Kocherlakota on negative supply shocks
Marcus Nunes directed me to an article by Narayana Kocherlakota, discussing the impact of negative supply shocks:
Let’s consider three ideas that have been popular on the campaign trail.
- Increasing the minimum wage. What if Congress decided to increase the federal minimum wage by 10 percent a year over the next five years? Typically, economists would be concerned about the impact on employment: Higher wages might lead businesses to employ fewer workers. With monetary policy out of the picture, though, the move might actually help. The expectation of higher wages would cause consumers to expect more inflation over the next few years, leading them to buy more goods and services now, before prices went up. To meet this added demand, businesses would have to boost production and hiring.
- Increasing import tariffs. Suppose Congress gradually raised tariffs on imported intermediate goods, such as steel and sugar. Economists would worry that this would reduce the benefits of free trade. But as long as the Fed didn’t respond by raising interest rates, there would also be a positive effect: Households would expect higher prices, which would again prompt them to demand more goods and services today — creating much-needed demand for businesses.
- Imposing restrictions on immigration. Most economists would oppose such a move, because immigration is seen as an important contributor to overall growth. Yet again, though, the logic changes somewhat if inflation is too low and the Fed is passive. Households might expect the relative scarcity of labor to drive up wages and prices, triggering purchases that would benefit businesses and the economy more broadly.
The Fed’s response is crucial in all these cases. Typically, the central bank reacts to increases in inflation by raising interest rates sharply — a move that would choke off any demand that the policy measures might generate. With inflation running well below target, however, it’s appropriate for the Fed to hold rates low even if it sees a modest increase in inflationary pressures. It’s this subdued reaction function that allows the policy initiatives to have more positive effects.
I find this peculiar, for a number or reasons. First, I doubt that any demand-side effects of negative supply shocks would overcome the negative supply-side effects of these policies. Second, I deny that these policies would boost demand, even at the zero bound. Higher minimum wages will lead to expectations of lower profits, and this will reduce investment. What makes corporations invest more is higher expected NGDP. What makes firms build more houses, is more immigration. The crackdown on immigration in 2006 slowed the housing boom.
If you prefer Keynesian language, negative supply shocks reduce the Wicksellian equilibrium interest rate, making the “zero bound” problem worse. Low immigration is exactly why the zero bound problem is most severe in Japan, and high rates of immigration is one reason why Australia never even hit the zero bound. Fast NGDP growth leads to higher nominal interest rates, and no zero bound problem.
So even at the zero bound these policies do not work, as we found out when FDR raised wages sharply in July 1933, aborting a robust recovery in industrial production. But it’s far worse. We are not at the zero bound, and hence the Fed would simply raise rates to neutralize the effect on inflation. Kocherlakota writes the final paragraph in a way that almost seems to suggest the Fed agrees with him, and would react the way he wishes. But clearly they would not, or the Fed would not have raised rates in December. So it’s a moot point. Elsewhere, Kocherlakota says:
The Federal Reserve faces a big challenge: It wants to get inflation up to its 2-percent target, but so far its stimulus efforts have failed to reach that goal.
That’s simply inaccurate, for reasons that Kocherlakota has himself explained numerous times. The Fed raised rates in December over Kocherlakota’s (wise) objections. That means the Fed does not share Kocherlakota’s inflation objectives, or else they think they’ve already succeeded in the sense that expected future inflation is 2%. But either interpretation is inconsistent with Kocherlakota’s “tried and failed” suggestion. Either they are not trying, or they think they’ve succeeded. Take you pick, there are no other plausible options.
In fact, these initiatives would tend to reduce NGDP growth, as monetary policy would tighten to prevent any increase in inflation, thus reducing real GDP growth. Because wages are sticky, lower NGDP growth would boost unemployment. And in the case of higher minimum wages, the unemployment effect would be especially large.
The fact that even a dove like Janet Yellen is aggressively raising interest rates to keep inflation from exceeding the Fed’s two percent target is a shot across the bow to progressives. Yellen is essentially saying; “You go ahead and raise wages to $15/hour. But we aren’t going to allow higher inflation. Instead, we’ll raise interest rates enough to create lots more unemployment.” The progressives have been warned, the only question is whether they care.
I’m starting to see a trend in the comment section that I never thought I’d live to see. Progressives write in complaining that it’s cruel to have an economic system where low productivity people need to work (even with wage subsidies.) Instead we should have a guaranteed annual income, so they can pursue other activities, such as hobbies, or volunteer work.
Maybe my lack of empathy comes from the fact that I was abused as a child. My father tried to give away surplus games to charity, from his little store. Things like Monopoly games with a few pieces missing. But the charity would not take them, insisting that children receiving these slightly flawed gifts would be mentally scarred. So instead he gave them to us. Since then, I’ve never been the same.
Even worse, I ingested megadoses of lead.
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20. April 2016 at 06:59
>>The progressives have been warned, the only question is whether they care.>>
Sanders has come out in favor of a more stimulative monetary policy in order to stimulate employment. Silence from Clinton. Tighter monetary policy, if not return to the gold standard, from the Republicans (other than Trump, who just said nice things about low rates).
More attention to monetary policy by progressives would be good. Less insanity by conservatives would also be good.
Your framing would really help: monetary policy to boost national income rather than the current monetary policy to increase inflation.
20. April 2016 at 07:20
> Higher minimum wages will lead to expectations of lower profits, and this will reduce investment. What makes corporations invest more is higher expected NGDP.
Would be interested to see how close private sector investment is to bottoming out due to very weak NGDP forecasts over short-mid term. If close to bottom, increased consumption could very well offset decreased firm investment.
I applaud Kocherlakota for at least suggesting some unorthodox monetary policy fixes to spur discourse, even if it’s clearly fiscal policy that is broken, and that is truly needed to get growth back on track and ensure a higher standard of living for future generations – as he has pointed out previously.
20. April 2016 at 07:50
>> So even at the zero bound these policies do not work, as we found out when FDR raised wages sharply in July 1933, aborting a robust recovery in industrial production.
This bit is debatable. From G.Eggertsson’s research (cited in footnote 1 in N.Kocherlakota’s article) it seems like these policies actually fostered the strong recovery. At least that’s what you get from a standard New Keynesian model.
Now it is true that the Fed would likely raises interest rates should similar policies be carried out today, so that these would be contractionary.
20. April 2016 at 08:11
According to Timothy Taylor immigration has already slowed drastically;
http://conversableeconomist.blogspot.ca/2016/04/mexico-to-us-border-apprehensions-and.html
‘How to limit or regulate the enormous inflow of immigrants from Mexico was a legitimate policy concern from the 1970s into the early 2000s. As Gonzalez-Barrera puts it, that migration was “one of the largest mass migrations in modern history.” But now that flow has fallen substantially, and even reversed itself. The main issue now is be how we deal with the after-effects of that enormous mass migration and the immigrants who are already here–many of whom have been here for quite some time. ‘
20. April 2016 at 08:20
This is a weak effort by Kocherlakota. Anyways, I have news for macroeconomists: most households are not contemplating the long-term inflationary impact of various government policies. I wonder what fraction of the public could pick Janet Yellen out of a thug line up in Brooklyn.
How about when California cities tighten property zoning? Does that mean I run out and spend money, since inflation will be going up in the future?
20. April 2016 at 08:30
Just when you think it’s safe to go back to reading the WSJ;
http://www.wsj.com/articles/monetary-reform-or-trade-war-1461104951
——–quote——-
This floating exchange-rate system, combined with the official reserve-currency role of the world dollar standard, explains why free trade has been getting a bad name among Democrats, Republicans and independents. Under the floating exchange-rate reserve-currency system, free trade has become no more than a romantic fantasy.
The solution is to establish a level trade playing field with a system of stable exchange rates among the nations of the G-20, or at least the G-7, to which emerging countries will conform. Such a solution would require the next president to bring together the major world leaders to establish stable exchange rates to avoid trade and currency wars that inevitably lead to protectionism and sometimes to real wars. This international monetary solution of stable exchange rates would eliminate the burden and privilege of the dollar’s reserve-currency role.
———-endquote————
I thought Lehrman was dead.
20. April 2016 at 08:36
Scott hit it with this statement:
“The fact that even a dove like Janet Yellen is aggressively raising interest rates to keep inflation from exceeding the Fed’s two percent target is a shot across the bow to progressives. Yellen is essentially saying; “You go ahead and raise wages to $15/hour. But we aren’t going to allow higher inflation. Instead, we’ll raise interest rates enough to create lots more unemployment.” The progressives have been warned, the only question is whether they care.”
Not sure how aggressive, but clearly the Fed does not want any inflation. I gave Scott a link as to why, discussing the views of Christopher Phelan. The Fed simply cannot raise rates enough in an inflationary environment. Phelan says it is political. I think it is because the banks would all go under: http://www.talkmarkets.com/content/economics–politics-education/federal-reserve-mandates-slow-growth-so-fed-must-finance-american-infrastructure?post=91756
20. April 2016 at 08:36
“I’m starting to see a trend in the comment section that I never thought I’d live to see. Progressives write in complaining that it’s cruel to have an economic system where low productivity people need to work (even with wage subsidies.) Instead we should have a guaranteed annual income, so they can pursue other activities, such as hobbies, or volunteer work.”
Hmm, I wonder who you’re targeting with that comment.
What reason do you have to favour the economic distortion of wage subsidies over a non-distortionary basic income? While I completely support people freely choosing to spend their time on volunteer work or hobbies, there is plenty of reason to think most people would still spend plenty of time working in order to earn additional income, as most economists correctly assume when they talk about the distortionary effects of taxes.
Wage subsidies don’t really make economic sense unless you believe that low income people have a particular tendency towards being self-destructively lazy and require wage subsidies in order to make up for innate flaws, or that employers aren’t sufficiently motivated to create low-wage jobs. Besides that, having wage subsidies also means that low income earners face higher effective marginal tax rates than they would otherwise, thus reducing their incentives to find higher-paying work.
Also, I have to push back at least somewhat on the characterization of “low productivity people”. There is a non-negligible extent to which low productivity is not so much an innate characteristic of a person but rather a product of the situation they are in. When someone is in a position where they are completely reliant on employment in order to satisfy their basic living needs (and particularly those of their children), you will sometimes find that that person has very little choice other than to have “low productivity”. Going from “low productivity” to “high productivity” often involves huge risks, such as enterpreneurship, education, training, relocation, etc., that some people simply cannot afford to take. For that matter, if you can’t afford to not have a job, then having “low productivity” can sometimes be a matter of simply not having the bargaining power that you need in order to be fairly compensated for said productivity.
20. April 2016 at 08:45
“low productivity people”. He means economists. Just kidding!
When I mentioned above that banks would go under with inflation, they would either go under or be forced to lend more if inflation soared. The S&L’s went under when Volker raised interest rates abruptly. So, Greenspan’s life has been to never let that happen to the main stream banking system. Greenspan is still in control, intellectually, of the banking system and will not tolerate too much inflation. Banks have bet on low rates and low inflation.
20. April 2016 at 08:55
It’s a wonder more economists don’t support taxes on economists, given the well-established negative externalities ^_~
20. April 2016 at 09:14
foosion, Sanders has no impact on monetary policy, but he does have an impact on the minimum wage debate. And even with an optimal monetary policy, higher wages mean fewer jobs.
Roy, I don’t know of any evidence that fiscal policy is effective.
Jordan, My research, and that of most other experts I am aware of, reached exactly the opposite conclusion from Eggertsson. Even Keynes thought the NIRA was a bad idea. I have a new book out on the Great Depression, but you can also look at this blog post.
http://www.themoneyillusion.com/?p=48
Patrick, I guess they figure the eurosystem worked so well, why not extend it globally!
Dimitri, You asked:
“Hmm, I wonder who you’re targeting with that comment.”
Actually several differnet commenters, of which you were the most recent.
You said:
“What reason do you have to favour the economic distortion of wage subsidies over a non-distortionary basic income?”
Show me a non-distortionary BI and I’ll support it.
You said:
“Also, I have to push back at least somewhat on the characterization of “low productivity people”. There is a non-negligible extent to which low productivity is not so much an innate characteristic of a person but rather a product of the situation they are in.”
I completely agree, what made you think I did not? Peasants in India are extremely low productivity, but might be high productivity in America. And even here it depends on lots of factors, as you say.
20. April 2016 at 09:21
What would happen in a world without labor laws?
https://panampost.com/elena-toledo/2016/04/19/66729/
———–quote———
For the first time, El Salvador’s Ministry of Labor will execute a special plan to inspect the work conditions of exotic dancers with the aim of verifying that they meet labor laws, according to Head of the Ministry Sandra Guevara Pérez.
The Ministry of Labor has received lots of complaints about working conditions, and has fined various locations US $57. In many cases, dancers aren’t paid hourly, aren’t offered Social Security or overtime pay. The new plan for enforcement will begin in the San Salvador metropolitan area and later extend to the rest of the country.
———endquote———–
20. April 2016 at 10:27
Progressives write in complaining that it’s cruel to have an economic system where low productivity people need to work (even with wage subsidies.) Instead we should have a guaranteed annual income, so they can pursue other activities, such as hobbies, or volunteer work.
I assume that’s what a lot of *fans* see in Bernie’s agenda and promises. A lot of European countries are extremely close to a basic income. It’s pretty unconditional in a lot of countries here. The toughest condition is basically that you have to show up and open your hand.
When you see things like this every day you will start to think that The Donald is not the worst thing that can happen to a First World country. By far.
20. April 2016 at 13:09
Patrick: “What would happen in a world without labor laws?” Hong Kong
(Though in their case it would without labour laws.)
20. April 2016 at 13:41
@scott You said, “I find this peculiar, for a number or reasons.”
I would have used a stronger word than peculiar.
Who knows…. maybe Kocherlakota was kicked in the head by a horse.
20. April 2016 at 14:20
Kocherlakota also says printing money by the Fed and handing it over to the Treasury (currently illegal; last done essentially in the US Civil War) is not a radical change from QE. Sumner agrees, but long term thinks it’s bad for the US fiscal balance. Sumner should blog more on this provocative idea (so we can hear the inner conservative in Sumner)
20. April 2016 at 15:13
Patrick Sullivan: there is an interesting history about the Reagan Administration and the so-called Plaza Accords. Secretary Baker wanted a cheaper dollar.
Then we have Nixon on August 15th 1971, instituting across-the-board tariffs and wage and price controls, partly in an effort to get trading partners to raise the value of their currencies.
Were are the Reaganauts and Nixonians wrong?
In theory, yes. But then there is also the idea that “The way we do it here and now is the best way it can be done, and what we believe here and now is the true belief.”
20. April 2016 at 16:58
James Baker wasn’t a Reaganaut, he was a Texas politician (all hat and little cattle when it came to economic smarts). The Finance Ministers were doing what savvy politicians do; giving the appearance of being important.
The value of the dollar was always going to be what Paul Volcker wanted it to be, and he went out of his way in his memoir to thank Reagan for supporting him in his policies.
20. April 2016 at 20:41
Oh Reagan pleased the Fed alright. Check out who signed the Garn-St Germain Act of 1982 making toxic, adjustable rate loans legal. To bad Ronnie Raygun didn’t live long enough to see he had been duped by Wall Street.
20. April 2016 at 20:54
Patrick Sullivan-
Was Ronald Reagan himself unaware or behind the Plaza Accords? They were reached in the Plaza hotel in NYC, so maybe Reagan was out of the loo.
It was Reagan’s administration that coordinated the Plaza Accord effort to successfully reduce the value of the U.S dollar–just as Nixon was behind dropping the value of the dollar in 1971. The Nixon Shock!
Volcker praising Reagan? He must have forgot the day Baker and Reagan had him into the Oval Office carpet for a little chat pre-election 1984, and told him to keep his foot off the brake.
Nearly forgotten today, a younger version of Meltzer served as an Acting Member of President Ronald Reagan’s Council of Economic Advisers in 1988-9. Ten years after his stint on the CEA, Meltzer recounted the Reagan Days (1981-1989), in a piece entitled, “Economic policies and actions in the Reagan administration.”
Meltzer’s chastising study reads in part—
“Uncertainty and lack of a coherent monetary policy were not limited to 1981-82. During the years 1984-87, the Reagan administration shifted from a freely fluctuating exchange rate to encouraging dollar devaluation first by talk and then, in 1986, by increasing money growth. These actions were followed by a decision at the Louvre in January 1987 to set a band for the exchange rate against principal currencies. Within a few months, the dollar was overvalued relative to the agreed-upon rates, so maintenance of the band required increased money growth in Germany and Japan and lower money growth in the United States. The band required higher interest rates. Between July and October 1987 interest rates on long-term U.S. government bonds increased approximately 25 percent (from 8 1/2% to about 10 1/2%). When anticipations of further increases in interest rates contributed to a rather dramatic decline of prices on the world’s stock exchanges, the administration shifted its position again. The dollar declined about 8 to 10 percent below the presumed bottom of the previous band.
It is difficult to find a consistent pattern, much less a coherent policy, in these shifts within less than one year from efforts to force devaluation by raising money growth and lowering market interest rates to a program of stabilizing exchange rates, lowering money growth, and raising interest rates and then to a program of lowering interest rates and allowing the dollar to fall. The shifts suggest an extremely short-term focus….” (boldface added.)
Well, okay so the Reagan Administration was incoherent on monetary policy. And they ran big deficits. Meltzer says they balanced that by riding on Jimmy Carter’s coat-tails in terms of regulatory relief and accomplished little on the front too, besides engaging in some protectionism here and there.
Volcker praises Reagan? Volcker is a pol, and needed money badly after leaving the Fed. The Reagan Administration has become legend. When stuck between truth and the legend, tell the legend–especially if legend-worshippers have money!
20. April 2016 at 21:37
A GBI isn’t, in my opinion, a necessarily “progressive” idea. Personally I support it for what I consider to be rather conservative reasons, that is, the effect on incentives.
Currently we have a system that effectively pays people to be poor/unemployed. Obviously not enough to make it attractive for everyone to do so, but it does affect behaviour on the margin. If you can get $X from welfare, or work at a crummy job for $2X while incurring $1.5X of disutility, then you will rationally choose to avoid work.
Plus many govt payments have various conditions attached to them that have similar distortionary effects. E.g. here in Australia you can’t claim the age pension if you are still working – so it encourages people to retire earlier than they otherwise would.
So a shift to a GBI system, replacing our current welfare and social security systems, in my opinion would increase the incentive for low income people to work. Obviously it’s a complicated idea and the way all the various effects would balance out is debatable, but I think the idea deserves to be engaged with intelligently rather than simply sneered at.
20. April 2016 at 22:21
“The Reagan Administration has become legend.”
I know lots of people believe that, but think about it Benjamin. He sowed the seeds of financial totalitarianism. Thatcherism was destruction of sovereignty and the establishment of the international banker cartel that did really bad things to America in the next century. Thatcherism was based on the fact that the UK had no Glass-steagall at all. It was open territory for toxic loans and imported those to America. But the framework had been built by Reagan.
No, Reagan was a tarnished hero if he was a hero at all.
20. April 2016 at 22:37
https://twitter.com/kocherlakota009/status/722949174912794624
20. April 2016 at 23:37
Scott, I know you don’t like Twitter, but there has been a few exchanges going on about your argument: One between Kocherlakota and Vaidas Urba. Kocherlakota seems to think that although negative supply shocks would reduce current AS, it would raise future expected growth in AS for some reason (?) and this would help boost current consumption. In a separate exchange, Tony Yates seems to agree with Kocherlakota, saying that “using Eggertson like arguments”, lowering AS now would be stimulative of actual output growth and would not hurt in the long run if you later reversed the harmful policy once the output gap closed. It’s all a bit esoteric for me.
20. April 2016 at 23:37
Oops – see above.
20. April 2016 at 23:46
“The (Reagan) administration added more trade barriers than any administration since Hoover. The share of U.S. imports subject to some form of trade restraint increased from 12 percent in 1980 to 23 percent in 1988.” –Niskanen
Another untold legacy of Reagan is that he was the posrwar era’s leading presidential protectionist!
Like Nixon, Reagan makes Trump look like a small-time piker, when it comes to protectionism.
Still, the Reagan tactics of protectionism, a cheaper dollar, and tax cuts produced robust national growth. Give credit where credit is due.
I actually like Reagan, who like Eisenhower avoided foreign entanglements. After 241 Marines were bombed to death in Beirut, Reagan left the Middle East and never went back.
21. April 2016 at 02:40
One more comment by Kocherlakota:
https://twitter.com/kocherlakota009/status/723096910622502912
21. April 2016 at 05:22
Everyone, My own comment got held up in arbitration, see above.
http://www.themoneyillusion.com/?p=31636#comment-671329
Christian, What makes you think “the Donald” doesn’t support these ideas?
Let me guess, you believe what he tells you.
Ben, See Patrick’s reply.
Nathan, You said:
“Obviously it’s a complicated idea and the way all the various effects would balance out is debatable, but I think the idea deserves to be engaged with intelligently rather than simply sneered at.”
I hope you aren’t implying that I sneered at the idea. What I sneered at is the idea that replacing a BI with wage subsidies is mean to poor people, because then they have to work to get the subsidy.
Vaidas and Urba, I wish people would look at the evidence, examples like the NIRA
21. April 2016 at 05:41
Benjamin, the compromises Reagan made with his free market principles were merely bows to the political realities of the day. Specifically, he agreed to ‘voluntary’ quotas on Japanese autos because Malcolm Baldridge told him that if he didn’t, congress would pass worse laws that would be even more harmful. Veto-proof laws.
Reagan used to carry a copy of ‘Capitalism and Freedom’ with him in his suit coat pocket. He knew the economics of free trade, but he also knew about political forces opposed to it.
Politics he learned first hand from being Governor of California, and, before that, head of the Screen Actors Guild. The latter was DEADLY serious business–he took to carrying a pistol.
Here’s Murray Weidenbaum:
https://fraser.stlouisfed.org/scribd/?title_id=1316&filepath=/docs/meltzer/weiadv2005.pdf#scribd-open
‘I write this with the clear knowledge that few if any decisions in government policy–be they labeled economic or social or foreign affairs–are made solely or even primarily on the basis of economic analysis or information from economists.’
21. April 2016 at 05:59
A little more from the Weidenbaum (Reagan’s first CEA Chair) memoir:
‘Looking back, it seems clear that, on balance, “Reaganomics” was a success. Certainly, the President’s policies had injected a new sense of realism into the decision making in the private sector. The government no longer was expected to rush in to aid the losers in the continuing competition in the marketplace. Management and workers alike became more concerned with controlling costs and increasing productivity in order to maintain competitiveness.
‘ …. Surely Reaganomics did not work painlessly. Recession occurred during the transition from rapid inflation and price stability. Overall, the benefits outweighed the costs. Certainly, the Reagan economic program provided a model for much of the rest of the world. Witness the simultaneous spread of free-market economics to many parts of the globe, including former communist economies. Warts and all, the Reagan presidency was a higher watermark for the American economy.
‘Certainly the U.S. economy was in better shape when Reagan left office than when he first was sworn into the presidency.’
Also, Weidenbaum was a participant at the meeting in January 1981 with Paul Volcker. He, as have others who were in it, said that Reagan stressed to Volcker that he believed in the independence of the Fed.
21. April 2016 at 06:05
Scott, you said:
“Show me a non-distortionary BI and I’ll support it.”
A basic income that pays you, $X per month regardless of whether you’re working or not is not a distortion. There is no distortionary incentive on your decision-making precisely because the money is given to you 100% regardless of your decisions.
On the other hand, wage subsidies *are* a distortion which incentivises low-paid work over non-work and also over higher-paid work.
Scott, you said:
“I completely agree, what made you think I did not? Peasants in India are extremely low productivity, but might be high productivity in America. And even here it depends on lots of factors, as you say.”
Great!
My point is that when someone is reliant upon their job to meet their basic living needs, or the basic living needs of their children, they are effectively “priced out” of taking many other kinds of actions that might generate a net welfare improvement and/or an economic benefit.
Wage subsidies are justifiable only if you think people are insufficiently motivated to work and require the paternalistic influence of the state in order to sufficiently “sweeten the pot”. Also, wage subsidies also act to subsidize the lowest-paying jobs relative to slightly higher paying jobs, which results in a bias towards seeking/creating lower-wage jobs over higher-wage ones at the low-wage end of the spectrum.
Of course, distortions are inevitable due to the necessity of taxation, but this raises separate questions about how optimal taxation ought to work.
21. April 2016 at 06:51
Dimitri, You said:
“A basic income that pays you, $X per month regardless of whether you’re working or not is not a distortion. There is no distortionary incentive on your decision-making precisely because the money is given to you 100% regardless of your decisions.”
I find this claim to be rather bizarre. Every BI proposal I’ve seen involves fairly steep MTRs. I don’t think that’s even debatable. Please provide numbers. How much would it cost, how would it be financed, etc.
21. April 2016 at 08:32
It’s hardly bizarre to separate the distortionary effects of basic income qua basic income from the distortionary effects of raising the necessary revenue to support it.
There are plenty of taxes that distort in a positive way (e.g. Pigovian taxes such as carbon taxes), and other taxes (e.g. land value tax) that distort very little. There are also plenty of efficiency gains to be had from having much simpler welfare systems that require less government bureaucracy to support them.
That being said, I can agree that modern governments and welfare states cannot be funded solely on taxes with positive or zero distortions, so in the end we still reach questions about how to better allocate distortionary taxes like income or consumption taxes.
In any case, as a rough guess, and keeping things simple, the US could cut somewhere between $1 and 2 trillion in existing welfare programs (excluding health care; including middle- and high-income welfare in the form of various tax credits), and make up the other $1 to $2 trillion or so with land value taxes. As a second-best alternative, you could also use a consumption tax of somewhere between 10% and 20% on average.
21. April 2016 at 09:27
Christian, What makes you think “the Donald” doesn’t support these ideas?
There’s no indication whatsoever that Trump supports a basic income in any form. He never made a statement like that. In other fields you are very scientific and normally you look only at the evidence. But when it comes to Trump you just project any evil thing you can imagine into him. That’s very unscientific.
21. April 2016 at 09:29
In any case, the argument for wage subsidies is quite weak unless you have specific reasons to distort peoples’ decisions to induce them to work rather than not work.
If you think the poorest citizens already receive sufficient benefits, why pay some of them extra just for finding a job, and only low-income jobs in particular?
If you think they don’t receive enough, why is it OK deny those benefits to those who are unemployed, even though they might have good reasons for it?
21. April 2016 at 09:39
Incidentally, supporting wage subsidies in conjunction with abolition of minimum wages results in hilariously stupid distortions.
Doing this creates huge incentives for people to create rent-seeking fake-work companies that would exist only to tick government “I did work!” boxes in order to split government checks with their employees.
Is that the kind of thing you want? Or would you then also support additional government bureaucracy to stop those kinds of things from happening?
21. April 2016 at 13:51
Dimitri, Why would you not want to incentivize people to work? You don’t think paying people not to work would incentivize
people to do nothing?
21. April 2016 at 15:32
Patrick–
Okay.
But if Reagan only endured rampant protectionism and was not the promoter of protectionism but had to cater to Congress, then what do we say about the so-called Reagan tax cuts?
After all, Congress controls tax legislation.
It seems some people ascribe to Reagan every success in the 1980s, but then ignore an incoherent monetary policy and rampant protectionism as features that belong to somebody else.
It is a matter of historical record that the Reagan Administration erected aggressive trade barriers and maneuvered to lower the value of the US dollar.
21. April 2016 at 16:40
Alexander, the whole point of a basic income is that you get the BI whether you work or not, so there is no incentive effect in either direction.
People already have plenty of good reasons why they want to work, they don’t need the government to nudge them into doing it.
21. April 2016 at 19:12
Dimitri, I have to say that’s a baffling statement. People have one important reason they want to work: sustenance. Removing this reason will obviously disincentivize work. But to say everyone will just continue to work regardless seems like wishful thinking at best and dogma at worst.
I’d like to add I’m not totally against basic income if it simplifies the welfare system as long as it isn’t enough to live on for an extended period.
22. April 2016 at 06:22
Dimitri, You said:
“There are plenty of taxes that distort in a positive way (e.g. Pigovian taxes such as carbon taxes), and other taxes (e.g. land value tax) that distort very little. There are also plenty of efficiency gains to be had from having much simpler welfare systems that require less government bureaucracy to support them.”
It’s very possible that the BI would be better than the current system, but the wage subsidy approach is better yet. And keep in mind that taxes are very distortionary at the margin, even if there are some beneficial taxes (I support both carbon and land taxes, BTW.)
Christian, You said:
“There’s no indication whatsoever that Trump supports a basic income in any form. He never made a statement like that.”
Oh, so now we are going by what he says? What if he keeps changing his mind, like on abortion? He thought Pelosi was good, but her only weakness was not impeaching Bush. That’s what Trump said. So what inferences can we draw from that about his politics? He says he will eliminate the national debt in 8 years. Pay it all off. That’s what he says, can we assume he will do that?
I have no idea what Trump will do, other than that I’m certain it will have little or nothing to do with the things he talks about.
Dimitri, The current policy regime massively discourages people from working. So you are simply wrong when you claim there is no theoretical justification for wage subsidies—it’s classic second best.
You said:
“Doing this creates huge incentives for people to create rent-seeking fake-work companies that would exist only to tick government “I did work!” boxes in order to split government checks with their employees.”
All government programs have those kinds of distortions. Under BI you’d have people collecting 5 checks, 4 from dead people. Also, keep in mind that there are countries that have wage subsidies, such as Germany. Last time I looked the unemployment rate in Germany had plunged in the years after their 2004 labor market reforms.
Also, a BI high enough to eliminate all other welfare programs would lead to massive immigration, which would push the tax burden even higher. Eventually you might get a death spiral. Even places like Denmark are sharply reducing things like unemployment insurance, due to relatively low amounts of immigration.
22. April 2016 at 20:52
Alexander, you said:
“Dimitri, I have to say that’s a baffling statement. People have one important reason they want to work: sustenance. Removing this reason will obviously disincentivize work. But to say everyone will just continue to work regardless seems like wishful thinking at best and dogma at worst.
I’d like to add I’m not totally against basic income if it simplifies the welfare system as long as it isn’t enough to live on for an extended period.”
If work is simply about sustenance, what exactly is the problem with high tax rates on high income earners? After all, they’re going to be able to sustain themselves either way, right? Maybe the problem with the current economy is that high income earners aren’t sufficiently motivated because they have too much money and thus don’t have to worry about staying alive?
Do I think that everyone will continue to work even if they’re being provided a basic income? Of course not! However, the fact that a vast majority of people continue to work *well after* they have enough wealth to sustain their basic living costs for the rest of their lives is clear evidence that quite a lot of people will indeed continue to work.
Or do you think there’s something particularly wrong with poor people, such that they need the threat of destitution in order to work while middle and high-income earners don’t have this problem?
Scott, you said:
“It’s very possible that the BI would be better than the current system, but the wage subsidy approach is better yet.”
You make this claim, but what’s the basis for it? Why exactly do you think that subsidizing low-income work leads to better economic outcomes?
Scott, you said:
“Dimitri, The current policy regime massively discourages people from working. So you are simply wrong when you claim there is no theoretical justification for wage subsidies—it’s classic second best.”
If you think people need extra encouragement to work, you should support a lump-sump benefit for working rather than a wage subsidy. Also, the bigger issue is the presence of huge “welfare cliffs” and high effective marginal tax rates at very low incomes. Wage subsidies only *increase* effective marginal tax rates on low incomes, which is a problem. They’re not a second-best solution, they’re fourth- or fifth-best.
Scott, you said:
“All government programs have those kinds of distortions. Under BI you’d have people collecting 5 checks, 4 from dead people.”
The more complex and conditional the benefits are, the more bureaucracy is required to sustain the, and the worse the distortions are.
The two things aren’t comparable; wage subsidies without minimum wages result in a much more pernicious distortion. Requiring the government to keep track of whether people are really working is far more of an issue than requiring the government to keep track of whether they’re alive…
Scott, you said:
“Also, a BI high enough to eliminate all other welfare programs would lead to massive immigration, which would push the tax burden even higher. Eventually you might get a death spiral.”
You phrase that as though it’s self-evident, but that’s far from being the case.
For a start, immigrants are not simply a drain on the economy; they also help to expand productive capacity.
Secondly, if they would have benefited from those welfare programs, why does replacing those welfare programs with basic income increase the incentive to immigrate? If immigrants wouldn’t normally be getting all of those benefits, why not equalize this by paying them a lower basic income for some period of time, until you consider them as full-fledged residents?
Finally, if they truly are much less productive than the average US citizen, then what the words “tax burden” and “death spiral” really mean is that you’re reallocating the resources of the US economy into providing the basic needs of people who weren’t having them met. In other words, higher immigration might reduce the GDP per capita of the US, but those immigrants will (on average) be more productive in the US than they were in the country they came from. I agree with your argument about free trade (it benefits the very poorest), but the same argument also should lead you to support immigration policies that raise the GDP per capita of the world as a whole?
22. April 2016 at 21:26
Regardless, the case for a basic income is a rather simple one: economic freedom is a good thing. Someone who is forced to accept whatever job comes their way in order to stay alive has *very little* economic freedom.
If they had their basic needs met and would choose to continue working anyway in order to earn more money, that’s great! If, on the other hand, they would choose not to work and do something else with their time, that’s also great! If we assume people (yes, even poor people!) are capable of making decent decisions on their own, then having the opportunity to choose *not* to work must also be a net improvement in welfare.
Of course, you will correctly note that this isn’t a free lunch: giving this opportunity to poor people requires higher taxes, and thus some amount of reduction in freedom for people who earn higher incomes. However, the two things are barely comparable; the net welfare gain at lower incomes dwarfs the loss of welfare at the higher end.
One might argue that the deadweight loss of the higher taxes would lead to lower total productivity, and this is probably true for a narrow conception of “productivity”. Who cares, though?
Economics dictates that low wage jobs are not very productive jobs, so why should we care much when people instead spend more time doing things that don’t directly show up in GDP, such as training, education, housework, volunteer work, or taking care of their children?
I’m inclined to think that despite the deadweight loss at higher incomes, vastly increased economic freedom at low incomes would actually lead to better productivity in the long run. Someone who can’t afford not to have a job is also someone who can’t afford to spend the time or take the risks needed to improve their productivity.
More significantly, the children of people who don’t have the time and/or money to take care of them end up being worse off (worse nutrition, worse educational outcomes, etc.).
23. April 2016 at 06:27
Dimitri, You said:
“Wage subsidies only *increase* effective marginal tax rates on low incomes, which is a problem. They’re not a second-best solution, they’re fourth- or fifth-best.”
I would argue they decrease these rates, and I’d like to decrease MTRs on all incomes.
You say:
“For a start, immigrants are not simply a drain on the economy; they also help to expand productive capacity.”
I agree, but the sort of basic income many people are talking about would be a huge inducement to the world’s lowest skilled people. I am pro-immigration, but I see BI as hurting the case for immigration (which of course does far more to help the world’s poorest than would a BI).
You said:
“If immigrants wouldn’t normally be getting all of those benefits, why not equalize this by paying them a lower basic income for some period of time, until you consider them as full-fledged residents?”
I’d go even further, and deny welfare benefits to immigrants for their entire lives. And then I’d massively increase the amount of immigration. The net effect of the combined policy would be good for immigrants.
You said:
“Regardless, the case for a basic income is a rather simple one: economic freedom is a good thing.”
That doesn’t persuade me, as I’m a utilitarian. You could just as well say “Why should I be “forced” to pay taxes to support someone who wants to go to the beach every day?”
You said:
“However, the two things are barely comparable; the net welfare gain at lower incomes dwarfs the loss of welfare at the higher end.”
I’d agree, if there were no distortions. But I’d expect large distortions.
23. April 2016 at 07:57
‘…what do we say about the so-called Reagan tax cuts?’
That Reagan was on the same page as Jack Kemp, Bill Bradley and Phil Gramm.
‘It seems some people ascribe to Reagan every success in the 1980s, but then ignore an incoherent monetary policy…’
People like Milton Friedman, who said that Reagan was the only president who could have taken the heat from Volcker’s (necessary) recession that brought inflation under control?
‘It is a matter of historical record that the Reagan Administration erected aggressive trade barriers and maneuvered to lower the value of the US dollar.’
In 1980 $1 bought what $.88 did in 1979. In 1988 $1 bought what $.96 did in 1987 (according to the BLS CPI calculator). How is that ‘lowering the value of the US dollar’?
23. April 2016 at 08:23
Here’s an informative discussion between Robert Hetzel and Martin Anderson, talking about how Reagan interacted with his economic team;
https://fraser.stlouisfed.org/docs/historical/hetzel_interviews/anderson_m_19960408.pdf
————quote———–
Robert L. Hetzel: None of these weren’t exactly your shrinking violet type.
Martin Anderson: No. I mean these are people who had been chair of The Fed. Who had run Secretary of the Treasury, who had been Chairman of the Council.
Robert L. Hetzel: Sure. Sure.
Martin Anderson: And had done it better you see than… and what happened was interesting. It was a very powerful group because of that first year when the policy had been set during the campaign and locked in the transition, when there were deviations, for example.
I remember Stockman and Don Regan would get quite upset when the deficit started to widen. We had to postpone the tax cuts. And basically what I would do is go down and put a phone call into George Schulz and say, it may be a good idea to have a meeting. He would call a meeting. We would come in. We did this six times in the first year. And call all this group in and they would sit down in the Roosevelt room, usually the Roosevelt room and meet for a couple of hours from nine to 11 and then we’d go and open up and President Reagan would walk in. And very unusual. He would; just walk in and he really, he liked this group of people. He thought these were fun. This was his private advisor group who gave him straight advice. Now you know Don Regan and Stockman and Weidenbaum, they’re all sitting there.
But he would come in and he would usually, you know, wink at Milton Freidman and go over and shake hands with Eisner and laugh and giggle and talk to George Schulz and to Bill Simon. And I think they were all friends.
Robert L. Hetzel: Sure.
Martin Anderson: And then George Schulz was chairman, and would take about ten minutes and sum up everything that had been discussed. And said, bing, bing, bing, bing. And they’d open it up. And the President would say what he felt and they would say… in my—I remember, I’ve got notes that I kept bringing to meetings. And basically the basic—what this group did, they said look, you know, what-what you’re doing in terms of economic strategy is exactly right. You know, stick by it. This is terrific. And they reinforced
tremendously what president Reagan was doing that first year. And I would argue, and I’ll just—no one else was paying attention, but then look at that group. I don’t think you would have gotten his economic plan done. Because the way the institution works, you know,
people were getting shaky. Now with coming back with—starting out with Volker attitude about The Fed, there were some people internally arguing, oh, my God, you know, The Fed is too tight.
Robert L. Hetzel: It was tight.
Martin Anderson: Yeah. But the predominate view was and Burns was a very, very strong exponent of this. He goes look, leave The Federal Reserve alone. This is an independent group. Do not try to lecture them or talk to them, et cetera, et cetera. That was the first thing. Leave them alone. And you know for first—you know, for a good ethical reason and second as a practical reason. If you do try to fool around and change them, then they’ll probably do just the opposite. So leave them alone. They’re okay. And then periodically,
Volker would come over and meet the president. I remember during the first year, I even—I used to attend some of the meetings. They would go in and sit down. Basically it was just a very friendly meeting, laugh and tell—joke a little bit. Volker would give them information,
what was happening, summing it up and so on, and then ask you a question. But never did Volker try to, you know, say this is what you should do in fiscal policy or never did the president say well, you should go easier on rates or anything like that. So it was very careful separation. And I think a lot of that was due to Arthur Burns’ influence as the former Chairman of The Fed, now saying this is how it should be done. Technically. I’d love to go back to my file because I think I even recall some-some way when the debate really started to heat up about we got to try to influence the Fed, and then Arthur stepped in. Couldn’t swear to that.
Robert L. Hetzel: … August of ’81 was when interest rates, federal funds rate got up around 21 percent. So and that was the longest restrictive. And even then your recollection is that Reagan was willing to let The Fed trust its –trust its judgement.
Martin Anderson: This was something which was agreed and, you know, the people really involved in politics, whether it was Ed Meese, Michael Deever, Jim Baker, they all had that basic idea of look, leave it alone. And of course it was, you know, working properly.
The only thing I remember, we used have the first year there was –they normally have a troika, we had a quandary, that was every Tuesday morning, I think it was, we met for breakfast at Regan’s office. Regan, Stockman, Weidenbaum and myself. And we went over
where the economic policy was. And I think the only problem they had with monetary policy is that it was screwing up their projections. That inflation was coming down much faster than anyone thought. And on the one hand, everyone was very sort of delighted and pleased. That this is terrific, look at, you know, the thing is coming down. And on the other hand Stockman was going crazy because he said, look, this is not producing revenue here. I’ve got a problem.
Robert L. Hetzel: Right. Yeah.
Martin Anderson: And as budget director, he had a problem. And I think he was primarily concerned with how he looked as budget director.
————endquote————
And, I’ll add, now that Stockman has been writing about economic policy lately, that he didn’t know (still doesn’t) the first thing about economics.
23. April 2016 at 08:30
Scott, you said:
“I would argue they decrease these rates, and I’d like to decrease MTRs on all incomes.”
Sorry, I was wrong. To be more precise: wage subsidies tend to decrease EMTRs for very low incomes, but also increase EMTRs at the levels where they are phased out.
When viewed in isolation I doubt the effect is worthwhile, but I can agree with you that in a system where EMTRs on very low incomes can be quite high it does make sense to have wage subsidies to cancel out other problems in the tax code. Generally, I’d say that EMTRs on very low incomes should be very low, but not negative.
I had thought you were arguing for net subsidies on low incomes, i.e. *negative* EMTRs. That, I think, is a much harder case to make, since (like positive EMTRs) negative EMTRs also carry a deadweight loss.
Scott, you said:
“I’d go even further, and deny welfare benefits to immigrants for their entire lives. And then I’d massively increase the amount of immigration. The net effect of the combined policy would be good for immigrants.”
I can see where you’re coming from with this. I pretty much agree with you on immigration, and while I would generally support giving the same basic income to immigrants as to citizens I do understand that there are political issues around it (c.f. Europe).
Most likely, to make it politically feasible you would need some sort of compromise between denying them benefits altogether and giving them the full shebang. If that’s what it takes to get much higher immigration I would definitely support it.
Scott, you said:
“That doesn’t persuade me, as I’m a utilitarian. You could just as well say “Why should I be “forced” to pay taxes to support someone who wants to go to the beach every day?””
Oh, I’m also more or less a utilitarian. While that kind of argument can appeal to some kinds of libertarians, I think the utilitarian case for economic freedom is much stronger. The thing about economic freedom is that in addition to being of value to people in and of itself, it’s also very instrumentally useful: it leads to improved welfare due to people having the opportunity to do the things they want to do.
Scott, you said:
“I’d agree, if there were no distortions. But I’d expect large distortions.”
The utilitarian case is a pretty simple one: if the utility of $10K to someone in poverty is worth X times the value of that $10K to the rest of the economy, then as long as X is large then even large distortions are worthwhile.
For example, consuming 5 million smartphones instead of a mega-yacht could be a “distortion” if it were possible to produce 6 million smartphones with the same resources, but if government taxation and spending is needed in order to get the smartphones instead of the mega-yacht it’s clearly a better outcome.
Granted, the more interesting question is with regards to growth, but here the answer is far from straightforward. Taxes can hurt growth, sure, but greater economic opportunity tends to aid growth, so providing that opportunity to the poor could easily be a net benefit.
PS: I still want to answer you w.r.t QTM in the other thread, but I’ll have to save that for later.
27. April 2016 at 06:25
@Dimitri Klimenko – Re “Someone who is forced to accept whatever job comes their way in order to stay alive has *very little* economic freedom.”
That’s a rather odd use of the term freedom IMO. Freedom means that your not being restrained and your rights are not infringed, not that you have positive results from your efforts. It means you can choose, not that you have great choice in front of you. You freedom is not violated, or really reduced, by people not giving you good options and opportunities (it is if a third party uses force to disallow a good opportunity that someone wants to give you).
Freedom obviously isn’t the only important value or only important thing in life, but not having those other things, or generally having a crappy life without a lot of options != a restriction on or infringement of your freedom.