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Axel Leijonhufvud on fiscal stimulus
Here is one bit from a generally interesting article:
Fiscal stimulus will not have much effect as long as the financial system is deleveraging. Even if that problem were to be more or less solved, the government deficit would have to offset both the decline in industry investment and the rise in household saving – a gap that is rising as the recession deepens. Here, too, the public is sceptical and prone to conclude that a program that only slows or stops the decline but fails to “jump start” the economy must have been a waste of tax payers’ money. The most effective composition of such a program is also a problem.
It is worth noting that Leijonhufvud is generally considered a Keynesian, not a rational expectations theorist. In my opinion the sophisticated Keynesian view is still that the stimulus won't work.
Posted by Tyler Cowen on February 14, 2009 at 07:49 AM in Economics | Permalink
Comments
Details of the plan are sketchy at best right now. I would agree, a "good" plan would jump start the economy. It is my opinion that a good plan would ease credit and invest in areas that would make it easier for companies to compete globally. How this is done is beyond me and definitely beyond a politician.
Posted by: Mike C at Feb 14, 2009 8:08:34 AM
Mike C,
The stimulus plan is not sketchy -- it has close to 1,500 pages! The problem is that nobody has been able to read it. Maybe you mean that Geithner's financial stability plan is sketchy. The problem with this plan is that Geithner, actually BHO, does not know what to do or worse he doesn't want you to know what he's going to do.
Posted by: E. Barandiaran at Feb 14, 2009 9:01:51 AM
E. Barandiaran,
I don't know if the final document has been posted yet, but there have been several pages linking to what will compose the majority of the final legislation. Thus your indication that most people are being kept in the dark about this is pretty hollow.
As far as the plan for rescue the financial system, the details do appear to be vague, but there's hardly some sort of sinister reason behind it. As Tyler himself admitted back in the fall when several institutions were failing and anyone who had a blog or knew someone who had a blog was proposing something, it was hard to keep track of all of the various plans. There are indeed a lot of different suggestions floating around, and since the problems we face are not exactly common, it's a little strange to think that he should settle on something. There's also the idea that this is purposefully vague because the ultimate goal is to determine which institutions are insolvent without being direct with the language so that there isn't more turbulence and uncertainty in the markets.
As far as the stimulus itself and whether it will work, I appreciate the open-mindedness of many on this blog. It's kind of bizarre to see some, like Will Wilkinson, flatly state that the Democrats are not only not going to bring about economy recovery, but that they will deepen and lengthen the recession.
Posted by: Brian J at Feb 14, 2009 9:22:43 AM
Brian J,
You can read the stimulus plan here
http://www.readthestimulus.org/
and you can watch this video
http://www.youtube.com/watch?v=CvnwOjDjnH4
Regarding Geithner's plan, you should know that he has had at least 5 months to elaborate it (remember that he was personally responsible for monitoring banks before the crisis). Last Tuesday people were disappointed because they expected details and he didn't provide any. I know how difficult it is to prepare such type of plan (I worked 17 years as an expert on solving financial crisis, starting with Chile's in 1982-83) but if you cannot do it in a month, then you better look for someone that can do it.
Posted by: E. Barandiaran at Feb 14, 2009 9:35:55 AM
"In my opinion the sophisticated Keynesian view is still that the stimulus won't work." In support of this Tyler cites Leijonhufvud, then selectively quotes from the very article he cites. I offer this quote instead:
"Strong contractionary forces are at work in the US emanating both from the capital and the income accounts. Stabilisation requires major policy actions on both fronts.
* First, the financial system must be recapitalized so as to remove the relentless pressure to deleverage from the banks.
* Second, a spending stimulus sufficient to reverse the rapidly worsening decline in incomes must be administered."
Leij. is clearly saying under current circumstances fiscal stimulus is necessary but not sufficient. That's not the same as saying that fiscal stimulus won't work. It's saying it won't work unless accompanied by recapitalization of the banking system.
Let me add something on a related point. There has been extensive discussion, some of it on this blog, on the efficacy of New Deal recovery programs. Much has been written about fiscal and monetary policy, much less about the extensive efforts to rehabilitate the financial system, which involved both recapitalizing banks through the RFC and measures to deal with residential and farm mortgage debt. These efforts were largely completed by the end of 1935. Whether or not it was cause and effect, it was only in 1935 that a sustained recovery began. At the same time historians have noted that despite these efforts, bankers remained highly risk averse throughout the 1930s, and so efforts at restoring normal flows of credit were never completely successful.
Posted by: Phil P at Feb 14, 2009 10:05:32 AM
Off topic: The reason the plan is "sketchy" at all is because the banks are going to have to be nationalized, Geithner realized this, and then made the logical assumption that coming out with a plan that does this with no political preparation is suicide, possibly literally.
He released a vague plan for the same reason we have so many regulations that are only sporadically enforced. He wants to be able to point to the provisions that allow nationalization without being blamed for it right now.
On topic: He does not say that spending would not work, only that the amount of spending required might be large, and politically difficult.
Then on the topic of deleveraging, from his article, this is primarily a problem when we fail to nationalize the banks, and the U.S.'s listening to people who say that nationalization is not politically possible. It is a political problem more than a real problem.
From his post:
"US policy: A strangely contrived way out of a political impasse
The American public understands clearly that the present disaster was fashioned on Wall Street (albeit with some stimulus from Fed policy). Outright bail-outs are a “hard sell” therefore. But the American ideological taboo against “nationalisation” also stands in the way of dealing with the matter in the straightforward way that Sweden did. The present administration, like the last, would like to recapitalise the banks at least partly by attracting private capital. That can hardly be accomplished as long as the value of large chunks of the banks’ assets remains anybody’s guess. Government guarantees against (some part of) losses that may be incurred might solve this problem. But it would be a strangely contrived way out of a political impasse."
Zombie banks will not lever up.
But lets assume for a moment that fully capitalized banks will not leverage up again to the extent they did just last year. Most of the excess leverage happened in the 20 largest world banks and their prime brokerage operations for hedge funds. The other banks were constrained by both legal and risk concerns, while for some reason the RBS's and Merrils thought risk was a number rather than a company threatening situation. (Call this Fisher Black's bastard child) Lets assume that they will only leverage up 1/3 to 1/2 of what they did before.
Their balance sheet risk and NPV is on the order of $3T. If they are only going to lever up 1/3 as much, then we need to replace about $2T of NPV somehow. This is a spendable number.
Posted by: Mike S. at Feb 14, 2009 10:23:13 AM
Phil P,
The summary was extremely misleading. Was the quote pulled out of context, given the thrust of Tyler's post? I would say that Axel would be angry with this summary.
Posted by: mickslam at Feb 14, 2009 10:25:47 AM
For a sophisticated Keynesian perspective that does lend support to the idea of public spending as stimulus, refer to:
http://www.newyorkfed.org/research/economists/eggertsson/ContractionaryTaxes.pdf
According to the author, the New Keynesian framework suggests that when interest rates have reached the zero lower bound, the effects of fiscal policy change dramatically, and that therefore historical precedent in the post-war period, during which we have never reached the zero lower bound, is inappropriate as a guide for the current situation. Furthermore, public spending becomes much more stimulative at the zero lower bound than tax cuts, which can actually be contractionary.
Posted by: Aleph Naught at Feb 14, 2009 10:55:29 AM
My view of his post:
An excellent post. I agree that:
1) We should use a version of the Swedish Plan.
2) The stimulus was a poor mix with too much infrastructure and not enough incentives.
3) Social Safety Net spending is essential, including aid to states for essential services. If unemployment gets much higher and people don't feel secure, serious social disruptions and dislocations could occur. This would be very bad news.
4) We cannot overspend because we don't know at what point foreign creditors will balk. ( Buiter )
5) I am for a guaranteed income in any case, but it would certainly be useful here as a Negative Income Tax.
6) The use of WW II for comparison is strange. What can be conspicuous consumption in a recession can be seen as treason during a world war.
I differ in that I believe that we need to use quantitative easing to attack debt-deflation, a la Fisher. I also believe that a massive stimulus could work as Shiller believes, but we do not have the money to try it in these circumstances.
Posted by: Don the libertarian Democrat at Feb 14, 2009 11:20:36 AM
The urgency of stopping the present catastrophe becoming a calamity (or perhaps t'other way round) is because of the need to put it behind you so that you can focus on the Big Question: how exactly should the USA execute its necessary repudiation of its sovereign debt?
Naturally I am not suggesting that other countries won't do that too.
Posted by: dearieme at Feb 14, 2009 11:57:32 AM
Don, I agree with you but for number 3. There is no 'safety net' (as semantically rich as that phrase is) in the US. We can't just conjure that up in a few weeks. A funding influx to the varied state welfare/relief programs would be even more wasteful than infrastructure spending based on the percentage of spending per program in the country's 12 biggest welfare consuming regions.
Take the same amount of money and roll back payroll taxes instead and you would create a huge incentive to expand employment-- same social welfare benefit, but with actual social stability results that boost the economy at the same time.
Posted by: The Other Eric at Feb 14, 2009 12:12:42 PM
I must have a different and apparently far more severe definition of "catastrophe" than the one being used so commonly in discussion of the financial crisis.
Posted by: PB at Feb 14, 2009 12:53:40 PM
Is the sophisticated Keyensian view that our economy is basically fucked? Is that the sophisticated view from most other schools too?
Posted by: michael vassar at Feb 14, 2009 2:02:38 PM
This has post and its predecessors on the stimulus have been very disappointing. Tyler sometimes says things that seem reasonable and make sense, but then he comes up with something like this post. I really don't know what to make of it. Maybe he's suffering some cognitive dissonance. The private actors have proven incompetent, libertarians assume the government is inherently less competent, and history tells us that doing nothing is a really, really dumb idea. So, what to do? I'd call it the random walk blog, or maybe stochastic blogging. I know Tyler's a very smart guy, so I'll keep reading to see if he ever gets it sorted out. I still give him and Alex an 80% chance of coming up with something truly brilliant when the dissonance ends...even if it'll be ignored by the gov't.
Posted by: Paul at Feb 14, 2009 2:50:40 PM
"history tells us that doing nothing is a really, really dumb idea."
Where in the history of the US economy can you point to an permanent economic problem caused by the government doing nothing?
Posted by: kebko at Feb 14, 2009 3:07:20 PM
Anybody on either side of this care to put their money where their mouth is? Given that this stimulus bill will be passed, whats the over/under in years on say, unemployment below 5% with consumption above 2007 level?
Posted by: josh at Feb 14, 2009 3:20:31 PM
kebko,
This is a straight Minsky interpretation of the housing crisis, and one that points to a huge problem when the govt just does nothing when faced with ponzi financing.
The current crisis was caused by the government looking the other way as ponzi financing based products were mass marketed to the U.S. consumer. Specifically, I am talking about option ARMs, which essentially rely upon rising home prices for people to be able to pay them off. These products should have been regulated by the fed, after the fed pushed all other agencies out of the way to be the final regulator for the mortgage market. However, the fed at the time was lead by a person who thinks the free market can always accurately gauge risk. These financial products are not viable in stagnant or falling house price regimes, like for example recessions. Once these products were introduced, we began to see significant price appreciation. Then, the inevitable minor recession began, housing prices stagnated. The weakest ponzi financing products that require rising asset prices began to place pressure for asset owners to sell, causing other ponzi financing product holders to have to sell.
We are now facing a multi-trillion dollar economic problem, all due to regulators sitting on their hands while the system was over leveraged and ponzi financing products were mass marketed.
If the govt had regulated these products, we would have had a much smaller, more gradual real estate boom, and probably would not be in the crisis we are today.
Posted by: mickslam at Feb 14, 2009 3:57:04 PM
So we're going to pump $800 billion from the circular flow and pour it back in - bypassing the invisible hand of the market for the dead hand of the state in the process. Some people call this a stimulus. I call it an inhibulus.
The only way this economic downturn could possibly be countered is by printing money - but we don't go there. Instead we maintain the belief that more spending financed by borrowing from within the circular flow will do the trick. Its a collective delusion.
Let's not forget the broader context of this recession - a decline in the savings rate from +12% to -1% over a 20 period, and private debt some multiple of GDP. The American public has now made a collective decision to reduce its debt and lift savings. The savings rate is already above 3% and will probably go higher. Apart from some short term pain, this is a good thing. We should let it happen and stop interfering.
The attempt by the Obama Administration to impose its will on the people and keep savings at pre-GFC levels can't possibly work - they can only pretend to be steering the ship. Ultimately however, we will get what the market - that is, the people - wants, not what the proponents of the stimulus want.
Posted by: Oz Andrew at Feb 14, 2009 8:14:11 PM
Eric, I'm sorry I didn't get back to you earlier. A tough day. Yes, I would prefer a Sales tax break of $200 Billion, but a Payroll tax cut would be my second choice. Don
Posted by: Don the libertarian Democrat at Feb 14, 2009 11:47:35 PM
Why would banks want to delever?
Posted by: Andrew at Feb 15, 2009 1:49:49 AM
The banks, and the market forces in that sector, already are delivering - consolidation.
However, we are, like a kangaroo caught in the headlamps, completely terrified at the thought of this, and prevent it from happening. Though in our case it isn't the approaching lights of a car that have us dumbstruck, but a single terrifying phrase - To Big To Fail. But this notion is nothing but the domino theory repackaged, with about us much scientific validity to back it up as it had the first time.
As this article on the New Deal indicates,
www-ac.northerntrust.com/content//media/attachment/data/econ_research/0902/document/ec020909.pdf
there were over 9000 bank failures in the U.S. during the depression, but a net total of only $1.3 billion dollars of deposits were lost as a result - trivial, even in the 1930s. And of course there is the case of Canada, with zero bank failures in the same period but who suffered a depression just as great as the United States. Bank failures, and inactivity by the Fed, were not the primary cause of the Great Depression.
So what is the problem with letting a few banks fail? Let the industry consolidate of its own accord - stop the bailouts, avoid the moral hazards and prevent a decade or more of zombie banks and a stagnant economy. There is only one thing we have to fear.
Posted by: Oz Andrew at Feb 15, 2009 4:18:20 AM
re: "It is worth noting that Leijonhufvud is generally considered a Keynesian, not a rational expectations theorist."
Perhaps Leijonhufvud in particular is neither an RE theorist nor a real business cycle one, but, more generally, New Keynesians may embrace RE while rejecting RBC. Your brevity may have obscured a distinction between RE and its RBC subset.
Posted by: d4winds at Feb 15, 2009 10:14:48 AM
It may be possible to classify Axel as a "Keynesian," but he is certainly a somewhat idiosyncratic one,
and is certainly not a "New Keynesian."
He is the original advocate of the "corridor of stability" argument, and clearly thinks we are now outside
of the corridor of stability, where things are probably very much destabilized fundamentally, a difficult place
to be.
Regarding the stimulus, of course some Keynesians are arguing that it will fail because it is not big enough.
Regarding the bank bailout, well, we still do not know what it will be, the vaguenss in Geithner's speech being
its biggest problem.
Posted by: Barkley Rosser at Feb 15, 2009 2:59:38 PM
In spite of being a fiscal conservative, I could get on board with a stimulus package...not THE stimulus package, but A stimulus package. I'm all for the idea of cutting taxes to encourage spending; give people more of their own money to spend or invest. Typical conservative thinking... but perhaps that won't be enough action to get us out of the current downward spiral. If there are infrastructure projects that are truly needed, let's borrow and build and hopefully put enough people back to work to crawl back up out of the hole we're in. If roads need repaving and schools need to be repaired or built, what better time than now to get started and put people to work?
But here's the problem... the 1170 page monstrosity that was touted as the salvation of the U.S. economy was so full of pork and pet projects that it should have been called the "2012 Re-election Plan"... despite what the President said. I'm tired of hearing that this stimulus needs to be "big enough and bold enough". Let's just do what's really necessary to jump start the U.S. economy and maybe that plan wouldn't create a burden of debt that our great grandchildren will still be paying off. Why don't we just come up with a plan that's "sensible enough" to work.
Posted by: my2girls at Feb 15, 2009 5:40:26 PM
In spite of being a fiscal conservative, I could get on board with a stimulus package...not THE stimulus package, but A stimulus package. I'm all for the idea of cutting taxes to encourage spending; give people more of their own money to spend or invest. Typical conservative thinking... but perhaps that won't be enough action to get us out of the current downward spiral. If there are infrastructure projects that are truly needed, let's borrow and build and hopefully put enough people back to work to crawl back up out of the hole we're in. If roads need repaving and schools need to be repaired or built, what better time than now to get started and put people to work?
But here's the problem... the 1170 page monstrosity that was touted as the salvation of the U.S. economy was so full of pork and pet projects that it should have been called the "2012 Re-election Plan"... despite what the President said. I'm tired of hearing that this stimulus needs to be "big enough and bold enough". Let's just do what's really necessary to jump start the U.S. economy and maybe that plan wouldn't create a burden of debt that our great grandchildren will still be paying off. Why don't we just come up with a plan that's "sensible enough" to work.
Posted by: my2girls at Feb 15, 2009 5:46:10 PM
