The causes of our present difficulties

There's nothing mysterious about the economic circumstances we find ourselves in. It's all easily understood in light of standard economic models that would be familiar to people like Keynes, Hicks and Friedman. Brad DeLong has articulated this view well in a number of posts and so I'll more or less summarize his analysis.

The economy is organized around three markets: the market for goods and services ("goods"), the market for safe assets in which to store wealth ("money," but I include U.S. Treasury securities in my definition), and the market for risky assets that generate an expected positive rate of return on wealth such as stocks or corporate bonds ("risky assets"). The economy as a whole is in equilibrium when each of these markets is in equilibrium. The economy is in a full employment equilibrium when demand in the goods market is high enough to generate employment for everyone who wants to work (accounting for labor market frictions, this means an unemployment rate of about 5 percent).

The proximate cause of the recession (depression?) of 2008-???? was a flight to safety on the part of first the financial sector, then businesses and households. What this means is that in the panicky environment that prevailed in late 2008, institutions felt compelled to shy away from all risky activities and hoard risk-free assets. In other words, the demand for stocks and other risky assets fell, as did demand for goods and services, while demand for risk-free assets rose. In real life, this process took the form of: a crash in the stock market, freezing of credit markets, shutdown of bank lending as financial market participants sought to shed risk; contraction of consumer spending and business investment, mass layoffs of workers as businesses and households sought to shed risk; and massive purchases of US Treasury securities which drove their prices up and yields down, even below zero for a brief time at the end of 2008.

We have not fully recovered from this economic meltdown. Interest rates on US Treasury securities are still extraordinarily low, unemployment is still extraordinarily high. Ordinarily there are a number of things that can happen to push the economy back to a full employment equilibrium. First and foremost, the Federal Reserve can reduce interest rates. This punishes people who store their wealth in safe assets and pushes them to buy risky assets or purchase goods and services instead. The Fed did indeed do this, but after short-term interest rates hit zero percent in December 2008 this mechanism could no longer do the job. There may be automatic adjustment mechanisms brought about by falling prices that can push the economy to full employment without any government action. But as Keynes argued (General Theory, Chapter 19) these mechanisms are very weak, especially when interest rates have hit zero, and offset by effects on expectations and wealth. Consequently, getting us out of the recession requires government action. Our government did two things in 2009 that were perfectly sensible and almost certainly prevented utter catastrophe:

1) Quantitative easing and "credit easing". The Federal Reserve bought long-term government bonds and risky assets of all sorts. The idea: if our problems are caused by excess supply of risky assets and excess demand for money, then the solution is for the Fed to buy risky assets to extinguish the excess supply and in the process create money to satisfy the excess demand.

2) Fiscal stimulus. The government passed the ARRA in 2009 that increased spending and cut taxes to the tune of about $900 billion over a three year period, and followed this up with a number of other stimulative efforts such as the 2010 budget deal that extended the Bush tax cuts. The idea: if our problem is excess supply of goods and excess demand for risk-free assets, then the solution is for the Treasury to issue a bunch of risk-free assets (i.e. run deficits that it finances by borrowing), thereby extinguishing the excess demand for risk-free assets, and spend the proceeds (or give the money through tax cuts and subsidies to people who will spend it), thereby extinguishing the excess supply for goods.

Although the government's efforts saved the economy from catastrophe, they did not restore the economy to full employment. The most likely reason for this is that the government did not do enough. Quantitative easing should have been more aggressive: the Fed should have announced an open-ended commitment to buy long-term and risky assets in whatever quantities and for however long it took to restore growth to a healthy rate. Fiscal policy should have been more aggressive and better structured: more money for things like infrastructure investment, less for tax breaks to corporations and wealthy people, less to Congress' pet projects (though I think the scale of the spending boondoggles is smaller than critics would have us believe). But the government did not act aggressively enough, and now here we are and the political dynamic dictates a reversal rather than a doubling down of these actions. The Federal Reserve is ending it's second round of quantitative easing and Congress and the President are negotiating large cuts in spending rather than increases.

Critics of the government's policies since 2008 argue that retrenchment can stimulate the economy. How might this happen? Well, if it is to happen it has to work through the process described above: it must somehow increase demand for goods and reduce demand or increase supply of risk-free assets. The critics' argument is that this will happen through "confidence": if the Federal Reserve swears fealty to "sound money" and if Congress demonstrates maturity by reining in spending, then businesses and financial markets will have greater confidence in the future. They will once again be willing to take on risk, meaning they will lend more, invest more, employ more. Demand for risk-free assets falls, demand for risky assets and goods rises, and the economy heads down the path to full employment.

There are a number of problems with this way of thinking. First there are the facts: there is no evidence, based on the interest rates the government is currently paying on its debt, that financial market participants are at all concerned about the government's solvency (would you accept a 3% rate of return on 30-year government debt if you thought the government was on the verge of default?). Therefore it's hard to imagine that solving the solvency "crisis" will have any impact on financial markets. In surveys small business owners say that the main reason they are not expanding is the lack of demand for their products, not budget deficits, regulation, taxes, or the other things that critics claim are impeding growth. Businesses are in fact investing at a healthy rate; the thing holding the economy back is consumer spending and home building, and this is due largely to the continuing decline in house prices (one of Keynes', or more accurately Irving Fisher's, offsetting factors to the natural adjustment process).

But the big conceptual problem with this analysis is that it relies on magical thinking. Why does the government's tightening of belts and the Fed's announcement of a "sound money" policy restore business confidence rather than, say, a commitment by the government and the Fed to fight the recession directly? There's really no theory that relates this kind of measure to business confidence, it's just wishful thinking. The claim puts a tremendous amount of faith in the effect of austerity on "confidence," especially since austerity involves doing things (reducing the supply of the risk-free assets that are in excess demand, reducing the demand for goods and services that are in excess supply) whose direct effect is to harm the economy.

Proponents of austerity argue that we might as well try sound money and budget cutting because the previous policies did not work. That's about as sensible as saying that because the two aspirins I just took didn't cure my headache I should hit myself in the head with a mallet (as opposed to, say, taking two more). It's important to note (and this is something that Paul Krugman has been harping on for some time) that the analysis I've presented above is perfectly conventional. No exotic untested theory, no magic asterisks or bells and whistles, just plain old conventional textbook economics. It's the proponents of austerity who are peddling the exotic theories. Once again, as in the Reagan and Bush II years (not to mention 1929-33), political gain seems to have been found in bad economics.

Random thoughts on our founding fathers

Some thoughts upon reading Jill Lepore's book, "The Whites of Their Eyes: The Tea Party's Revolution and the Battle over American History":

1) In 1787 President Adams submitted and the Senate ratified unanimously the Treaty of Tripoli that ended the war with the Barbary pirates. Article 11 states:

As the Government of the United States of America is not, in any sense, founded on the Christian religion,—as it has in itself no character of enmity against the laws, religion, or tranquility, of Mussulmen,—and as the said States never entered into any war or act of hostility against any Mahometan nation, it is declared by the parties that no pretext arising from religious opinions shall ever produce an interruption of the harmony existing between the two countries.

2) Sarah Palin caused a stir last month when she offered a bizarre summary of Paul Revere's ride:

"He who warned, uh, the British that they weren’t gonna be takin’ away our arms, uh, by ringing those bells, and um, makin' sure as he’s riding his horse through town to send those warning shots and bells that we were going to be sure and we were going to be free, and we were going to be armed."

She had spoken before about Paul Revere's ride. From Lepore's book:

The former governor of Alaska arrived. She grabbed hold of the microphone. "I love Boston," she said. It's the town that the Sons of Liberty called home." She spoke of the city's history: "You're sounding the warning bell just like what happened in that midnight run and just like with that original tea party back in 1773."

The ringing of the bells seems to be important in her mind. This time she implied correctly that it was the city (of Lexington actually) that rang the warning bells rather than Paul Revere. But Sarah, "Midnight Run" is a movie starring Robert DeNiro and Charles Grodin. "Ride" is the word you're looking for.

This would be pretty ok, if true

Matt Yglesias reports that the Obama Administration is considering pushing for a payroll tax cut to address the apparent slowdown in the economy. That's a step in the right direction relative to what seems to be an attitude at both the Fed and the Administration that they've done quite enough to fight the recession thank you very much, and now have to pivot to the "problems" of inflation and government debt. But at this point - almost two years into the recovery with unemployment still at 9.1 percent and the economy slowing down, I think much more drastic measures are in order. How about:

1) A bounty for firms to hire long-term unemployed workers. If a company hires a worker who can document having been on unemployment compensation for 26 weeks or more, and can document that this worker represents a net addition to payrolls, it receives an amount of money representing say half of that worker's compensation paid in monthly installments for the next 12 months.

2) Obama makes a deal with Republicans: present to me your list of the most onerous regulations that are impeding small business hiring and I will offer a temporary waiver. In exchange, Republicans agree to some element of the Democrats' stimulus agenda: more spending on infrastructure, aid to state and local governments, whatever.

3) An open-ended commitment by the Fed to a program of quantitative easing that does not stop until we have solid economic growth and inflation in the three to four percent range. Increasing expectations of inflation can help stimulate the economy by reducing real interest rates (i.e. if a business can borrow at four percent but believes the price of its product is going to rise at four percent, it's borrowing at a zero percent expected real rate of interest - free money!).

4) Restrictions on bank and non-bank lending to hedge funds and other institutions for speculative purposes and a strong swift kick in the backside to banks to get them to make more conventional business, mortgage and personal loans.

5) A bold program to resolve the foreclosure mess. I still don't understand this issue well enough, but I do know that the relentless slump in the housing market is killing the economy. If what is required is for Freddie Mac and Fannie Mae to buy up every outstanding mortgage under say $500,000 at face value and then work out debt restructuring agreements with the borrowers, then go ahead and do that.

I don't for a minute believe we're going to get that aggressive an array of policies, however. It looks, for reasons that are really unfathomable, as if the Administration is spurred to action only when economic growth threatens to fall close to zero, but is content to see us muddle through at a 2-3 percent growth rate. At that rate we will never, and I mean never, see a complete recovery from this recession.

Rating Anthony Weiner

How serious are Anthony Weiner's transgressions? What is the appropriate punishment? Here's how Weiner stacks up against some of his recent competitors.

The criminality of the underlying act. Sending pictures of his junk to women he met on the internet is not a crime. Good patriotic God-fearing capitalists make billions facilitating this kind of behavior every year and we hardly blink an eye (how much do you think Twitter or Google would be worth if it weren't for internet porn?). This is no Abu Ghraib or Watergate. On a scale of zero to 5 (5 being ordering the torture of people scooped up on the battlefields of Afghanistan), Weiner's actions earn a score of zero "Cheneys".

The sordidness of the underlying act. Again, Weiner was engaged in conduct that lies within the range of "normal" as it has been defined down in the internet age. What sordidness there is comes from the fact that he is married, plus the possibility that some of his partners in smut were quite young. Still, this does not compare to Newt Gingrich's or John Edwards' or even Arnold Schwarzenegger's betrayal of their wives. And it doesn't come close to the standard-setter in this category, Larry Craig's solicitation of sex in the stall of an airport men's room. On a scale of zero to five, we'll give him one bathroom stall.

Sheer stupidity. Here's where Weiner picks up some serious points. Middle school children are warned of the dangers of sexting. Surely a United States Congressman should know better. Elliot Spitzer might have reasonably hoped to keep his d'alliances with prostitutes secret, but Weiner should have known that when the internet is involved there is no such thing as privacy. On a scale from "Congressman" to "Republican" to "Republican Congressman" to "Tea Party Republican Congressman," Weiner scores a near-perfect Republican Congressman. He does not earn the coveted "Tea Party Republican Congressman" only because in contemplating his actions he did not deny the validity of well-known scientific laws (although erasing the images on his computer in the hope that that would prevent them from being further circulated comes close).

Dickishness. Weiner's attempts at denial are really in a class by themselves. There are three essential elements that define the denial of an embarrassing act as dickish. The first is that the stakes must be low. Covering up the break-in of your opponent's campaign headquarters is criminal but not dickish. Covering up a sexting incident, where nothing illegal was done and the only punishment would be embarrassment and some marital tension, is dickish. The second element is the ease of falsification of the denial. There was no way the truth was not going to come out in a matter of days, especially since it was already known that there were other photos in addition to the original junk shot. The third element is a broad category that is related to the second: the brazenness of the denial. Weiner didn't just deny the charges against him, he engaged in verbal combat with the press, then gave separate interviews to a dozen news organizations in which he repeated his lie. What a dick. For these efforts Weiner earns a full 5 Clintons. This is quite a feat considering that Bill Clinton himself only earned 4 during the Monica Lewinsky scandal (he had one point shaved off for valiantly continuing to do the job of president even during the impeachment proceedings).

So that's how we rate the severity of the acts. How about the punishment? I recommend the full Spitzer. Resign in disgrace, be photographed in your shame with your wife looking like she's deciding whether to use the hedge clipper or electric sander on the offending anatomical parts, then condemned to spend eternity as a CNN talking head.

It's not always all about the media, is it?

So here's Mark Leibovich taking the media to task for being miffed that Sarah Palin has kept them out of the loop during her non-campaign tour up the East Coast.

But how dare she disregard the media like that?

That was a subtext of so much of the press grumbling that followed Ms. Palin and her family as they zigzagged through a Northeast itinerary of “biker caravanning” (at a veterans’ motorcycle rally), historic sightseeing (Gettysburg, etc.), office politicking (the headquarters of her employer, Fox News) and Donald Trump (his own category). By “winging it,” or at least not telling journalists where she was headed next and leading them on what some called a “wild goose chase,” Ms. Palin once again showed contempt for a class of people she plainly despises.

“I don’t think I owe anything to the mainstream media,” Ms. Palin said in an interview aboard her bus with Greta Van Susteren of Fox News.

But Ms. Palin does owe something to her fans/supporters, doesn't she? What does Palin's secrecy during her trip say about her attitude toward the poor deluded Palin supporters who donned their American flag tee-shirts, grabbed their Don't Tread on Me banners and waited for her in vain for ten hours at the Pennsylvania Monument in Gettysburg? I think Palin's message to her supporters is: It's not about you, it's about me. I don't need to respect you because you are so in love with the image I have cultivated about myself that you will stick with me no matter how much I abuse you.

And I do believe Palin is right about that.

Huh?

The New York Times says that persistent high unemployment threatens Obama's chance at reelection. No argument there, but the article drops this nugget: "No American president since Franklin Delano Roosevelt has won a second term in office when the unemployment rate on Election Day topped 7.2 percent. Seventeen months before the next election, it is increasingly clear that President Obama must defy that trend to keep his job."

Some trend. The unemployment rate has been over 7.2 percent on election day when an incumbent president is on the ballot exactly once since the Truman Administration: 1980 (7.5% in November) when Jimmy Carter lost in his attempt at reelection. Ronald Reagan won reelection in 1984 when the November unemployment rate was exactly 7.2 percent. These are the only two times that the unemployment rate has exceeded 7 percent when an incumbent president was up for reelection, so it is equally true to say that "50 percent of American presidents since FDR have won a second term in office when the unemployment rate on Election Day topped 7 percent." Not as compelling a headline however.