WILLIAM GALSTON JUNE 1, 2010
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As President Obama’s bipartisan fiscal commission gets set to convene, the Greek budget disaster has triggered the predictable flood of cautionary notes about how we’re spending too much and heading toward a debt crisis. Should these concerns illuminate the commission’s work—or are they merely alarmist?
Paul Krugman harbors no doubts: “Despite a chorus of voices claiming otherwise,” he writes, “we aren’t Greece.” But that’s not as encouraging as it sounds, he adds: “We are however, looking more and more like Japan. ... [Recent data] suggest that we may be heading for a Japan-style lost decade, trapped in a prolonged period of high unemployment and slow growth.”
This diagnosis of our economic disease has implications for the policy prescription, Krugman argues. “For the past few months, much commentary on the economy ... has had one central theme: policy makers are doing too much. Governments need to stop spending, we’re told. ... Meanwhile, there are continual warnings that inflation is just around the corner and that the Fed needs to pull back from its efforts to support the economy.”
Krugman will have none of this: “[T]the truth is that policy makers aren’t doing too much; they’re doing too little.” We should enact another stimulus plan, and administration officials would push for one if Congress had not been “spooked by the deficit hawks.” For its part, he adds, the Fed should abandon its groundless fears of inflation and work instead to ward off the threat of deflation—the true cause of Japan’s failure to regain economic vitality.
So is Japan really a better baseline for U.S. policymakers than Greece, and is it close enough to serve as a guide for policy? To be sure, there are some important resemblances. Like the U.S., Japan experienced a sharp run-up in equity and real estate, followed by a collapse. As in the U.S., this reverse weakened the banking system and coincided with a sharp contraction in commercial lending. Like their American counterparts, Japanese policymakers responded with substantial fiscal and monetary stimulus.
These are qualitative similarities. But there are quantitative differences, and they are large enough to warrant caution about direct policy inferences. Stocks in the U.S. are down about 40 percent from their all-time high, versus 75 percent for Japan. While U.S. real estate is down about 30 percent from its peak, Japanese land values are down more than 80 percent. In Tokyo, residential real estate has fallen by more than 90 percent, and commercial real estate in the heart of the financial district sells for 1 percent of its 1989 value. Brookings economist and former CEA director Barry Bosworth estimates that as a share of GDP, the destruction of wealth in Japan from peak to trough was about five times what it has been in the United States. Given the key role of stocks as well as real estate loans in the balance sheets of Japanese banks, it’s reasonable to assume that the Japanese banking system experienced a disruption far worse than ours.
It would stand to reason, then, that restoring Japan’s economy to health would require an even larger policy response than the one we’ve seen in the United States thus far. In some respects, that is what happened. Unfortunately, it hasn’t worked.
After falling from its 1989 peak, the Japanese “bubble economy” collapsed in 1991. The government responded with a long series of stimulus packages and (after a lag) interest rate reductions as well. Between 1993 and 2005, Japan’s budget deficit averaged 6.3 percent per year, and the government’s gross debt rose from 67.6 percent to more than 175 percent of GDP. Nonetheless, economic growth averaged an anemic 1.1 percent during that period—the worst performance in the industrialized world.
Japan’s Deficit, Gross Debt, and Growth, 1989 to 2008
Year
Budget deficit
(as percentage of GDP)*
Debt
(as percentage of GDP)
Annual rates of economic growth
1989
1.3
66.7
5.3
1990
2.0
63.9
5.2
1991
1.8
63.2
3.4
1992
0.6
67.6
1.0
1993
-2.5
73.9
0.2
1994
-3.8
79.0
1.1
1995
-4.7
86.2
2.0
1996
-5.1
93.8
2.7
1997
-4.0
100.5
1.6
1998
-11.2
113.2
-2.0
1999
-7.4
127.0
-0.1
2000
-7.6
135.4
2.9
2001
-6.3
143.7
0.2
2002
-8.0
152.3
0.3
2003
-7.9
158.0
1.4
2004
-6.2
165.5
2.7
2005
-6.7
175.3
1.9
2006
-1.6
172.1
2.0
2007
-2.5
167.1
2.4
2008
-2.7
172.1
-0.7
*A negative figure indicates a deficit
Source: OECD Factbook 2010: Economic, Environmental and Social Statistics
As one might imagine, these disappointing results sparked debate within Japan’s economic establishment. Writing in a special 2003 issue of the journal World Economy, Japanese scholars Toshihiro Ihori, Masume Kawade, and Toru Nakazato summarize the debate as follows: “One hypothesis is that the effects of fiscal policy were very large and hence recession would have deepened without fiscal expansion. Alternatively, it may be that fiscal policy did not have enough of an expansionary effect to push up macroeconomic activity, and hence unlimited public expenditures simply made the fiscal crisis worse.” Using quarterly economic data, which enabled them to track the effects of successive stimulus packages, they concluded that the second hypothesis is far more plausible than the first: “[I]ncreasing public investment in the 1990s crowded out private investment to some extent and did not increase private consumption much. ... The overall policy implication is that the Keynesian fiscal policy in the 1990s was not effective.” The problem wasn’t that the stimulus packages weren’t big enough; it was that they were mistaken in principle, because they rested on the incorrect assumption that sustained deficit spending would stimulate aggregate demand.
It’s not clear whether Krugman would accept this conclusion. In a series of blog posts written while he was still at MIT in 1998 and 1999, he diagnosed the Japanese situation as a rare real-world example of Keynes’s famous “liquidity trap” in which monetary policy loses its effectiveness: while interest rates can’t be reduced below zero, it turns out that zero isn’t low enough to stimulate economic activity. At the same time, Krugman expressed deep (and as it turned out, warranted) skepticism about the effectiveness of the conventional Keynesian response—namely, expanding public expenditures to compensate for decreased private spending (fiscal “pump-priming”)—both in Japan and in other future troubled economies. His reason is interesting: for pump-priming to work, “it must lead to large increases in private demand, so large that the economy begins a self-sustaining process of recovery that can continue without further stimulus.” Any policy that depends on open-ended stimulus is a failure.
On the other hand, he continues, “None of this should be read as a reason to abandon fiscal stimulus—in fact, one shudders to think what would happen if Japan were not to provide further packages as the current one expires.” But why should we think that? If Ihori et al are right—if the ongoing Japanese fiscal policy displaced private demand rather than stimulate it—then Japan might well have been better off abandoning that policy altogether. And, indeed, based on their analysis of fiscal crises through the ages (This Time It’s Different), Carmen Reinhardt and Kenneth Rogoff argue that rising debt to GDP levels eventually slows economic growth. By the late 1990s, Japan was well into what they identify as the zone of danger, when the debt to GDP ratio reaches 90 percent. The U.S. is not there yet, but we’re on track to get there by the end of this decade unless we change course.
Krugman has a different analysis. The root of the Japanese crisis, he contends, is deflation, and the only remedy is a credible shift to a long-term inflationary policy. The Japanese Ministry of Finance should publicly commit to such a policy and back it up with whatever policies are necessary to make it real, including unusual monetary devices such as scrip whose value declines and then expires on a fixed timetable. This is why he emphasizes the most recent report on U.S. consumer prices, which showed inflation at a 44-year low. Japan, he argues, got stuck in a deflationary trap more than a decade ago and can’t get out. And, unless the Fed sheds its unwarranted fear of inflation and embraces a monetary policy whose principal objective is to prevent deflation, “it could happen here.”
The issues I’ve raised in this piece are more than academic. If the deficit hawks are right, we need to shift gears toward fiscal restraint, starting with the upcoming fiscal year. If Krugman is right, restraint would only make matters worse, and besides, it misses the point: the last thing the Fed should do is retreat from the extraordinary measures it adopted to boost the supply of money after its reduction of interest rates to zero proved insufficient.
I’m no economist; neither are most policymakers. And one may well believe that just as war is too important to leave to the generals, the economy is too important is leave to the economists. Nonetheless, the dismal science has a key role to play. Krugman has flung down the gauntlet; others should rush to pick it up. We need our best economists to enter a robust, focused, and publicly accessible debate about the fundamentals of our current ills, and the media should serve the public interest by featuring this debate on a regular basis.
At the same time, there’s a role for the rest of us. For what it’s worth, my preferred policy would link continued stimulus for another year or two (including basic safety net programs such as extended unemployment insurance) with credible commitments to shift our long-term fiscal course. Until someone refutes Reinhardt and Rogoff, our operating presumption must be that excessive debt accumulation will eventually reduce economic growth. Besides, if CBO is right that we’re on track to incur annual interest payments of more than $900 billion by 2020, and if foreigners continue to hold nearly half our debt, we’ll be transferring about 2 percent of GDP overseas every year in interest payments alone. And how can we afford the substantial increases in future-oriented investment—in infrastructure, basic research, science and technology, and education—if we stay on our current path?
The future of our economy and society depends on getting these large judgments right—the need to make decisions is getting more urgent, and our margin for error is steadily shrinking. We’ll soon find out whether our economists and policymakers can do any better than BP’s experts.
24 comments
"For what it’s worth, my preferred policy would link continued stimulus for another year or two (including basic safety net programs such as extended unemployment insurance) with credible commitments to shift our long-term fiscal course." For what it's worth, that's also my reading of Krugman so that most of Galston's article creates a Japanese straw man to come to a conclusion that is really a distinction without a much of a difference. Krugman has written much more extensively on this topic on his blog in the last couple of weeks -- that a selective quote or two by Galston does NOT capture the points being made by Krugman (with lots of data references). A key point not captured in Galston's article is that Japan's problems have lasted for almost two decades in large part because Japan dithered early and often on its stimulus packages. Also read Krugman and many others on FDR and the effects of deficit-hawk return to Hoovernomics in 1936. My reading of Krugman is that he would advocate a large ($200-400B) stimulus package now aimed specifically at jobs that would terminate in about 18 months. If enacted 18 months ago, it would not be needed now. Tax increases on the upper 1% could begin now(200-300B there). Ending the hopeless wars in Iraq and Afghanistan saves another $200-300B/year. Additional mega-billions are realizable by instituting real heal care reform (rather than insurance reform that may or may not ever be realized in 2012-2014). In addition to the growth in GDB by some or all of these measures, the US economy and current accounts deficit would also be helped by modest inflation (2-4%) and a decline in the dollar versus the Euro and the yuan/renminbi. If at least some of these measures are enacted or occur, the US deficit and economic outlook is nowhere near that of Greece-- and need not follow the path of Japan. The major difference that I see between Galston and Krugman (and others that say much the same as Krugman: DeLong, Johnston), is Galston's constant emphasis on the deficit. Galston would seemingly not be much concerned if no additional stimulus ever occurred. Krugman, in contrast, places a stimulus as the highest priority -- and would deal with the deficit after the economy is growing to the extent that new jobs are produced that reduces the unemployment rate from 10% to more like 6%. Such growth in times of recession increases tax revenues more than the cost of the stimulus. Following such growth, some tax hikes on the middle class will probably also need be enacted and Galston's deficit-hawk Hoovernomic desires given delayed gratification.
- drofnats1
June 1, 2010 at 3:16am
Galston begins his article citing Greece. "As President Obama’s bipartisan fiscal commission gets set to convene, the Greek budget disaster has triggered the predictable flood of cautionary notes about how we’re spending too much and heading toward a debt crisis. Should these concerns illuminate the commission’s work—or are they merely alarmist? " Then he slides to Japan and Krugman. But Krugman on Greece is worth reading. The following is probably the "money quote" that Galston should re-read. "In short, we’re not Greece. We may currently be running deficits of comparable size, but our economic position — and, as a result, our fiscal outlook — is vastly better. That said, we do have a long-run budget problem. But what’s the root of that problem? “We demand more than we’re willing to pay for,” is the usual line. Yet that line is deeply misleading. First of all, who is this “we” of whom people speak? Bear in mind that the drive to cut taxes largely benefited a small minority of Americans: 39 percent of the benefits of making the Bush tax cuts permanent would go to the richest 1 percent of the population. And bear in mind, also, that taxes have lagged behind spending partly thanks to a deliberate political strategy, that of “starve the beast”: conservatives have deliberately deprived the government of revenue in an attempt to force the spending cuts they now insist are necessary. Meanwhile, when you look under the hood of those troubling long-run budget projections, you discover that they’re not driven by some generalized problem of overspending. Instead, they largely reflect just one thing: the assumption that health care costs will rise in the future as they have in the past. This tells us that the key to our fiscal future is improving the efficiency of our health care system — which is, you may recall, something the Obama administration has been trying to do , even as many of the same people now warning about the evils of deficits cried “Death panels!” [My take is that Obama punted on health care reform-- settled for modest, delayed insurance reform instead.] So here’s the reality: America’s fiscal outlook over the next few years isn’t bad. We do have a serious long-run budget problem, which will have to be resolved with a combination of health care reform and other measures, probably including a moderate rise in taxes. But we should ignore those who pretend to be concerned with fiscal responsibility, but whose real goal is to dismantle the welfare state — and are trying to use crises elsewhere to frighten us into giving them what they want." Enter Galston, stage right.
- drofnats1
June 1, 2010 at 3:44am
drofnats1, very impressive comments. I will add only two. Greece's public spending (as a percentage of GDP) is not out of line with other European countries. What is out of line is public receipts - Greeks love public spending, but taxes not so much. Sound familiar. There is a major difference, however. In the US our representatives actually adopt tax cuts for the wealthy, whereas in Greece tax evasion is the common practice. Second, deficit forecasting is like New England weather: if you don't like it, wait an hour. We've gone from obsessions about deficits, to obsessions about surpluses, to obsessions about deficits, at each turn an intractable problem. And that's just this decade! Of course, for those on the right, the policy prescription is always the same: cut taxes for the wealthy. And so it will be in a few years when the Republicans inevitably return to power. Galston may claim that he wants a good public debate among the economists. But what's the point of a debate when one side always comes to the same policy prescription regardless of our economic circumstances. One final comment about Lord Keynes, the revered (except for a few cranks in Chicago, everybody was a Keynsian when I majored in economics 40 plus years ago) forecaster. That's right, forecaster. Keynes was not totally ignored in the 1930s because his forecast about the consequences of the peace (after WWI) was right on the money. Today, by contrast, policy makers continue to listen to economists who have spent entire careers on the wrong side of history, as though the odds of finally being right must favor them!
- rayward
June 1, 2010 at 7:47am
ralston. right on. One additional difference between the US and Greece, is that we can devalue our currency and inflate our way out of some of the pain of deficits. As pointed out by Krugman and others, Greece can't so long as it's currency is the euro. On Japan, a few days prior to Galston's article, Krugman also said that "Japan had low debt and fast growth before the 90s, high debt and slow growth since, but surely we believe that Japan’s financial crisis is what both slowed growth and increased debt; similarly, the onset of Eurosclerosis is what led both to slowing growth and higher debt in Europe." On May 25th, yet again, this and several other issues are addressed in detail, "especially the effects of Japan’s “quantitative easing” policy, which involved pushing up the monetary base in the hope of getting some traction. (Unlike what we now call quantitative easing, this didn’t involve large purchases of nontraditional assets.) [If you're going to present arguments that contrast with Krugman and other Keynesian economists, please read and understand them before so doing.] ....it’s hard to make monetary policy effective in a liquidity trap. There are some writers who suggest that all we need is more determination on the part of Bernanke et al; while I dearly wish the Fed would try harder, it’s not all that easy, because just pushing out money doesn’t do anything. You either have to buy lots of long-term assets — we’re talking multiple trillions here — or credibly commit not just the current FOMC, but future FOMCs, to pursuing higher inflation targets. Part of the argument for fiscal policy as a response to this crisis is precisely that it doesn’t pose the same kind of commitment problems — a point that Gauti Eggertssson has made at length.... On the contrary, a surge in government purchases of goods and services is more, not less, effective if the public believes that it’s only temporary. Anyway, studying Japan remains very useful for understanding where all of us are these days. Here’s where we are: growing GDP, but mass unemployment still the law of the land, with only tiny progress so far. What can be done? Well, we could have more fiscal stimulus — but Congress [And lots of kibbitzers. Like Galston] is balking even at the idea of extending aid for the ever-growing ranks of the long-term unemployed. Fiscal responsibility, you see — hey, and let’s make sure estate taxes stay low! We could get tough with China, which continues its currency manipulation and, in the face of a world of grossly inadequate demand, is actually tightening monetary policy to avoid an overheating economy — when basic textbook economics says that it should be appreciating its currency instead, which would not only rebalance China’s economy but help the rest of the world. So given China’s outrageous behavior, Geithner went to China, got nothing .. and pronounced himself very pleased. We could do more through monetary policy. Macro theory suggests that the theoretically right answer, if you can do it, is to get central banks to commit to a higher inflation target. But the Fed and the Bank of Japan [and OECD] say no, because … well, that’s not what central bankers do. It’s depressing: shibboleths and conventional wisdom are blocking all routes out of this slump. And I worry that policy makers will just sit there, for years and years, all the while congratulating themselves on the soundness of their policies." Japan anyone???
- drofnats1
June 1, 2010 at 9:18am
Look at your data. In particular look at the early 1990s. Nominal (?) GDP growth collapsed. It wasn't negative, but it was way below potential. Inflation dropped from 3.8% in 1990 to -0.3% in 1996. But the government was running a fiscal surplus for the first few years and small deficits later. Krugman's point, I think, is that Japanese policymakers didn't act quickly or aggressively enough to head off the problems of deflation and stagnation that only became apparent in the late 1990s. One can't blame them. They didn't have the "Japan syndrome" as an object lesson. We don't have that excuse. Krugman is right that it is better to err on the side of too much stimulus than too little, because slowing growth and risking a deflation trap does not "solve" the "Greek" problem. It makes it worse.
- gurwia
June 1, 2010 at 11:33am
drofnats, I'd take issue with your assertion that the Bush tax cuts only benefited the rich. See http://www.taxfoundation.org/publications/show/26320.html From this summary, Bush "gave" the single earner family of 4 $2200 in tax breaks compared to Clinton, while Obama will give them $2600. In short, the Bush tax cuts were pretty significant compared to Clinton across the board. Not just the rich. As a percentage, the $50K earner and the $500K earner both saw around a 4-5% reduction in taxes under Bush. Obama will treat the $150K to $300K family the same as Bush. Not sure who is calling for dismantling the welfare state. I've not heard anyone calling for that. But I have heard for those warning that we should not get as generous as the EU. And for good reason, as I think the EU is wondering how to pay for all this too. The math is actually very simple. Just pick how many workers should pay to support a single retiree. In the 50's, 16 workers paid to support one retiree. Today, 3 workers work to support one retiree. But more lavish benefits indeed mean that we must push closer to one worker supporting one retiree. Perhaps you'd share with us your ideal ratio. How many workers should pay to support a retiree?
- seattleeng
June 1, 2010 at 12:06pm
Shorter Galston: Postpone robust fiscal stimulus until such time as deflation is well underway and we can replicate the Japanese experience. Incidentally, in one of his posts on the topic, Krugman comments that a credible commitment by the Fed to a ~3% inflation would be his #1 preference. That wouldn't require any fiscal stimulus. Any takers? Didn't think so. Krugman's right that conventional pieties are likely to win the day over tried-and-tested economics on this one. The right answers just conflict too sharply with our moralistic intuitions about the economy.
- bmoodie
June 1, 2010 at 1:28pm
Krugman a href="http://krugman.blogs.nytimes.com/2010/05/27/bad-analysis-at-the-deficit-commission/">has already posted a pretty convincing slapdown of Rogoff and Reinhardt's work in this regard. Convincing at least in that narrow sense by which we should be concerned about high fiscal deficits and debt burdens, and the risks of attendant ramifications running the gamut from Japan to Greece. The reality is that Krugman's consideration of these issues is superficial, as the experience of Japan and our own in the last decade makes clear. The underlying issue is whether it is even possible for policymakers to keep economic activity humming along in the wake of its squandering of copious quantities of investment resources over decades. Krugman and the Neo-Keynesians believe that it is, and to support it, they point to the sure dangers of debt deflation and liquidity traps. Which is to say, they support it by ignoring the question. Meanwhile, Schumpeter and Minsky, and their devotees would argue that the business cycle cannot be so neatly extricated from long-run considerations: that it is precisely the cycle of boom and bust that facilitates adherence to long-run forces which account for sustainable commercial relationships or the lack thereof. Speaking of which, I have a few questions for Professor Krugman too. First, is the US's rigidly persistent, structural trade deficit sustainable? Is the overwhelming composure of its economic activity toward service industries likewise sustainable? Do these evince functional or dysfunctional trade relationships? Does it make sense that with absurdly favorable demographics, as judged by the percentage of the population that is working age, our countries aggregate savings rates have hovered around about zero for a decade? Is the attendant underinvestment in fixed and other forms of capital sensible in light of that demographic shift. Is it coincidence that US savings rates steady collapse over the past three decades corresponded with the increase of global debt to GDP from more than 1 and a half time to more than 3 times coincidental? The reality is that the implicit assumption of the neo-Keynesians, (if, as Minsky argued, not Keynes himself), that all sins can be healed by the application of a bit of liquidity and some regulation flies in the face of human experience since the invention of banks. Investment bubbles create economic dead enders- think million room casinos in Las Vegas not to mention Dubai World's exploits- that fiscal and monetary rescue operations only manage to resuscitate to suck up more resources and investment before their inevitable demise. In addition to its direct consequences, this activity has profound implications for the incentive structures of real economic actors, amongst other things. Moral hazard is certainly part of that, but so is Hyman Minsky's observation that stability breeds instability: that, sheltered from the brute force storms of real world forces, economic actors become increasingly complacent about the risks of their activities. The results are more of the same. Of course, there is a political calculus as well to the costs associated with these behaviors. Overlooked in the casting about for historical allegories to our own crisis, amongst other things, is that the explanation for the Japanese response to the meltdown of their colossal investment bubble of the 1980s had as much to do with cronyism as it ever did with Keynesianism. The distinction matters, as Simon Johnson has pointed out with respect to our own financial/fiscal crisis, and highlights the fact that some of the most important implications for responses to crises regard who bears the greatest costs. In Japan, with its old and rapidly aging population, it should come as little surprise that such a disproportionate share of the fallout from their own investment bubble will be borne by future generations, courtesy of their adherence to remedies proposed by the likes of Professor Krugman, amongst others. Speaking of which, I'll leave it to readers of this comment to judge whether Professor Krugman's or Norman Gall's 10 year old commentary on these matters has proven the more prescient. From the latter's 10 year old paper, Money, Greed and Technology:
- I Majorajam
June 1, 2010 at 1:42pm
Sorry Majorajam. Incoherent ramblings and ex cathedra statements do not a refutation make.
- drofnats1
June 1, 2010 at 2:31pm
Krugman was an OK trade economist of little note until his lobotomy and conversion to liberal hack (after which he got a Nobel). He has no special expertise in macro-econ, has never practiced in this field, and opines from the vantage point of moonbat chief economist. Keynes was discredited decades ago with stagflation, the IS/LM curve is a joke and is never used as a model, and Keynes teachings are a historical footnote these days outside of liberal politics. Liquidity traps only occur in the world of Keynesians. There are more holes in this theory (hey prices do matter) than not. The European countries still enamored of Keynesion policies are drowning in debt with a weakened private sector unable to consume its way to properity Other than above K & K are awesome
- mr_rationale
June 1, 2010 at 2:47pm
Mr. Rationale - "Liquidity traps only occur in the world of Keynesians." That's why we had the Great Depression and why we have zero interest rates right now and only a feeble economic recovery, right? And, as a refutation of liquidity traps, "hey, prices do matter?" It's obvious that you have loads of expertise in macro-econ...
- bmoodie
June 1, 2010 at 3:46pm
Sorry drofnats1, but what a hopeless ignoramus would judge as incoherent rambling is of no consequence, and certainly not to me. This is not to downplay the significance of the policy recommendations about which you wax lyrical, such as "aiming stimulus packages specifically at jobs that would terminate in about 18 months", only to note that said lies more in its comic value than its grasp of the theoretical macro it caricatures. Blog comments are for fun, no doubt, but next time go crazy and maybe pick up a book or something. If nothing else, you'll get a sense of how little you know- perhaps even make yourself look less the horse's ass. A win win.
- I Majorajam
June 1, 2010 at 4:10pm
irrational majorajam. Hate to intrude upon your neocon world views and Palinista logic, but try reading and understanding Krugman and Posen in their own words. Krugman:Pre-refuting William Galston So William Galston has an article in the New Republic questioning Keynes — and me. He lays great stress on the Reinhart-Rogoff claim that growth slows substantially when debt exceeds 90 percent of GDP. First of all, that’s not in the Reinhart-Rogoff magnum opus. It’s in a later working paper, which is not nearly of the same standard. And when Galston writes, Until someone refutes Reinhardt and Rogoff, our operating presumption must be that excessive debt accumulation will eventually reduce economic growth I sort of wonder at the absence of a link to my blog post in which I, well, refuted Reinhart and Rogoff. OK, that post was very recent — but it’s not the first time I wrote about this issue; see here. I don’t want to be too cranky here, but if you’re going to cite me in the title of an article, and accuse me of not having an answer to what someone else wrote, shouldn’t you do a search to see whether I have, in fact, said anything about it? Anyway, the punchline: I’m a great admirer of the Reinhart-Rogoff work on crises — but NOT of their work claiming that 90 percent debt/GDP ratios constitute a red line, which isn’t at all up to the standard of the other material. It’s based on a crude correlation — and as soon as you look at specific examples, it starts to look all wrong. The details are at the links. So as the title of this post implies, I believe I pre-refuted Galston. Oh, and before commenting on Japan, one has to read Adam Posen (pdf).
- drofnats1
June 1, 2010 at 5:16pm
drofnats, you and mr_dunning_kruger are two sides of the same coin. You should be suspicious of your ability to wedge all of the world neatly into a binary librul v neocon analytical prism. You made a snide comment about it, but did you even read my comment? This is its first sentence:
of course, the link didn't come through as a link for one missing pointy [ thing, but how hard is it to detect the mistake and read it how it was intended? Is copy and paste really a bridge too far? Here is that link again, fyi. Pretty sure it's the same one Krugman now says your man should've pointed to. I'd say that counts as understanding the Professor in his own words, not that anything I wrote approaches misrepresentation. My prior advice stands. Investigate a text book or two. In the meantime, RTFC before you respond to it.- I Majorajam
June 1, 2010 at 6:16pm
bmoodie: catch a clue and do a wiki search at very least The term liquidity trap is used in Keynesian economics (and only Keynesian economics) to refer to a situation where the demand for money becomes infinitely elastic........academic economists had come to give little credence to the concept of a liquidity trap by the 1960s. And 'prices matter' wasn't a refutation of liquidity trap it was mocking one the numerous holes in Keynesian Econ. And will.i.am --- this has less to do with liberal vs conservative and more to to with Public Sector vs Private Sector.
- mr_rationale
June 1, 2010 at 6:39pm
the highly skilled underrate their abilities - thanks
- mr_rationale
June 1, 2010 at 7:11pm
I believe that the proper statement of a liquidity trap is that the demand for credit becomes inelastic, not infiinitely elastic, in that it no longer responds to a decrease in price. Even if the price falls to zero, there is no increase in demand. I don't know which academic economists decided to dismiss the concept in the 1960s. Probably the same Friedmanite numbnuts who handed us this crisis because, as Greenspan put it, they hadn't envisioned this mode of failure. The explanation is not really that arcane -- if there is sufficient slack in consumption demand, no one will borrow to invest because they have no expectation of selling the output, and people won't borrow to consume because they are too nervous about the future to go into debt even at a zero interest rate. One need not be an "academic economist" to understand the problem. As an aside, the only plausible macro explanation for the Reinhart-Rogoff these that too much debt reduces growth is that a maldistribution of income, with too much in the hands of too few, is bad for growth because there is insufficient consumption demand. This is because the interest in the debt is just a transfer payment from one household to another. So if it reduces growth, it can only be because the transferee, already being wealthier than the average, spends less of the transferred amount than the transferor (including a transferor via taxation) would have. I find this plausible, but it is an indictment of monetarist-Reagan-Bush economics, something Reinhart and Rogoff no doubt fail to notice. (I am pretty sure I read this paper just this past semester, too lazy to look it up, and it was a rather weak case on the numbers. These dynamic programming growth models are more than a little bit unrealistic in any case and it is a pity that so much of the profession is caught up doing this work, mostly unthinkingly.) In any case, the answer to too much money in the hands of too few is to raise their taxes and lower taxes for everyone else, putting more spending power back in the hands of the masses. The problem is not insoluble. But, as I said, that is all an aside. Even if we assume that there is a debt limit out there, at least one that is de-stabilizing, the answer is not to cut government spending in a recession but to raise high-end taxes. They aren't going to consume more than they do anyway, so taking the money from them in the form of taxes rather than proceeds of loans more or less satisfies the requirements of "Ricardian equivalence." We keep demand up with government spending without having to increase the debt at nearly the same rate. While we are at it, we need to get over the insanity of free trade. We are the only nation that comes close to this ideal -- everyone else manages their trade -- and as long as we are free-trading while everyone else is not, we are going to continue to be the dump for their excess capacity, or shortfall in domestic demand. Completely idiotic. There is no reason on earth why we should continue to run trade deficits other than more neo-classical stupidity. If we insisted on balancing our trade, de jure if necessary, there would be more than enough additional domestic demand to put everyone back to work. So, the answer is: force our trade into balance -- you don't buy from us, you cannot sell to us -- and raise high-end taxes to get reasonably close to balance, close enough so that it is clear that, as the economy recovers, we will have a structural surplus rather than a structural deficit. Our whole debt problem now is simply due to the fact that Bush the Idiot gave us structural deficits during a boom, the opposite of what should occur. This a case in which merely doing the opposite of what the Idiot was doing would actually be good policy
- roidubouloi
June 1, 2010 at 8:16pm
Can anyone name any reason to take seriously anything a professor of "public policy" has to say about macroeconomics? Especially when he shows no evidence of ever having read those he criticizes. Bizarre.
- NR126407
June 1, 2010 at 9:02pm
But Roid, our trade imbalance isn't due to us not trying to sell to the Chinese. It's because we don't have anything to sell that the Chinese want. And if we do, it's likely export controlled, or they don't have the money to buy it. Your nirvana can only work if both economies are at similar evolutionary points in time. We've discussed taxes in depth. The rich don't have enough to pull us out of this. You are aware that our middle class and upper middle class are taxed at rates far below their EU counterparts. You know where the money is. I'll note that Obama just left taxes on those making from $150K to $300K the same place Bush set them. So that is two administrations and boatloads of economists that seem to not agree with you.
- seattleeng
June 1, 2010 at 9:49pm
It does not matter whether the Chinese want to buy from us. The point is that, if they don't, then they should not be permitted to sell to us. We would then make ourselves what we buy now from the Chinese and we would not have nearly the same shortfall in demand that we have now. Or maybe the Chinese would decide that they would rather continue to sell to us and hence figure out some things to buy from us that, compared to what they are selling us, we make relatively cheaply. Either way, by eliminating the current account deficit, we no longer have huge hole in domestic demand and consequent slackness in labor markets. Your argument only makes sense if you assume way the power of our government to regulate our external trade, which is exactly the nonsense that the free-traders peddle -- that we are captive to the decisions of consumers and of the Chinese with no national agency. Yes, we discussed taxation of the upper end at length, but we did not agree. You think there is not enough there, even though 10% of the population has something like half the national income, because you simply decline to count the $2 trillion of net national product that is not currently counted in adjusted gross income for tax purposes. Sure, if you exclude enough income from the tax base, there is nothing to tax. The whole point, however, is to stop excluding large swathes of the income of the wealthy from the tax base. You also do not understand that the "money" has to be there in the economy if in real terms the government is already spending it. As a matter of accounting identity in the national product accounts, the government demand already accounts for that portion of the net national product no matter how it is paid for. Since every is living off the remainder now, they can continue to do so even if we decide to stop issuing paper for the funds and just raise them through taxation. Virtually all income is private in the first instance. Hence, the government spending that exceeds government revenues has to be income to someone. That's who you tax because, by definition, they are not spending their income now. Your notion that tax policy is set based on economics, and that tax policy is therefore self-proving economic policy, is also nonsense. Not since Reagan when magical thinking about fiscal policy became the American way. Obama is just not prepared to take the political hits necessary to set the economy on a sound path because, as soon as you raise taxes, that is blood in the water for the idiot Republican/conservatives. Indeed, that is the crux of the problem: The idiot Republican/conservatives simply refuse to permit any sort of rational fiscal policy and they peddle a bunch of nonsense to a guileless public to do it -- such as the notion that there is not enough income to tax.
- roidubouloi
June 1, 2010 at 10:22pm
William Galston, you state: " Until someone refutes Reinhardt and Rogoff, our operating presumption must be that excessive debt accumulation will eventually reduce economic growth." The problem is that Paul Krugman seems to have refuted Reinhardt & Rogoff prior to your post. (See his blog in response to your article.) Now the ball is in your court. Krugman HAS RESPONDED TO YOU. Now if you are really interested in a discussion about serious matters of economics, then it is time for YOU to respond to his critique. Or am I missing something here?
- SRC--Mpls
June 2, 2010 at 9:37am
Looks like we'll continue to disagree on the taxation point. However, I'd note that Obama has all the tools he would need to whack the top 1% hard with almost zero political fallout. Plus, he said he'd do this during the campaign. If what you say is true, then it's odd that Obama hasn't done it. It'd be so easy to dial up the effective tax rates on the top 1% from 30% today, to 40% in 2 years, and 50% in 4 years. If what you say is true, then it'd be piles and piles of money for the government. But instead, Obama will raise the effective tax rates on zillionaires less than 1% above Clinton. So, either what you say is NOT true, or there are huge unmentioned ramifications of doing so, or Obama has a soft spot for the top 1%. Either way, you are out in the woods on this one. Neither Bush nor Obama agree with you.
- seattleeng
June 2, 2010 at 12:48pm
It is a curious notion indeed that tax law is driven by policy rather than politics. Hence, it is rather hard to tell at this juncture what Obama thinks would be optimal tax policy. Conventional Keynesian macro says don't raise taxes in a recession. I happen to think that is wrong if the tax increases are at the high end of the spectrum where the economic incidence roughly coincides with the source of funding for new government debt. The same people are out the same amount of money. In one case, they get back a piece of paper. In the other case, they don't. Considering what a small piece of their income the upper end consumes, and that they will not be investing much in the midst of a recession in any case so that crowding out is not a problem, I see very little economic downside to high-end tax increases, even in a recession, in order to calm deficit fears. Larry Summers probably disagrees, but he is as much responsible for the current debacle as Alan Greenspan so I don't take him seriously.
- roidubouloi
June 2, 2010 at 10:25pm
As to the politics of taxes, see this in TNR today: http://www.tnr.com/blog/jonathan-chait/75279/conservatives-ignore-their-one-proven-success
- roidubouloi
June 3, 2010 at 1:10pm