Macroeconomics roundup

Okay, recessions suck, but discussion about who should do what to make them milder is fascinating. To me, anyway. And this week there has been a whole smorgasbord of macroeconomic policy reading on the internet.

First, via Greg Mankiw, eminent monetary historian Anna Schwartz, co-author with Milton Friedman of Monetary History of the United States, has issued a scathing rebuke of recent Federal Reserve monetary policy.

"The new group at the Fed is not equal to the problem that faces it," she says, daring to utter a thought that fellow critics mostly utter sotto voce.

"They need to speak frankly to the market and acknowledge how bad the problems are, and acknowledge their own failures in letting this happen. This is what is needed to restore confidence," she told The Sunday Telegraph. "There never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for," she says.

According to Schwartz the original sin of the Bernanke-Greenspan Fed was to hold rates at 1 per cent from 2003 to June 2004, long after the dotcom bubble was over. "It is clear that monetary policy was too accommodative. Rates of 1 per cent were bound to encourage all kinds of risky behaviour," says Schwartz.

She is scornful of Greenspan's campaign to clear his name by blaming the bubble on an Asian saving glut, which purportedly created stimulus beyond the control of the Fed by driving down global bond rates. "This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can't be blamed on global events," she says.

Federal Reserve Chair Ben Bernanke spoke to the House Budget Committee today, saying that a fiscal stimulus enacted by Congress could help economic growth, but cautioned legislators about its form.

A number of analysts have raised the possibility that fiscal policy actions might usefully complement monetary policy in supporting economic growth over the next year or so. I agree that fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone. But the design and implementation of the fiscal program are critically important. A fiscal initiative at this juncture could prove quite counterproductive, if (for example) it provided economic stimulus at the wrong time or compromised fiscal discipline in the longer term.

To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next twelve months or so. Stimulus that comes too late will not help support economic activity in the near term, and it could be actively destabilizing if it comes at a time when growth is already improving. Thus, fiscal measures that involve long lead times or result in additional economic activity only over a protracted period, whatever their intrinsic merits might be, will not provide stimulus when it is most needed. Any fiscal package should also be efficient, in the sense of maximizing the amount of near-term stimulus per dollar of increased federal expenditure or lost revenue. Finally, any program should be explicitly temporary, both to avoid unwanted stimulus beyond the near-term horizon and, importantly, to preclude an increase in the federal government's structural budget deficit.

Kevin Drum sees Bernake's speech before Congress as a refreshing change from the evasive, cryptic style of his predecessor.

This is remarkably clear and direct, especially for those of us used to 18 years of impenetrable Greenspanese. Bernanke is saying, as clearly as he can, that a temporary economic downturn shouldn't be used as a cynical excuse to pass new long-term tax cuts or to make existing tax cuts permanent. Not only would that have no effect on the economy right now, but it would likely make future economic problems even more intractable.

In other words, Bernanke isn't nuts: he thinks tax cuts reduce revenue and make long-term deficits worse. What's more, unlike Alan Greenspan, he has the guts to say so in plain English instead of disingenuously tap dancing around the issue and then pretending later that he had done as much as he possibly could have to endorse fiscal discipline. That's progress.

I won't pretend to be any sort of expert on macroeconomics, but I can't argue with Kevin's preference for Bernanke's straightforward communication.

Okay, so what form should the fiscal stimulus take? Greg Mankiw comments on a suggestion by the Congressional Budget Office that it could take the form of a temporary increase in food stamp benefits.

In standard macroeconomic theory, the business cycle is symmetric. That is, stimulating an economy that is suffering from insufficient aggregate demand should be the opposite of cooling off an overheated economy to reduce inflationary pressures. Would anyone seriously propose a temporary cut in food stamp benefits in an overheated economy? I don't think so. Food stamps seem the wrong tool to address the business cycle.

By contrast, the first line of defense against short-run economic fluctuations--monetary policy--is applied symmetrically. You cut money growth and raise interest rates in an overheated economy, and you increase money growth and lower interest rates in a lackluster one.

Since one of the main problems with using fiscal policy to smooth out the business cycle is the inevitable slowness of Congressional action, Mankiw proposes creating a fiscal policy that will automatically shift with the economy.

If we are going to use fiscal policy to smooth out the business cycle on a regular basis, then we should think harder about improving the economy's automatic stabilizers. For example, imagine we enacted an investment tax credit, the size of which was a function of the unemployment rate. Firms would have an incentive to time their investment projects toward those periods when the economy was weakest and most needed a shot in the arm.

I can more easily imagine, when the economy starts to overheat, telling corporations that their investment credit has shrunk or disappeared than telling poor families that their food budget has been cut.

Interesting.

And the mysterious knzn weighs in with a warning to Democrats in Congress.

If Congress passes a stimulus package full of new programs and all sorts of bells and whistles and tinsel and lights and stars and angels and golden balls with glitter on them, one that President Bush is almost certain to veto, and one that he, given his ideological preferences, could very easily justify vetoing, and indeed would have a hard time justifying signing, then it will be your fault, not his fault, if the recession turns out more severe than expected. I will hold you responsible. I suspect that voters will hold you responsible too.

If, on the other hand, Congress passes a simple if imperfect stimulus program that works on the revenue side -- say an across-the-board one-time tax rebate -- one that President Bush may not be happy with but will have a hard time justifying a veto, then if he does end up vetoing it, that will be his fault -- and all the more reason to elect a Democratic president. And if he signs it, well, I guess you'll just have to take the risk that the stimulus will actually work and that it will make things look a little better on election day than they otherwise would. A non-recessionary economy in 2008 -- seems to me that's a risk worth taking.

(Though I'm not sure why knzn writes "This means you, Senators Edwards and Clinton," when John Edwards retired from the Senate in 2004. Perhaps he meant "Senators Obama and Clinton.")

UPDATE: knzn has struck through "Edwards and" in his post, and added,

I guess I should include Senator Obama in my warning, too, but his suggestions have come closer to the sort of thing of which President Bush would have trouble justifying a veto, so I kind of felt he didn't need to be warned.