decades. That’s no surprise. We’ve known about it for a half century. The additional interest we will pay as a result of the borrowing we do for fiscal stimulus will only exacerbate that problem.
Third, there are no prospects whatever that robust growth will enable us to pay down the additional debt. For the last two hundred years the U. S. has seen a very steady 3% year-over-year GDP growth, 2% in real terms. That itself is very atypical among developed countries (the UK, France, and Germany haven’t had the same experience).
Fourth, the current level of debt is around 100%. There’s economic scholarship that’s shown that levels of public debt this high reduce growth.
I’ve made no secret of my wariness of fiscal stimulus as a solution to our economic problems or of my dismay that the stimulus that was enacted into law in 2009 was the size that it was, had the structure it had, and was spread out over so long a period. IMO to whatever degree fiscal stimulus might have helped us was negated by the construction of the bill that was enacted into law. I also don’t think that permanently higher taxes, the natural implication of undertaking higher debt, is a formula for greater prosperity.
That’s why I’ve emphasized methods of stimulus that don’t include increasing the debt like approving more free trade agreeements and replacing measures that don’t produce a great deal of increased economic activity with those that do.
Please help me out with this. Why more fiscal stimulus? In your answer please address some of the issues I’ve brought up in this post. “What else we can do?” isn’t a very reassuring answer. Please don’t try to explain Keynesian multipliers to me. I understand that. The question is what the multipliers of specific strategies are and whether they exceed their cost.
I think that there was some utility in the initial stimulus since it helped stop the precipitous drop we were facing. It made for a softer landing. At this point, I think we mostly need balance sheet repair, so I am not sure that stimulus will do much. If we had started with lower levels of public debt maybe, but we didnt.
Steve
Or, to make it shorter, this graph at the WSJ.
http://blogs.wsj.com/economics/2011/10/01/number-of-the-week-the-economys-housing-albatross/?mod=WSJBlog
Steve
Any who have followed my posting philosophy will know that my initial reaction would be to give reasons to NOT have another stimulus package. I’d like to look at it through the other sides prism and figure out if I could find a reason TO do it.
Totally separately, and off topic. I was one of the luckiest men in the world last night. Here in Naperville at the North Central College (in a marvelous venue) we got to enjoy Yo Yo Ma for 1 1/2 hours of perhaps the finest cello player of our era on stage. Three Bach pieces. You were both mesmerized at the quality of Ma’s play and the ability to reproduce without sheet music the six movement pieces from memory.
But then I thought, “how in the hell did this Bach guy compose this?” Other worldly.
These are the problems facing the U.S:
Short term, jobs
Medium term, deficits
Long term, entitlements
If there is little excess capacity, then stimulus spending will increase inflation. If there is little excess capital, then stimulus spending will increase the cost of borrowing. There is little core inflation and very low interest rates.
A stimulus makes sense if there is excess capacity and excess capital. You want to balance this against the long-term costs (and dangers) of borrowing, so a proper stimulus will have to demonstrate to the markets that the stimulus will have the desired effect of increasing production, while also having a plan in place to repay the debt over the long term.
Instead, since 2001, the U.S. has been borrowing just to pay for day-to-day expenses. This is very dangerous and can lead to a financial meltdown. Oh. Oh, right.
See the difference?
Zachriel: the stimulus will have the desired effect of increasing production, while also having a plan in place to repay the debt over the long term.
By the way, this is no different than what an individual or business will propose when borrowing from a bank. They want cash now, and have a plan to use it to increase their long term prospects, including a plausible repayment schedule.
Compare this to someone who lives on credit card debt to maintain a lifestyle beyond what they can pay for with their income. (Or compare this to trying to borrow from the bank while your junior partner is loudly threatening to default on the bank if he doesn’t get his way.)
Zachriel:
I agree, more or less, with your statement of the problems and priorities. I disagree that we have a plan in place or are likely to put a plan in place to pay down the debt.
Also IMO the best we can expect from fiscal stimulus in the absence of structural reforms are temporary jobs accompanied by a permanent increase in the debt. Judging by the construction of the last round of fiscal stimulus we won’t even get a lot of temporary job creation. We will, however, enable the states to defer the structural reforms they need to put in place a little longer (which was one of the things that happened the last time around).
Dave Schuler: I agree, more or less, with your statement of the problems and priorities. I disagree that we have a plan in place or are likely to put a plan in place to pay down the debt.
Didn’t say the U.S. had such a plan. The U.S. political system is somewhat dysfunctional as shown by brinkmanship over the debt ceiling.
Dave Schuler: Also IMO the best we can expect from fiscal stimulus in the absence of structural reforms are temporary jobs accompanied by a permanent increase in the debt.
No. A well-directed stimulus will still have the desired effect. Most investors still have confidence in the U.S. That means low interest rates.
In the long term, such a stimulus will result in increased overall GDP as people are put back to work. Nevertheless, having a plan in place to address the deficits will prevent a long term problem, and help keep interest rates low over the repayment period. The latter requires the sort of discipline the U.S. has not shown recently.
Is there any empirical evidence for this and if so, what is it? Also, what would a “well-directed stimulus” actually look like? IOW, how and where should actual stimulus money be spent? Third, what is the desired effect?
Andy: Is there any empirical evidence for this and if so, what is it?
Most economists basically agree that stimulus spending transfers wealth from the future into the present, and when there is excess capacity now, it acts to even out the market cycle. (It also works if you save, in which case it effectively transfers wealth from the previous cycle into the present.) The classic “experiment” was during the Roosevelt Administration. When the New Deal was implemented, GDP rose. When the New Deal was cut back in 1937, GDP fell. When the New Deal was resumed, GDP rose again. With WWII spending, the Great Stimulus, the Depression became just a memory. It’s hard to get a more direct experiment than the Roosevelt recession of 1937, at least in the real world.
More recently, you might look at the CBO report on the stimulus,
“Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from January 2011 Through March 2011.” They analyze a number of models to determine the effects of the stimulus.
http://www.cbo.gov/doc.cfm?index=12185
Andy: Also, what would a “well-directed stimulus†actually look like? IOW, how and where should actual stimulus money be spent?
People are deleveraging. The problem occurs when everyone deleverages at the same time causing a collapse in demand. Most people, especially the well-to-do, use tax cuts to further reduce their debt, not to spend. Similarly, low interest rates do not lead to increased demand because people are still wary. From a personal point of view, jobs are insecure, so people don’t want to make big purchases. From a business point of view, businesses don’t want to invest when there is so little demand, and when prices are deflating.
Due to the extent of the problem, it will take direct spending to spur the economy. Prudent investments in infrastructure may give the biggest bang for the buck. The problem with infrastructure spending is that it takes time for the money to enter the economy, especially for the big projects that America has been postponing for so long. Meanwhile, investment in retraining and education will have long term benefits.
Andy: Third, what is the desired effect?
The short term effect is to put people back to work. With unemployment around 9%, that is a huge number of workers not contributing to GDP or the tax base.
Of course, a stimulus can only be temporary, and a way has to be found to move forward into a growth economy. It’s not atypical for a great economic power to be undermined by fiscal and trade deficits as they attempt to maintain their standards of living in the face of a changing world. Continuing trade deficits will ultimately erode the U.S. position.
This gets to the root of my question. Both Mark Zandi of Moody’s and Macroeconomic Advisers have recently written that a stimulus package of the size and structure that’s been proposed would increase 2012 GDP while decreasing 2013 and 2014 GDP. That’s pretty darned temporary.
It seems to me that the advisability of additional fiscal stimulus depends very much on whether you think that the economy will recover on its own by 2013 (which seems very unlikely to me) or new fiscal stimulus will be added in 2013, 2015, and so on.
Increasingly, it seems to me that fiscal stimulus is less a remedy for our economic problems and more like first aid. If you apply first aid exclusively and don’t do anything to cure the underlying issues, it will inevitably fail.
The underlying issues include excessive borrowing and bad trade policy just to name two. The overwhelming preponderance of consumer deleveraging that has taken place over the last four years has been via foreclosure rather than saving. I don’t think that’s a formula for a rebound in consumer spending. When you reduce both consumer income and credit what do you expect them to consume with? Not to mention that replacing private borrowing with public borrowing doesn’t really address the problem of excessive borrowing. It just changes the accounting.
Possible off topic, but surprisingly without intellectual property protection. Shocking I know.
Very well argued text book vulgar Keynesianism…
Personally, I think we need a stimulus package of $1 trillion in rubber dog poo and plastic vomit. We can never have too much of that.
[Hint, there is a criticism of Keynesianism in here, but I’m not sure many will get it.]
Honestly, Steve, I think that Zachriel has made a very good case that fast racehorses are faster than slow ones. The question I have is whether we have a fast racehorse?
Yeah, you didn’t get it.
My point about vulgar Keynesianism is that demand is not demand is not demand, whereas the Keynesian does not see such a distinction. To a Keynesian, $1 trillion more in rubber dog poo and plastic vomit is a good thing because demand, is demand is demand. We would all be better off with all that extra rubber dog poo and plastic vomit than without it.
It really gets to the “targeting” aspect of fiscal stimulus. Quick off the top of your head how many products/services are sold in the U.S. How many people work in the firms producing the top 100? Now, which ones should be recipients of stimulus money? Which ones have excess capacity? Should we look at excess supply too? Is there excess capacity in the housing market? I’d say yes, lots. But you yourself are very wary of spending money there. But according to the Keynesian that is exactly where the money should go. If we had $1 trillion more in housing that is a good thing…demand is demand is demand (to the Keynesian).
Additionally the Keynesian doesn’t see a need for short term investment. The capital stock, to the Keynesian, is fixed and any investments wont pay off till later, so don’t bother with that.
My point is even more fundamental, than you may realize Dave. It cuts to the very heart of the Keynesian world view and says, “Nope, it is flawed.” We can’t think aggregate demand, because once we do the conclusion is we should target stimulus money to housing and the financial sector and the automobile sector. So, we might have fast race horses, slow race horses, and race horses in the middle of the pack. Problem is there is really no way to know which is which.
And we haven’t even brought in the issues associated with rent seeking and the like.
As for Steve’s graph…
Yeah, here is the deal…you need to clear the excess supply. Until you do that you are pissing in the wind. Now, for those of you who suffered through a micro economics course…how do you clear excess supply?
Yeah, it probably is that simple. From an economics stand point. Problem is from a political stand point it is complete and entirely intolerable. And no amount of stimulus will help….well okay, maybe there is an amount that big, but we can’t borrow that much, so its pretty much not an option either.
Standard high school history text book, but there is quite a bit missing here, IMO.
When did the U.S. go off the Gold Standard? Now, when did GDP start increasing?
Why was the rise in GDP so damn weak relative to what was expected? Yeah GDP rose quickly when looked at over the period of 1933 – 1936, but it was still below what was expected. Look at this post,
Link
Note that Glasner is taking to task Lee and Ohanian’s claim about FDR prolonging Great Depression and their claims about aggregate demand. What is interesting is the graph. Note that once NIRA is implemented (one of the core programs of the New Deal) the upward trend for industrial production goes flat. Recovery aborted.
And look at the recovery prior to abortion. It was staggeringly large. Would the wait have been as long without NIRA, probably not.
As for WWII, the idea that sending of tens of thousands of young men to die, many thousands more to be wounded. And devoting large amounts of industrial capacity to producing things that get blown up is not an ideal way to end any kind of recession or depression. In fact, Simon Kuznets has argued that counting defense spending as part of GDP is highly questionable.
BTW if you are wondering who Simon Kuznets is, he is the guy who gave us our National Income and Product Accounts amongst other things. Or more simply when it comes to counting up things like GDP, Kuznets blazed the trail.
I got it. I’m skeptical of a lump of demand just as I am of a lump of labor or a lump of production.
I was referring to something slightly different: phrases like “well-directed stimulus” or “prudent infrastructure investments”. Those are a lot harder to reject than what we’re actually likely to get. Recent experience suggests that what we’ll get is infrastructure investments which don’t time-shift anything, create any jobs, or preserve any jobs that were at risk but rather a budget that shifts borrowing and spending from state and local budgets to the federal budget.
There is a range of effectiveness from a completely ineffective stimulus that creates no jobs and builds no infrastructure that will enhance future productivity at one extreme and well-directed stimulus with prudent infrastructure investment at the other. What is needed is a method of measuring where on the spectrum specific proposals lie which IMO is an empirical question, an approach that the CBO, including in the link that was supplied, has explicitly rejected.
Here is the thing, we should already be doing the good infrastructure work now. It tends to make sense if you are in a recession or not. Infrastructure tends to be closer to the public good end of the spectrum than most other goods. A bridge, a road, air traffic control systems, electricity grid reliability, etc., etc., etc.
Problem is we have lots of roads, and lots of bridges. So the opportunity to make new ones is probably quite a bit less than in 1935. Similarly repairing an aging bridge, while good, wont get you as much as building a needed bridge.
And none of this really addresses much in the way of excess capacity, IMO. You can’t replace excess capacity in housing with increased spending on infrastructure, at least not quickly. You’d have spatial/location issues–i.e. are unemployed housing construction workers living near where you need the infrastructure work done. Then there are issues with skill set, human capital acquisition–i.e. a construction worker who worked mainly building houses may not transition effortless into repairing roads and bridges. And what exactly infrastructure jobs are you going to put auto workers and financial industry people to work on?
The amount of work just finding these projects and getting resources into place is going to be significant. But maybe that is what you can get the financial industry people working on…well after they move to Kansas and take a serious pay cut. But wait, if their pay is cut they wont be spending like they used too….so chances are your multiplier is going to be a bit disappointing.
I know we are supposed to be coming up with really good ideas on how to get out of this mess, but really…the solution may be let housing prices drop to clear the market, then have some nice serious inflation. This is what got us out of the depression. We went off the gold standard and the producer price index went up. This is seen as a proxy for demand…of course NIRA nearly killed it, so I’d suggest we take all those vulgar Keynesians and lock their asses in the ivory tower for awhile.
“well-directed stimulus†or “prudent infrastructure investmentsâ€
Consider two perfect spheres, traveling through an ideal gas, with frictionless surfaces, colliding. Exclude the effects of gravity and energy loss from elasticity…………..now calculate…..
I’m thinkin’ politicians will get stuck at plastic dog poo vs plastic vomit………anyone hear of a company called Solyndra??
Not a good start!
“I know we are supposed to be coming up with really good ideas on how to get out of this mess, but really…the solution may be let housing prices drop to clear the market,”
Aye. Excellent point. Let them clear, first.
“I know we are supposed to be coming up with really good ideas on how to get out of this mess, but really…the solution may be let housing prices drop to clear the market,â€
I’m living in a part of town (Pine Hills) in Orlando where home prices have fallen over 80% since the peak. Houses can be had for prices not seen in 30 years. Houses still sit empty, with more abandoned every month. Exactly how much farther do they need to fall?
Excuse me, prices here have only fallen 79% here in Pine Hills.
Housing prices need to fall further, but that is not a short term solution as it will put even more homes underwater.
Steve
Icepick,
I owned a house in Melbourne Florida which got hit pretty hard, but nothing like Pine Hills. I bought it for $150k before the big bubble. I spent about $50k on upgrades, including a new detached garage (it didn’t have a garage at all). I went to sell it just after the peak and the agent listed it for whopping $495k. I eventually sold it for $200k (taking a loss thanks to transaction fees and commission, not to mention renting at a substantial loss for a year) and according to Zillow it’s now worth about $145k. Each month Zillow sends an email telling me the value’s dropped another 1-2%. All I can say is that I’m glad I don’t have that anchor around my neck anymore and that I was prudent enough not to do what a lot of people did, which was refinance and pull out that phantom equity.
It looks like much of the country is seeing prices stabilize, but it looks like Florida has some more dropping to do.
We’re moving back to Florida in a few months. We’ll be renting. In fact, I’m not sure we’ll buy a house again for a long time even though prices are low and are going lower. The demographic trends indicate to me that housing probably isn’t going to be a good investment. Plus, owning a house is a PITA and we still have several moves ahead of us.
Perhaps I’m missing something but, while I agree that housing prices have farther to fall (at least in some places), I don’t see how that solves the problems we actually have. One of the sectors in which the structural problem is the most severe is construction, both residential and commercial. Far too many workers and not nearly enough jobs.
Will reducing the inventory overhang alone create more jobs in construction? I’m skeptical. The speculatory boom is over. We need to find a different driver for the economy.
Construction, particularly in housing has been a significant factor in every recession and recovery. So, if you are correct that this wont happen for awhile, then a robust recovery may not happen for awhile. But there is one thing for certain, to the extent that there is excess supply you will not see a recovery in construction until that excess supply is dealt with. No amount of subsidies, cajoling, and other nonsense will work or will only work temporarily.
As for the “new driver” here is the thing, if I were to suddenly find it, trust me I wouldn’t be sharing it with any of you. Nobody is likely to find it prior to it becoming obvious to everyone. Oh a few people will have invested in that sector(s) prior to it becoming the “new driver”, but for most of those people it will be a fortunate happenstance vs. a shrewd calculation. Basically this idea, that it is something that can be discerned ahead of time is pretty much not going to work. Just like it is hard to predict when a bubble will occur, when it will burst, etc. There is no way to sit there and say, “This sector will provide future growth.” Any attempt to do so will likely end in frustration and wasted money. Learn from the mistakes of others, do NOT repeat the wrongheaded policy of NIRA. It may not be a pleasant thought, but the best solution might be to pursue an inflationary monetary policy and wait and see where future growth comes from.
The referent of “different driver” is “speculatory boom”. Sure, construction may employ more people next year or the year after than it does now. I strongly doubt it will ever employ and I do mean ever as it did in 2005. I also doubt that Holland has many tulip growers now as it did in 1637.
Andy, you got out well ahead of the game!
But let me ask again, how low do prices need to fall? Nominal prices in large parts of Central Florida are where they were 30 years ago. In inflation adjusted terms they’re much lower than they were then. Do prices need to fall to the point where houses are less worth than the change in the couches sitting by the curb on trash day? And exactly how is that supposed to help (a) the people who own their own houses, (b) the people who hold mortgages on houses that are now underwater, or (c) the financial institutions that have a piece of these properties, either through a mortgage or foreclosure?
And despite these insanely low prices, almost no one is buying. Historically low prices and historically low interest rates at the same time, and no one is buying. If houses aren’t clearing when they’re lower than the price of a mid-priced car, they’re just not going to clear. Which is to say, I no longer think the problem is what people keep claiming the problem to be.
Dave,
You are a speculator. The irony kills me.
BTW, Andy and Icepick…
Check out Vegas. Was looking at prices on line for shits and giggles and found a nice condo that was up for sale for $36,000. Not sure what its high point was, but I wouldn’t be surprised if it was somewhere between 5x-7x the current price.
Nah. I’m barely an investor. I don’t qualify on several grounds. First, I bought before the start of the bubble. Second, I don’t plan to sell. Rising prices are irrelevant to me. Speculators depend on rising prices.
Icepick,
I got out by the skin of my teeth and had to bring a non-trivial five-figure amount to closing. I consider myself lucky.
Florida is a strange animal. I’m reminded of this from Planet Money last year:
Seems to me a big question is whether or not boomers will be moving down there when they retire. Florida has long relied on retirees and snowbirds and people with second homes. The boomers have overspent and undersaved and their housing nest-eggs are diminished or gone. So it seems likely to me Florida’s housing glut will remain for quite a long time since I think it will be more difficult for boomers to move down there and buy a home.
Florida has long relied on retirees and snowbirds and people with second homes.
I wouldn’t say Florida so mush as I would the developers that have run the state for the last 100 years or so. Personally I’d be happy if the vast majority of people here moved back to wherever the Hell they came from. I miss the Florida I grew up in.
Steve V, if the situation in Vegas is supposed to make me feel better, it doesn’t. A lot of the homes I’m talking about are more than 30 years old. When I say prices have fallen back to those levels I’m basing it on what those houses sold for 30 years ago. Mom’s house doesn’t have far to go before it is priced at what it was when they (Mom & Dad) bought it in 1960. Again, that’s nominal terms, not inflation adjusted.
Icepick,
When I first moved to the Melbourne area I was quite surprised that the place seemed to be filled with New Yorkers.
Half the people in Florida grew up in Florida. They grew up watching Dukes of Hazard thinking it was a documentary. The other half are obnoxious jerks from New York. Where this makes for the most interesting clash of culture, is on the roads. Driving there is abysmal, though some of this is also due to the headless Cadillac effect.
Steve
Half the people in Florida grew up in Florida. They grew up watching Dukes of Hazard thinking it was a documentary.
Half the people here didn’t even grow up speaking English, so this claim is dubious at best.
When I decided to try and switch careers, there were only two people in the class NOT from the NY, NJ, CN area, me and the instructor. He was from Iraq, via Lebanon and Malaysia. One out of twenty ain’t bad!
Dave,
My comment was that you are here speculating on where future growth will come from. My view is that such prognostications is generally a fools errand.
No, Icepick, it was not meant to cheer you up, beyond possibly misery loving company.
Yeah, probably because they think prices have lower to go. Why buy now if you think prices are going even lower. A house will likely generate no income stream so you should wait as long as possible to buy to make sure you aren’t going to find yourself underwater in a few months to a year.
No, Icepick, it was not meant to cheer you up, beyond possibly misery loving company.
I’m sick of company. If there were fewer of us then it would be easier for those left to climb out of the hole.
How much lower are they going to go from 25K to 30K for 1800 sq ft?
A woman moved in next door to my mother about 18 months ago. She was a 22 yr old part-time waitress. She’s probably paying less than $300 a month for the place, including taxes and insurance. (List price of 32,000 for an FHA home.) Seriously, how big is the down-side risk to being underwater in that situation?
Steve Verdon: My point about vulgar Keynesianism is that demand is not demand is not demand, whereas the Keynesian does not see such a distinction.
In fact, Keynes argued for investment in long term growth and infrastructure.
Steve Verdon: Note that once NIRA is implemented (one of the core programs of the New Deal) the upward trend for industrial production goes flat. Recovery aborted.
Hmm. According to the Federal Reserve Industrial Production Index, production follows the GDP trend, which is contraction from 1929 to 1932, then growth until 1937-8 when the New Deal was scaled back, then growth again, exploding in WWII.
1929 7.5746
1930 6.2928
1931 5.2119
1932 4.0686
1933 4.8189
1934 5.2231
1935 6.0494
1936 7.1391
1937 7.8202
1938 6.1834
1939 7.5879
1940 8.7648
1941 11.0693
1942 12.7016
1943 15.4282
1944 16.5850
Steve Verdon: And devoting large amounts of industrial capacity to producing things that get blown up is not an ideal way to end any kind of recession or depression.
No, but it demonstrates the principle.
Steve Verdon: In fact, Simon Kuznets has argued that counting defense spending as part of GDP is highly questionable.
It’s pretty easy to understand that U.S. industrial production surpassing that of the Germans meant more tanks, more ships, more bullets, more rations, providing an important margin of victory. Huge increases in worker productivity translated directly into increased post-war production of cars, refrigerators and other consumer goods.
Dave Schuler: Those are a lot harder to reject than what we’re actually likely to get.
Yeah. Half the money is wasted even in the best run business. But which half?
Steve Verdon: Problem is we have lots of roads, and lots of bridges. So the opportunity to make new ones is probably quite a bit less than in 1935.
A good point. It’s much more difficult to produce good jobs in the modern economy. In the 1930’s, it was still possible to be productive with a shovel. Educating the workforce is probably one of the best expenditures for long term growth. That, and building the new technical and energy infrastructure.