Archive for the Category Fiscal policy

 
 

Where the FTPL applies

The fiscal theory of the price level does not explain very much in the US.  Inflation often soars much higher during periods when the national debt is low and falling (the 1960s) and falls sharply when the deficit increases dramatically (the 1980s).  But the FTPL does explain the inflation dynamics of Argentina:

“The [peso] price action looks like a loss of confidence by foreign investors coupled with some form of “capitulation” by domestic investors,” he added. “Markets need to see a radical tightening in fiscal policy in order to stabilise the situation, and that includes cutting wage hikes in order to fight inflation.

There is also some data that sounds suspiciously NeoFisherian:

Argentina’s peso is again feeling the heat.

The currency has fallen to a new record low of 23 against the dollar after slumping 5 per cent in morning trade on Tuesday. . . .

The declines come despite massive intervention by the Argentine central bank, which hiked interest rates by an unprecedented 12.75 percentage points to 40 per cent in the space of just seven days last week.

As always, however, you need to keep in mind the correlation/causation distinction.  Most likely it’s the high inflation causing the high nominal interest rates, not vice versa.  (Or if you prefer, the budget deficits are causing both.)

What is demand stimulus?

This is a sort of follow-up to my previous post.  One can think of demand stimulus as policies that boost NGDP.  (There are of course other policies that boost RGDP, such as supply side reforms, which work even if NGDP doesn’t rise.  But demand stimulus boosts NGDP.)

We know from long run money neutrality that the long run trend rate of growth doesn’t matter, except for second order effects like hysteresis and menu costs and taxation of capital income—and these second order effects might be positive or negative.  If someone argues that a certain policy may be able to significantly raise the trend line for RGDP, they may be right, but they are almost certainly NOT talking about demand-side stimulus.

The upshot of all of this is that there is only one coherent way to think about demand-side policies.  When should AD be more expansionary than average and when should it be less expansionary than average? It’s incoherent to say, “I think demand side polices should always be stimulative.”  That doesn’t even mean anything.  It’s like saying, “I believe all Americans should earn above average incomes.”  Any demand-side strategy should either call for stable AD growth, or else specify when aggregate demand should be more expansionary than average and when it should be more contractionary than average.

If you are advocating demand stimulus during a period of low unemployment, then (whether you know this or not) you are implicitly suggesting that demand-side policy should be more contractionary than average during a recession.  Not good.

A corollary of this is that terms like ‘hawks’ and ‘doves’ don’t have the meaning that almost everyone thinks they have.  If you have a 2% inflation target, exactly how do you implement a “dovish” policy?  A “hawkish” policy?

What if we turn to fiscal policy; does that change things?  Not at all.  The government’s national debt is constrained by the fact that the debt must be serviced in the long run.  This budget constraint means that budget deficits that are larger than average during certain periods must be offset by deficits that are smaller than average during other periods–to keep the debt manageable.  It makes no sense for someone to say, “I generally favor a more expansionary fiscal policy than what is favored by Sumner.”  It’s not even a coherent statement.  If you say that you favor a more expansionary fiscal policy that what I currently favor, you are implicitly saying, “and at some future date I prefer a more contractionary fiscal policy than what Sumner will favor at that point in time.”  I worry that the insights of Robert Lucas are being forgotten.

It’s not just about big government

The recent budget deal is even worse than I imagined.  Here’s Ravi Smith, from the previous comment section:

By repealing IPAB, which is essentially a cap on Medicare spending, the Republicans have massively increased the size of government. In the long run, that will probably be more important for sustainability than any of the tax changes or immediate spending items.

Conservatives used to try to argue that while the GOP would not cut spending, at least they would not increase it as fast as the Democrats.  But even that is no longer true, and the reason is that the GOP is no longer either a small government or a big government party; they are something much worse, the party of crony capitalism.  They are the party that forces the Pentagon to spend money on weapons that ever single military expert says are unneeded.  They are the party that wants to shovel more spending into the insatiable medical industrial complex, even when every health expert tells us the spending is utterly worthless.  They want to shovel more money to big agriculture, even though every economist will tell you it does nothing to prevent agriculture from becoming increasingly dominated by big farmers.

The Democrats also want to spend a lot of money on providing health care, but at least they have a slightly defensible reason, providing health coverage for the needy.  The GOP would rather double spending on Medicare and gut spending on Medicaid, as long as it enriched wealthy people in the healthcare industry (while denying coverage for the poor.)

One thing the left and right seem to agree on is that the GOP is the small government party.  That explains why the media are paying little attention to this fiasco.  But they are both wrong.  The GOP is the party of crony capitalism–small vs. big government plays no role in the modern political debate between the right and the left.  America has become a European country.  If it’s stupid bigots vs. stupid utilitarians, I’m with the stupid utilitarians.

The right used to mock the Democratic Party claims that high government spending does not hurt the economy.  Now I see conservatives engaging in “magical thinking” that would put 1960s-era liberals to shame.  All this orgy of spending is not a problem (we are told) because the GOP won’t pay for it with higher taxes.  Instead we’ll just borrow the money!  I’m not surprised that Trump thinks this way, he’s never had the slightest interest in reality.  But I am sort of surprised by the number of conservatives drinking the kool-aid.

So let me make it really simple.  There’s a pie.  The GOP is about to give the government sector a much bigger slice of that pie.  That means the private sector will get a smaller share of that pie.  And no amount of deficit spending will change that fact, unless you believe that pouring hundreds of billions of dollar into ships and airplanes with no military purpose, and into an out of control medical sector, will magically cause “the pie” to grow.

Here’s the National Review:

Republican congressional leaders have announced a deal with Democrats to bust discretionary spending caps by nearly $300 billion over the next two years. Appropriations will rise by 13 percent this year. . . .

[That 13% growth is in contrast to NGDP, which will rise by about 4.5%.  Think slices of the pie.]

The Republican Congress that aggressively pushed President Clinton on spending then turned around and rubber-stamped President Bush’s domestic spending spree. Now the GOP Congress that admirably fought President Obama’s spending agenda is set to bust the budget caps under President Trump.

So let’s see, we only get spending restraint when we have a GOP Congress and a Democratic President.  Pity Hillary didn’t win. Seriously, I think things would actually be about the same if Hillary had won.  The GOP would have done a deal of no repeal of Obamacare and a massive domestic spending increase in exchange for corporate tax cuts.  (That was my prediction before the election, and I’m even more convinced today.)  The only difference is that we wouldn’t have an embarrassing buffoon in the White House, with his finger on the nuclear trigger.

Hey Tea Party, how’s your support for Trump working out?

Has fiscal policy been unsustainable for decades?

After the previous post, Carl made the following comment:

I have a hard time believing it’s because “fiscal policy is unsustainable”. It’s been unsustainable for decades.

Here’s the data for 1947-2007:

So no, fiscal policy has not been unsustainable for decades.  The debt ratio fell from 80% of GDP in 1947 to 35% of GDP in 2007.  That’s not to say that there were no long term fiscal challenges in 2007—the looming retirement of baby boomers was an issue that needed to be addressed.

However it is not true that a longer life expectancy creates major problems for fiscal policy.   Living longer need not cause health care costs to rise dramatically, if people are also healthier.  To some extent the costs simply occur later in life.  The much bigger problem is that we now spend far more on the same health problems that we spent less on in the past. Singapore does not.

And greater longevity need not increase the pension burden, as long as the retirement age reflects improvements in health.  Longer life spans may create a problem if we don’t handle them in a sensible way, but that’s up to us.  Thus we could set the Social Security retirement age equal to the average life expectancy in America, minus 12 years.

Today, the debt burden is nearly back up to 80% of GDP, and likely headed much higher.  The problem today is that fiscal policy is currently unsustainable—we are running massive and growing deficits late in an expansion.  It was certainly not unsustainable when we were rapidly reducing the ratio of debt to GDP under Bill Clinton.

PS.  My previous post title should not be taken as a prediction of recession.  I do not expect another recession in the near future.  I would emphasize that the level of stock prices is still pretty high, even after the recent drop.

Unsustainable?

I suppose I ought to say something about recent stock market turmoil, even though I don’t have any great insights.  (I recommend John Cochrane’s recent post.)

I generally divide shocks up into two types.  There are negative demand shocks, like 1929 and 2008.  Then there are real shocks, when the market crashes without any big drop in NGDP growth expectations.  That might have been the case in 1987 and 2000, although I’m not certain.

As far as I can tell, the recent market decline seems more like a real shock.  I don’t see any sign of slower NGDP growth expectations.  The Hypermind market is almost unchanged, and there’s not much change in nominal bond yields or TIPS spreads.  If anything, bond yields have risen, which is not reflective of declining NGDP growth expectations.

So if it’s a real shock, then what caused it?  Keep in mind that thus far the decline has been modest, less than 10%.  And that follows a huge stock price run-up.  So don’t look for a huge real shock, merely something that means investors are still quite optimistic, just a bit less optimistic than a week ago.  It’s all about levels.

One possible culprit is an increasing sense that things are “unsustainable”.  Here are a couple areas where that perception may be building:

1.  Perhaps RGDP growth is unsustainable.  Unemployment has fallen to 4.1%, the working age population is growing very slowly, immigration reform seems unlikely, and nominal wage growth is accelerating.  The recent 2.9% wage growth number seemed to hit stocks.

2. Perhaps fiscal policy is unsustainable.  The GOP passed a big tax cut (which will end up costing much more than estimated.)  After you do that, you are supposed to tighten up on spending if you are the small government party.  Instead they basically took off all the restraints on spending.  The deficit is about to get much worse.  And when the next recession hits?  Don’t even think about it.

[Remember when Blair and Brown enacted a big fiscal stimulus at a time when the UK was booming in the early 2000s?  And then there was no money for fiscal stimulus when the Great Recession hit.  That’s basically the current GOP.]

I don’t have a lot of confidence that fear of unsustainable trends is what caused the recent market setback, but I can’t see any other plausible culprits.  Have I missed anything?