Jeffrey Miron examines both major political parties’ entrenched positions and finds them wanting:

The problem with the Democratic position is that it regards redistribution, rather than economic productivity, as the prime goal of government policy. The Democrats therefore want to address the deficit with higher taxes on “the rich,” not expenditure cuts.

This approach, however, cannot remotely address the long-term debt outlook; the available revenue from the wealthy is far too small. And higher taxes discourage economic growth, making deficits worse. Thus whatever the morality of soaking the rich, it will not work.

and

For Republicans, the crucial mistake is their refusal to distinguish between the tax revenue that comes from higher rates and that which comes from fixing tax loopholes that inappropriately privilege certain consumption or production.

The Republicans are correct that raising tax rates is a terrible idea. By discouraging savings, work and investment, higher rates dampen economic productivity in the long run. By reducing disposable income and corporate profits, they reduce consumption and investment in the short run. And higher rates will not raise as much revenue as initial forecasts.

But closing tax loopholes — lowering tax expenditure — is a terrific idea. Many tax expenditures distort economic decision-making and therefore slow economic growth. Crucial examples include the home-mortgage interest deduction and the preferential treatment of employer-provided health insurance. Thus Republican skepticism about explicit expenditure should apply equally to tax expenditure, regardless of the revenue implications.

He also points to the elephant in the room:

Likewise, Democrats refuse to accept that Medicare is the primary driver of the U.S. fiscal nightmare. This expenditure is growing much faster than the GDP has any chance of growing over the long haul. Unless a deal slows the growth of Medicare, nothing else matters.

A good approach to scaling back Medicare would be a substantially higher deductible. Imagine, for example, that every beneficiary paid an extra $2,000 out of pocket each year. This is affordable for most families, especially those a few years from retirement.

This one change in policy would save at least $100 billion a year.

I’m less sanguine on this approach to solving our healthcare system woes than Dr. Miron apparently is. The strategy hinges on the notion that healthcare providers are willing to take pay cuts, that they have no recourse, and that rate increases will be resisted by Congress. I believe that the buzz word used to describe this view is “time inconsistency”. It’s worth a try, though.

Hat tip: Amba

Can someone explain this story to me?

PORTLAND, Oregon — Kraft Foods Inc. said it plans to split into two publicly traded companies, with one focusing on its international snack brands like Trident gum and Oreo cookies and the other on its North American groceries business that includes Maxwell House coffee and Oscar Mayer meats.

The move by the food giant to split a high-growth international business from its domestic grocery brands highlights the increasing focus by U.S. companies on growth in emerging markets.

“Simply put, we have now reached a stage in our development with a global snacks and grocery businesses in North America in which each benefit from standing on their own and focusing on their unique drivers of success,” Chairman and CEO Irene Rosenfeld said during a conference calls on Thursday.

Kraft said the deal would allow both companies to focus better on their priorities.

That explanation doesn’t satisfy me. Why isn’t spinning off a division enough?

My speculation is that this has more to do with buying and selling stock at a profit than it does with competing more effectively in emerging markets. Or maybe internal politics.

Kenneth Rogoff gives a different prescription for dealing with “balance sheet recessions”:

Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession.” But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions.

For example, governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation. An analogous approach can be done for countries. For example, rich countries’ voters in Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms.

As I see it our key problem is that we’re mollycoddling the banks, just as the Japanese did. The big banks are insolvent. They were insolvent in 2008. They’re still insolvent. Propping them up just prolongs the agony.

Update

I’m still trying to figure out what to do about a balance sheet recession. One of the ways I thought I’d approach it was by considering previous successful strategies other countries have used in dealing with their own balance sheet recessions. The only other example I could find was Japan (the country for which the term was coined) and 20 years later Japan is still going through its recession. Real GDP growth has never returned to the levels it experienced prior to 1992 and GDP growth in 1991, the last year of growth over 3%, was substantially lower than the average GDP growth over the preceding decade. I’m not finding this encouraging.

Go over to The Big Picture and take a look at the graphs of the effects of the stimulus spending has been done since 2009. Taking special note of the first graph of public construction highway, street, and educational spending my immediate reaction was how similar it was to the effects of “Cash for Clunkers”. As I’ve said before, if you’re going to time-shift spending, time-shift from a point at which the spending will actually be growing. What appears to have happened is that what was boosted in 2009 has collapsed in 2011.

James Hamilton does a post mortem of the debt deal:

Let me begin by suggesting that the debt debate lumped together three issues that I regard as separate problems. There was first the immediate challenge of how the U.S. government was going to pay its bills for the rest of August. Second is the near-term need to bring unemployment down– we need to see more robust economic growth in order to get Americans back to work as quickly as possible. And third is the daunting challenge of putting U.S. fiscal policy on a sustainable long-run course– debt cannot continue to grow as a multiple of GDP, and something needed to change to ensure that it did not.

On these three issues I am relieved, uncertain, and deeply concerned, respectively.

I am relieved that the debt ceiling has been raised. I believed that it would be raised all along but the closer the deadline came the more nervous I became. IMO the exercise in brinksmanship was damaging of itself. Prudent policies aren’t constructed during heated debates, particularly heated debates that feature hyperbolic name-calling. What is more likely is that, not only will the can be kicked down the road, it will be shot down the road with a howitzer and to my eye that’s largely what has happened this time around.

I’m uncertain what is to be done about the unemployment situation. I think that the senior senator from Illinois, Dick Durbin, was correct in his assessment that the debt deal was the death knell for Keynesian economics if by “Keynesian economics” is means massive, amorphous stimulus packages. Characterizing the ARRA as “Keynesian economics” is an insult to Lord Keynes. If I remember the General Theory correctly, in it he was arguing less for the government as the consumer of last resort than as the employer of last resort. Work rules, regulations, laws, trade agreements, globalization, and technology have made that much more difficult than it was 75 years ago. Is opposition to the idea based on ignorance or experience?

I don’t believe that an aggregate demand story can be the whole explanation for what we’re seeing. Personal consumption expenditures are higher now than they were before the start of the recession, indeed, except for a brief dip they’ve remained high. Besides, the present dominant role of personal consumption in the economy isn’t a law of nature. 35 years ago personal consumption was 50% of the economy; now it’s 75%. What was the remainder? A lot of it was business consumption. I think that the higher proportion of business consumption then despite the lack of consumer demand goes against the view that the cause of reduced business consumption is low consumer demand. In my view the decline in entrepeneurialism, new business formation, over the period is a more compelling explanation.

Spurred by a comment to the Econbrowser post linked above, I’ve been toying with the idea that phlegmatic employment growth can be explained by flat or declining U. S. energy production. I’ll look into that idea more thoroughly in a later post. It’s certainly something to think about.

Finally, I’m deeply concerned by the fundamentally frivolous quality of the debate on the deficit on the debt. Consider the chart above of the cuts to total spending approved in the debt deal relative to the CBO baseline (hat tip: Russ Roberts). Remember that the CBO baseline assumes the expiration of the “Bush tax cuts” in 2012. That’s a long way from stabilizing our fiscal situation. Previous experience suggests that the expiration is far from a done deal and even with the increased revenue we’d need some combination of additional revenue and cuts twice as large as what’s been agreed upon just to stabilize our fiscal condition let alone improve it. Our innumerate leaders adamantly refuse to take the situation seriously.

Meanwhile primary default comes nearer and nearer.

I’ve just published a foreign policy-related post at Outside the Beltway:

A Russian Looks at the War in Libya

As you might expect the Russian take on the situation in Libya is somewhat different from what you’ve probably been reading in the American news media. The article includes what I suspect is the official view of the conflict, i.e. American aggression and colonialism met with opposition on the part of the majority of Libyans, an assessment of the NATO shortcomings the operation has revealed, and an estimate of the costs of the operation. Interesting reading.

Since the beginning of what has come to be termed “The Great Recession” in December 2007, we’ve been looking for analogies to understand the hole into which our economy has fallen. “The Great Recession” itself is a reference to the Great Depression of the 1930s. Others have compared the most recent recession to the twin recessions of the early 1980s, frequently with unfavorable views of federal government response to the recent downturn. Others have looked farther afield to the persistent doldrums that struck the Japanese economy in 1990 and continues to the present.

The comparison of the recent downturn to the Great Depression of the 1930s is particularly inapt. The Great Depression saw a decline in GDP of 25% or more in the United States, was worldwide, and saw sharp declines in production, wholesale prices, and foreign trade. Contrariwise the Great Recession has none of those characteristics. Increases in unemployment between the two economic downturns are, however, quite comparable. [Update: this is an error. I am grateful to Steve Verdon for pointing out that at no time has present unemployment neared Depression Era levels, however measured, cf. this comment. I had incorrectly compared Depression Era U3 unemployment with present-day U6.]

Comparison with the Fed-induced recession of the 1980s is even farther off the mark. Unemployment increased sharply but recovered even more sharply. It was sharp, harsh, and over relatively quickly, a classic V-shaped recession in which growth rebounded almost as fast as the NBER could declare that a recession was in progress.

Over the period of the last several years the term “balance sheet recession” has come increasingly into vogue until not only is it the prevailing wisdom that the recession of 2007-2009 was in fact a “balance sheet recession” but any attempt to call that into doubt is met with considerable derision. “Balance sheet recession” derives from economic Richard Koo’s 2003 book, Balance Sheet Recession: Japan’s Struggle with Uncharted Economics and its Global Implications. The timeliness of Dr. Koo’s work has given him near-oracular status on this subject. Under the circumstances and, particularly, considering the increasing likelihood of further declines or, at the very least, persistent unacceptably slow growth for the foreseeable future, I think it’s reasonable to consider the evidence that we are, in fact, experiencing the after-effects of a balance sheet recession, examine the relationship of our own economic woes to Japan’s, consider the implications of a balance sheet recession, and assess its implications for policy.

The graphic above is from the St. Louis Reserve’s FRED system and illustrates the growth in household debt from 1950 to the present. The graphic below, from the San Francisco Fed, juxtaposes U. S. household debt to income and Japanese nonfinancial corporate sector debt to GDP over 10-year periods before and after the leverage-ratio peaks. I have been unable to locate the data on actual post-war Japanese nonfinancial corporate sector debt. I think it would be very interesting.

The first graph is astonishing to me for how perfect an example of exponential growth it presents. Growth proceeds virtually at a fixed rate up to the point at which it becomes asymptotic, then declines sharply. Anything that cannot be sustained will not, indeed. In the second graph the Japanese experience presents nearly as many contrasts with our own as similarities. Yes, the graph goes up, then down. There the similarities end. Unlike the smooth exponential growth expressed in the U. S. instance, the growth in Japanese debt to GDP is more irregular and exhibits a very different pattern. Whatever is happening here differs from Japan rather dramatically.

Even if the analogy holds, I don’t think we should take much solace from it. Twenty years later Japan continues to be burdened with slow growth. The Japanese have tried Keynesian stimulus, massive infrastructure projects, and quantitative easing much as we have. None of these have reawakened growth in Japan.

Consider, too, the downturn in household debt here. Nearly all of that decline is due to foreclosures. Real retail sales have recovered by nearly three quarters while; real disposable personal income has continued unimpeded throughout the downturn. If there is balance sheet rebuilding here, I’m not seeing it.

Additionally, how far would household balance sheets need to recover? I have seen a return to 1990s levels bandied about: we haven’t even begun such a process. And why is that the right level? Why not the 1970s? The straight line curve-fitting of the 1970s is even better than that of the 1980s and 1990s and to my eye both look like partial segments of what is obviously an exponential growth curve.

Thirty five years ago 54.4% of our economy was based on personal consumption. Now 77.3% is. To return to 1990s levels let alone 1970s levels over anything but the very long term would constitute economic collapse. I conjecture that a considerable portion of that excess consumer spending is healthcare spending.

If we have, indeed, experienced a balance sheet recession what is the appropriate policy response? The Japanese experience isn’t helpful in that regard. Debt forgiveness? (something I’ve mentioned here before) More and faster foreclosures? We are a very different society than the extremely homogeneous and consensus-driven Japan. I don’t think we can stand 20 years of slow or no growth household balance sheet rebuilding peaceably. Can stand ten?

I think there’s another interpretation that I think should be considered: we have reached the end of a 70 year period during which a debt-financed model of economic activity has been pursued. It did not prove sustainable and it is not being sustained.

One of the things I noticed on my driving trip through central Wisconsin of the last several days was the large collection of dueling political signs, billboards, and bumper stickers. Typical of the contending factions were these two:

(On a Prius) “Recall Walker”

(On a pickup truck) The Gadsden Flag

I was also taken aback on one occasion at a billboard complaining about “leftists”.

I’ve driven through Wisconsin quite a bit over the years and I don’t ever recall seeing the sheer amount of signage.

I drove back from Minneapolis yesterday, making sure to stop in at The Tea Source in St. Paul to buy tea before I left the area. I knew my wife would be disappointed if I neglected to do so.

Although it’s not as hard to get decent tea in the U. S. as it used to be, getting really good tea remains absurdly difficult. We’ve got a well-known tea store here in the Chicago area. Its teas are adequate but they’re unconscionably expensive. The Tea Source, contrariwise, has good tea at very fair prices. We’ve been dealing with them online for years and always make a point of stopping by their physical location whenever we’re in town. I came back with a couple of pounds of tea.

On the way home I took my time as I had on the way there, this time stopping at several cheese shops along the way. Have you noticed how difficult it is to get decent medium brick cheese these days? When I was a kid it was commonplace. The stuff in the grocery stores these days is nearly tasteless. I guess that’s what sells in the mass market.

I have never in my life paid $40 a pound for cheddar cheese. I have learned that it’s not difficult to do. However, 12 year old cheddar is good but IMO not that good. A bought several pounds of cheese: medium brick, 7 year old cheddar, and a curiosity—smoked blue.