Archive for the Category Fiscal policy


How bad is the Italian debt situation?

Tyler Cowen recently linked to a John Cochrane post, discussing Larry Kotlikoff’s views on public debt sustainability.  Here’s Cochrane:

(By the way, if you’re feeling superior and taking comfort that Europe will go first off the cliff, Kotlikoff disagrees. Europe’s debts are larger, but their social programs are better funded, so their fiscal gaps are much lower than ours. The winner, it turns out, is Italy with a negative fiscal gap. Answering the obvious question, Kotlikoff offers

“What explains Italy’s negative fiscal gap? The answer is tight projected control of government- paid health expenditures plus two major pension reforms that have reduced future pension benefits by close to 40 percent.”Don’t get sick or old in Italy, but perhaps buying their bonds is not such a bad idea.)

I am a bit skeptical of that claim; so I decided to check with God, er . . . I mean I decided to check with the ultimate arbiter of truth, the asset markets:

Screen Shot 2017-04-24 at 4.13.10 PMAs you can see, Italian 10-year bonds offer considerably higher yields than German, French and Dutch bonds, and even higher yields than Spanish bonds. Italy has a massive public debt (third largest in the world), an economy that has shown almost no growth since 2000, and a very dysfunctional political system (which the voters recently decided not to reform.)

I greatly respect Kotlikoff, and even more so John Cochrane.  But I respect the markets far more than any mere mortal.   So unlike Kotlikoff and Cochrane, I remain relatively pessimistic about the Italian debt situation.

PS.  I am back from 5 days in Turks and Caicos (is there a law in the Caribbean mandating nothing but Bob Marley music at resorts?), and I am starting to get caught up.

I have a new post on Bretton Woods as an example of the guardrails approach to policy, and another post commenting on the French elections.

My guardrails post is intended to address tiresome criticism of NGDP targeting by people who have never bothered to actually read what I have written on the topic. No, neither the current lack of interest in NGDP futures trading nor the risk of market manipulation pose any kind of problem for the system I am actually advocating.  (Unless you believe, “Bretton Woods could not possibly have worked because speculators would have manipulated the market.”)

Ryan Murphy on state and local stimulus

Ryan Murphy has a new piece at Mercatus that discusses the problem of estimating spending multipliers using regional data:

Even if the central bank is perfectly competent and offsets the effects of fiscal stimulus entirely (meaning the multiplier at the national level is zero), these statistical methods when applied to subnational data still calculate the fiscal multiplier to be greater than one. Under conventional assumptions and settings where central banks credibly target certain nominal variables, any multiplier greater than zero should instead be interpreted as one region taking aggregate demand and jobs from another. In other words, a multiplier of greater than zero in one area implies a multiplier less than zero in another.

Unfortunately, most researchers seem to be aware of this problem:

Research employing these methods is published in elite academic journals such as American Economic Review and American Economic Journal: Economic Policy. Very rarely does it seriously address the negative externality problem. If it does, it often implies that states engaging in fiscal stimulus will provide a positive spillover for neighboring states. When the problem is referenced, it is noted as a small caveat deep within the paper. For instance, one paper states in its abstract that $100,000 of public outlays corresponds to 3.8 job years (implying a multiplier greater than one). This article has been cited 133 times as of September 2016, according to Google Scholar. Within the paper, however, the authors write, “given that the results from this cross-state approach do not incorporate equilibrium effects, cross-state multipliers, or the response of the monetary authority, we interpret this multiplier as only suggestive of the national multiplier of policy interest.” This interpretation entirely undercuts their point.

Now that we have a new administration determined to pursue tax reform and infrastructure spending, it’s worth reviewing where monetary offset does and does not apply.  Pundits often confuse the supply-side with the demand-side, when talking about the “growth” effects of “stimulus”.  If the stimulus is demand-side, then monetary offset probably prevents any meaningful effects.  But supply-side policies can still create growth, even with monetary offset.

Infrastructure spending is purely a demand-side policy as long as the infrastructure is still under construction.  Thus one should not expect any immediate impact on growth from spending more on big projects such as highways, bridges and airports. Once an infrastructure project is complete, it may (and I emphasize ‘may’) boost aggregate supply, and hence real GDP growth.  In my view, the supply-side effects of the sort of infrastructure package we are likely to see will be very small.  That doesn’t mean it’s not worth doing, just don’t expect a dramatic boost to GDP growth.

As of now, the GOP is still claiming that it intends to pursue revenue neutral corporate tax reform.  In that case, there would be no demand-side effects, so there would be nothing for monetary policy to offset.  If the tax reform boosts the supply side of the economy, it may also boost real GDP growth.  As with infrastructure, the long run effect may be greater than the immediate impact, as tax reform is likely to lead to more business investment.  In my view tax reform could have a stronger supply side effect than infrastructure spending, albeit still fairly modest in absolute terms.

PS.  I saw that the new Vegas football stadium was approved today.  When these stadium projects are sold to the voters, there are promises of multiplier effects from the spending of tax dollars.  Good luck.

According to Wikipedia, Vegas is just as sensitive to preserving its heritage as Boston:

The stadium as proposed is a domed stadium with a clear roof and silver and black exterior and large retractable curtain-like side windows facing the Las Vegas Strip. There is a large torch in one end that would house a flame in honor of the late Al Davis.[37] MANICA Architecture confirmed on March 28th, 2017 that a full nude strip club would be included into the stadium to honor the heritage of Las Vegas.

Does this project in some strange way remind you of a certain American politician?

Update:  I guess that Wikipedia quote has been corrected.  Shame on me for being so gullible.

Screen Shot 2017-03-28 at 5.40.39 PM

Brazil’s austerity experiment

Scott Alexander recently had this to say about a Vox article on Brazil:

Brazil has just passed the most extreme austerity measure in history in the middle of a recession, locked in with a clause making it impossible to repeal for 10-20 years. A…bold…choice. If nothing else, it’ll provide good data for future generations of macroeconomists. Register your predictions now!

I predict success, in the sense of faster growth.

I doubt, however, that the experiment will actually prove very much, as I know of no theory that predicts Brazil’s austerity would cause slower growth, and I know of no evidence that Brazil will in fact engage in extreme austerity.

Brazil has high interest rates and high inflation, and hence even Paul Krugman would not regard fiscal austerity as being contractionary in Brazil. Instead, the Brazilian central bank determines the rate of Brazil’s nominal GDP growth.

Might austerity hurt the supply-side of Brazil’s economy?  I suppose anything is possible, but it’s hard to see how.  Unlike China, Brazil’s high government spending goes to things like public pensions, not infrastructure.  In addition, Brazil’s government sector spends much more (39.1% of GDP) than other countries that seem to have at least as productive supply-sides, such as Chile (23.2%), Mexico (26.6%), Costa Rica (18.2%), Uruguay (32.6%), and Australia (35.3%).  It’s not clear to me that spending 39.1% of GDP makes your economy more efficient, especially if very little of the money goes to infrastructure.  To be fair, Venezuela spends 40.1%.  So Brazil is the not highest spender.

Perhaps the austerity will fail by increasingly inequality.  Brazil is already very unequal, although a bit less so than 20 years ago.  But that depends on which programs are cut.  In the past, government spending in Brazil has been regressive, mostly going to relatively well off government employees and pensioners.  Unfortunately, the Vox article that Scott links to doesn’t tell us where the cuts will come.

Nor does it say that there will be any cuts at all:

Americans worried that Donald Trump will try to shred the nation’s social welfare programs can take some grim comfort by looking south: No matter what Republicans do, it will pale in comparison with the changes that are about to ravage Brazil.

On Thursday, a new constitutional amendment goes into effect in Brazil that effectively freezes federal government spending for two decades. Since the spending cap can only increase by the rate of inflation in the previous year, that means that spending on government programs like education, health care, pensions, infrastructure, and defense will, in real terms, remain paused at 2016 levels until the year 2037.

A few comments:

1.   Notice that no specific cuts are announced.

2.  A constitutional amendment in Brazil doesn’t have the same meaning as in the US.  It’s more like legislation.  When a government engages in Augustinian promises to do something virtuous, but only far out in the future, it’s a pretty good indication that they have absolutely no intention to fulfill their promise.  Many governments have long range promises to balance the budget, which no one seriously expects to be enacted.  I hope the Brazilians will hold real spending fixed for 20 years (to become a bit more like Chile), but it seems very unlikely that they will do so.

The Vox article is highly misleading in all sorts of ways.  For instance, did you know that Brazil is one of the most highly taxed countries in the developing world? If you did not, you probably would not acquire that information by reading this from the Vox article:

While the amendment does a great deal to limit the expenditure of government funds, it doesn’t do anything to directly address how to generate them directly: taxes.

“The major cause of our fiscal crisis is falling revenues,” Carvalho says, noting that the populist Rousseff, known for her support for government programs, cut taxes for the corporate sector during her time in office over the past few years in an attempt to avoid losing public support.

Carvalho says taking an ax to spending is coming at the expense of discussing “taxing the very rich, who do not pay very much in taxes, or eliminating tax cuts that have been given to big corporations.”

Brazil’s tax code is extraordinarily generous to corporations and the wealthy, and helps buttress its status as one of the world’s most unequal countries. Brazil’s highest income tax rate is just 27.5 percent — for comparison, US tax rates go up to about 40 percent, and in Scandinavia they can exceed 60 percent.

The Vox article doesn’t really provide much context.  Readers are not told that a decade of socialist misrule has driven Brazil into a painful recession. Perhaps Brazilians have noticed the fact that Chile and Mexico are not in depression, and do not have as bloated a government sector.  Maybe they don’t think it’s wise to have a government sector that is almost as large as in Venezuela.

PS.  Over at Econlog I discuss the peculiar views of Trump’s new economic advisor

DeLong on fiscal stimulus

In recent years, I get the impression that Keynesians are being more and more aggressive in their arguments for fiscal stimulus.  I see economists arguing for stimulus when we are in a deep slump (2009), a sluggish recovery (2011-14) and even full employment (now.)  Here’s an example from Brad DeLong:

When should you use fiscal policy to expand demand even if the economy is at full employment?

First, when you can see the next recession coming: that would be a moment to try to see if you could push the next recession further off.

Second, if it would help you prepare you to better fight the next recession whenever it comes.

The second applies now whether we are near full employment or not.

Under any sensible interpretation of where we are now, using some of our fiscal space would put upward pressure on interest rates and so open up enormous amounts of potential monetary space to fight the next recession. It would do so whether or not it raised output and employment today as long as it succeeded in raising the neutral interest rate . . .

Like Mae West, they seem to think that too much of a good thing is . . . wonderful.  In my view, one of Bob Lucas’s greatest insights is that you need to think in terms of coherent policy regimes, not just gestures that might or might not seem appropriate at a given point in time.  In the standard Keynesian model, fiscal policy cannot be consistently expansionary.  For every year of expansionary fiscal policy, there’s another year of contractionary fiscal policy.  This is due to two factors:

1.  What matters is not the cyclically-adjusted deficit, but rather the change in the cyclically-adjusted deficit.

2.  In the long run the federal budget has a constraint; interest as a share of GDP cannot increase without limit.

In fairness, DeLong is focusing not on the direct impact, but rather the indirect effect on interest rates and monetary policy.  But I’d also make a practical argument here.  Any sort of plausible fiscal stimulus that might have a prayer of getting through Congress today (when the deficit is already $650 billion and rising), is likely to be on the order of a few hundred billion dollars/year, at most.  And that’s simply not going to move the equilibrium interest rate enough to have a meaningful impact on the potency of conventional monetary policy.  Big Japanese fiscal deficits also failed to significantly boost their interest rates.  It will also mean less fiscal “ammunition” in the next recession, when it might be even more necessary (from a Keynesian perspective.)

Nor is the direct impact of stimulus likely to be significant.  The Congress suddenly cut the deficit from about $1050 billion in calendar 2012 to about $550 billion in calendar 2013, and it had zero impact on growth (for standard monetary offset reasons).  Fiscal policy is a waste of time and money.

I explored these issues in more detail in my recent Lake Wobegon post, and in an even more recent post I pointed out that Janet Yellen suddenly seems to have changed her mind, and now agrees with me.

I’d really like these new Old Keynesians to write down a model on exactly:

1.  When do they want the cyclically adjusted deficit to be smaller than average?

2.  And exactly when do they want it to be larger than average?

I think I know their answer to the latter question (always), it’s the former question that has me perplexed.

HT:  Bob Murphy

The Fed’s bizarre call for infrastructure spending

Here’s something that caught my eye:

Federal Reserve officials are increasingly making the case that Congress should spend more money to stimulate the economy, with an eye on the infrastructure package that could hit the agenda next year.

Federal Reserve Chairwoman Janet Yellen and Vice Chairman Stanley Fischer have both nudged Congress in recent speeches. They said federal spending that bolsters demand and increases the labor force would take pressure off of monetary policy and help grow the economy.

“There are ways in which the response of fiscal policy to shifts in the economy could be strengthened, which could help take some burden off of monetary policy,” said Yellen in a September press conference.

“Fiscal policy has traditionally played an important role in dealing with severe economic downturns,” said Yellen in an August speech, suggesting work on “improving our educational system and investing more in worker training; promoting capital investment and research spending, both private and public; and looking for ways to reduce regulatory burdens while protecting important economic, financial, and social goals.”  (emphasis added)

I don’t use the term ‘bizarre’ lightly, as this stuff is not just wrong, or doubly wrong, it’s quintuply wrong.  It’s not even slightly defensible:

1.  The Fed claims the economy does not need any more demand stimulus.  Indeed any boost to AD from more spending would be offset by tighter money.  So what’s the point?

2.  Even if fiscal stimulus were needed, it should be done via tax cuts.  It’s not efficient to vary spending for anything other than standard cost/benefit reasons, where benefits do not include demand stimulus.  And why should the central bank be telling Congress where to spend money?

3.  The Fed might respond that fiscal stimulus would not boost demand, but it would allow the current demand to be achieved with less monetary stimulus.  But why is that desirable?

4.  The Fed might argue that it would prefer a higher trend rate of nominal interest rates, so that it hit the zero bound less often in future recessions.  But fiscal stimulus is an absolutely HORRIBLE way to achieve that objective:

a.  Fiscal stimulus can only boost nominal interest rates by raising the global real rate of interest.  Just imagine how much fiscal stimulus it would take to boost the global real rate of interest by even 100 basis points.  (Hint: far, far beyond anything Congress would ever contemplate.)  Then think about how Japan did a massive amount of fiscal stimulus in the 1990s and 2000s, and ended up with some of the lowest interest rates the world has ever seen.

b.  In contrast, monetary stimulus can easily raise nominal interest rates by 100 basis points, merely by raising the inflation target from 2% to 3%.  So why would the Fed prefer fiscal stimulus as a way of raising nominal rates?  Is the Fed seriously arguing that the sort of fiscal stimulus needed to boost global real interest rates by one percent is more efficient than simply raising the inflation target by 1%?  And if so, why is it that when inflation targeting was first being discussed and implemented in the 1990s, all of the academic discussion focused on the importance of setting the inflation target high enough to avoid the zero bound problem, and approximately zero effort was devoted to the idea that fiscal stimulus could raise the long term trend real interest rate, if the zero bound were a problem.  Were the economists of the 1990s stupid?

5.  Economists agree, or used to agree that the US and other developed countries face severe long-term fiscal changes, due to an aging population.  The consensus is, or used to be, that now is a good time to start addressing these issues. (Remember Simpson/Bowles?) It would be one thing if the Fed were proposing a short-term fiscal stimulus to boost demand right now.  But they aren’t, they don’t think we need more demand right now. Instead they are proposing a long-term fiscal stimulus, which would massively worsen the already worrisome long-term fiscal trends in America.  A decade ago, sensible economists (like Krugman) criticized these sorts of proposals as reckless, and they were right.  Japan has already shown that decades of fiscal stimulus do nothing to raise NGDP growth, and merely leave you with a higher debt/GDP ratio.  Why would we want to copy Japan’s failed experiment?  All they ended up with is lots of highway projects that are little used, and destroyed some of the once beautiful Japanese countryside.

6.  What does improving education have to do with fiscal stimulus?  The US already spends more on public education than most countries, and education experts seem to agree that the real problem is poorly designed schools or bad home environment, not lack of money.  Would throwing a few more billions of dollars at the LA school system boost growth?  Would it turn the LA system into the Palo Alto system?  How?

The passage I quoted is modern progressivism at its worst.  A lot of nice sounding bland generalities, that mean nothing.  I mean seriously, “working training”?  What a brilliant idea!!  Amazing that humanity never thought of that before, in 5000 years of human history. While we are at it, let’s reduce federal spending by 10% solely by cutting “waste, fraud and abuse”, without touching any “needed programs”.

And if the Fed is so worried about unemployment, how about telling the government not to raise the minimum wage to $15/hour?  Let me guess, that would not sound progressive.