When Obama took office the world knew that we were facing an economic crisis, but Obama and his team of experts seemed up to the task. In fact, it was Obama’s cool and composed response to the crisis contrasted with McCain’s weird fumbling that cemented his 2008 victory.
Team Obama lost no time in presenting a clear solution to the problem. They promised the American people that without action unemployment would rise to 9%, but that if their policies were followed unemployment would peak at just 8%. And so, in February 2009, American politicians passed the American Recovery and Reinvestment Act of 2009.
Things did not go as planned.
That chart shows unemployment rocketing right past 8%, past 9% and up above 10%. The rate has since come down to 9.3%, but that’s only because of double- and triple-counting of Census 2010 jobs that aren’t even really worth counting once (because they are temporary). The economic malaise has also gone global, with Greece as the poster-child for government debt gone bad. Despite everything that you might hear from the Obama administration, we’re not out of the woods yet.
In fact none other than Obama cheerleader Paul Krugman has come out and declared that not only are things not all roses and ponies, but we’re actually headed for: The Third Depression:
We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.
The question is: what do we do about it?
Krugman knows the answer, and it’s not cutting government spending.
In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.
Nope, what we need to do is spend more money. As Krugman puts it “the real problem is inadequate spending.” Just to be clear here, this is inadequate spending of money that we don’t actually have.
There are three criticisms of this plan. The first is that we’ve got to worry about taking debt to such unsustainable levels that we bankrupt the country, the second is that we’ve got to worry about printing so much money that we run the risk of hyperinflation, and the third is that lowering taxes might actually be a better way to stimulate the economy than profligate government spending.
Let’s take these one at a time.
1. Government Debt
Government debt is unsustainable. This isn’t something you argue about. It’s something you just occasionally have to remind people of because they would rather ignore it. Fed chairman Bed Bernanke–reported in the New York Times–recently stated that “the federal budget appears to be on an unsustainable path.” You think? The government of Greece is close to default and their bonds are rated as junk. Nations all across Europe are pulling back on their entitlement spending by raising the retirement age and other “austerity measures”.
Krugman addresses this issue head-on:
The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.
All this does is show Krugman’s unwillingness or inability to deal with the real issue. The problem is not a periodic, short-term episode of high debt. The problem is long-term and structural. The real crisis facing America is not the couple of trillion on our books right now, it’s the hidden trillions in unfunded liabilities.
You can’t solve a structural problem without a structural solution, and the European “austerity measures” are about more than fixing their balance sheet for this year. They are about starting to address the fundamental reality that welfare economies don’t work.
According to SocialSecurity.gov, when Social Security was first passed only about half of Americans who lived to age 21 could expect to live all the way to age 65. By the 1990s this number had risen to nearly 75%. One realistic way to solve this problem is to increase the retirment age. When you do this you not only help out your short-term balance sheet, but you structurally reform the way government spending works to bring costs into control for the long haul.
And–as Krugman should know–the long haul matters because even in the short run people base their economic decisions on their expectations for the future. He’s apparently just so unwilling or unable to do even consider these kinds of fundamental reforms that he doesn’t recognize them when he sees them.
Krugman addresses inflation too: “governments are obsessing about inflation when the real threat is deflation.” This is, once again, an example of Krugman’s shortsightedness. The Telegraph reports on just how much money the Fed is getting ready to print:
Entitled “Deflation: Making Sure It Doesn’t Happen Here“, it is a warfare manual for defeating economic slumps by use of extreme monetary stimulus once interest rates have dropped to zero, and implicitly once governments have spent themselves to near bankruptcy.
The speech is best known for its irreverent one-liner: “The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost.”
Bernanke began putting the script into action after the credit system seized up in 2008, purchasing $1.75 trillion of Treasuries, mortgage securities, and agency bonds to shore up the US credit system. He stopped far short of the $5 trillion balance sheet quietly pencilled in by the Fed Board as the upper limit for quantitative easing (QE).
Once again it’s a good time to take a look at a chart:
Now that’s what I call a hockey-stick graph! The Fed printed $1.75 trillion dollars (they didn’t literally print physical money, in case you’re wondering), and in doing that they nearly doubled the amount of money in circulation.
And that wast just $1.75 trillion out of a potential $5 trillion Bernanke might be willing to add to the pot. With pressure mounting from the likes of Obama and Krugman to do something, how much more money are we going to pull out of thin air?
I get that right now deflation is a bigger concern than inflation, but you have to ask yourself if you’re concerned with the next 5 months or the next 5 year or the next 50 years. Politicians are worried about getting re-elected in a couple of years. I am worried about the kind of country my children grow up in. I would rather go through some hard times now then saddle my kids and their kids with trillions upon trillions of debt they will spend their lives laboring to try and pay off. We’re essentially selling our children’s future to preserve our own standard of living.
3. Taxes vs. Government Spending
First: some macroeconomic theory. Paul Krugman’s plan is to impose textbook Keynesianism. Writing for National Affairs, economist Greg Mankiw summarized this theory:
According to Keynesian economics, the business cycle reflects not the wonders of Adam Smith’s invisible hand of the marketplace but rather market failure on a grand scale. Extreme and sustained unemployment during a recession, Keynesians argue, results from a decline in overall (or aggregate) demand in the economy. When the economy is knocked off balance by serious economic shocks, the government can help restore normalcy by increasing demand through government spending. And because the influx of government spending drives businesses to hire and consumers to spend, its impact is multiplied.
Generations of Keynesian economists have sought to model and quantify how that “multiplier” would function in different economic conditions. But most Keynesian economists have agreed that the multiplier effect of government spending is larger than that of the other approach to injecting demand into the economy — cutting taxes — because money from tax cuts might be saved rather than spent.
This notion–that government spending has a greater multiplier effect than tax breaks–is gospel to Keynesians. The multiplier for government spending is considered to be about 1.57 and the multiplier for tax breaks is considered to be 0.99. These are the numbers that the Obama administration used to justify the stimulus bill, but recent theory and empirical evidence suggests that numbers are wrong:
In an ironic twist, one key piece comes from Christina Romer, who is now chair of Obama’s Council of Economic Advisers. About six months before she took the job, Romer teamed up with her husband and fellow Berkeley economist David Romer to write a paper (“The Macroeconomic Effects of Tax Changes”) that sought to measure the influence of tax policy on GDP…
The Romers’ conclusion, which is at odds with most traditional Keynesian analysis, was that the tax multiplier was 3 — in other words, that every dollar spent on tax cuts would boost GDP by $3. This would mean that the tax multiplier is roughly three times larger than Obama’s advisors assumed it was during their policy simulations.
So recent work by economists in Obama’s own administration show that the tax multiplier should be 3.0 instead of 0.99. And the multiplier for government spending? Recent estimates put the number at 1.4 instead of 1.57. This means that tax breaks would be more than twice as effective as government spending in stimulating the economy.
But wait, there’s more:
Perhaps the most compelling research on this subject is a very recent study by my colleagues Alberto Alesina and Silvia Ardagna at Harvard. They used data from the Organization for Economic Cooperation and Development to identify every major fiscal stimulus adopted by the 30 OECD countries between 1970 and 2007. Alesina and Ardagna then separated those plans that were in fact followed by robust economic growth from those that were not, and compared their characteristics. They found that the stimulus packages that appeared to be successful had cut business and income taxes, while those that evidently did not succeed had increased government spending and transfer payments.
Mankiw concludes his piece with a quote from Milton Friedman:
As Milton Friedman once put it: “The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in light of what can be done, politics aside, and not to predict what is ‘politically feasible’ and then to recommend it.”
In a time of economic uncertainty and political turmoil, we economists — both in and out of government — could hardly do better than to follow Friedman’s sage advice.
I feel bad for Christina Romer. She works for the Obama administration now and, in a way, her position is similar to General McChrystal’s. She may disagree with the Obama administration’s economic plan (it certainly contradicts her own research), but her job is to support her boss.
Paul Krugman has no such excuse.
The take away from this long discussion is as follows. First of all, brace yourselves for more economic turbulence. We’re not over this yet, and the one thing I agree with Krugman on is that we might very well be entering another depression.
Secondly, for all that Obama loves to talk about the “failed economic policies of the past”, it’s not like Keynesianism is exactly cutting-edge. It’s a decades-old economic policy that was largely discredited in the 1970s. The reason that it is so attractive is that it’s compatible with big-government. It’s a belief in a centralized, top-down solution to what ails America.
Economic policy is never going to be simple, but that doesn’t mean that common sense doesn’t apply. We can’t continue to print money without ill-effects. We can’t ignore the corrosive effect on our political infrastructure of bailouts from the federal government. We can’t pretend that our looming entitlement debts are a problem that will just go away if we refuse to talk about it. Any solution to our economic problems has to rise above political partisanship and start to deal with the unpleasant realities that we face.