Joe Weisenthal has produced a quick response to my article with David Beckworth on why we need to cut federal spending and adopt a new rule to stabilize monetary policy. I admire his speed and appreciate his attention, but I’m unconvinced by his critique.
He writes that “it seems ludicrous to think that the answer to the debt crisis is: cheaper loans! People don’t want (and can’t utilize) cheaper loans: What people need is more income to pay off this debt.” Who’s talking about cheaper loans? Not Beckworth or me, with or without exclamation marks. If nominal incomes rise, as we want, interest rates will go up. And so will the ability to pay off debts.
Against our claim that monetary policy nullifies the effect of fiscal policy, Weisenthal counters that Bernanke has called for fiscal activism. But there is no contradiction here. Of course Bernanke would prefer that Congress and the president do more and he do less—it’s much easier on him. There’s no need for him to overcome internal Fed disagreement or face external criticism for the Fed’s activism. That doesn’t mean elected officials will change the end result by following his preferences.
Weisenthal says that it’s “just plain weird” to suppose that fiscal stimulus merely shifts economic activity around rather than adds to it. “If the government hires someone to, say, dig a ditch . . . then that person is gaining income without any ‘subtraction’ from another part of the income.” That’s true under certain assumptions. It’s false under the assumption we believe is realistic: that the government’s spending of this money causes the Fed to run a tighter monetary policy than it would have done without the federal spending. That’s what causes the displacement.
Weisenthal concludes that it’s “just intuitive” that fiscal policy would be more effective than monetary policy. “If you take the average person, ask them what will cause them to spend more money: A policy announcement from Bernanke, or the promise of a well-paying job for years to come. The answer is obvious” (bolding in original). Yes: It is indeed possible to construct a stacked hypothetical question that yields the answer you’re looking for. One constructed to my liking would ask: Which would have more of a positive impact on you, the prospect of a permanently higher amount of money in your pocket, or more federal debt? The answer to that one is obvious too. It’s just intuitive! Neither mental exercise settles anything important.
Two minor points. Weisenthal describes nominal GDP targeting as “super-aggressive monetary policy.” This is an inapt description. Nominal GDP targeting would on average have been no more aggressive than actual Fed policy during 1982-2007; it would if anything have been tighter during the tail end of that period. The headline says that “The Smartest People in Washington are 100% Wrong About Stimulating the Economy.” I’ll take the compliment, such as it is. But Professor Beckworth works in Texas, and many of the other influential supporters of nominal GDP targeting (the ones who have influenced me include Scott Sumner, Joshua Hendrickson, and Nick Rowe) rarely set foot in the D.C. area.
Mr. Ponnuru:
You know who is "causing" the Federal Reserve to run a tighter monetary policy than it otherwise would? Conservative dissenters.
The idea that these conservatives would have less influence rather than more if conservatives had more influence on fiscal policy is wrong. And they would use that influence to tighten monetary policy too.
Your view is logically consistent. If the Federal Reserve were to tighten in response to fiscal policy, they do indeed have the ability to cancel it out.
I think that the basic flaw is your premise that Federal Reserve policy is finely tuned to the needs of the economy. As though it were purely technocratic. What is really happening is that there is an ideological war going on with people who want looser monetary policy on one hand and people who want tighter monetary policy on the other. So, if you want to say that the Federal Reserve will tighten in response to looser fiscal policy, you need to explain the political mechanism by which that would give those who want tighter monetary the upper hand such that they could entirely cancel out the effects of expansionary fiscal policy.
Reply to this commentLinkReport AbuseYou're both wrong. Weisenthal is wrong because the government can't pick positive-net-present-value projects to spend its (our) money on, and you and Beckworth are wrong because expanding the money supply in response to increased demand for cash balances only makes sense when the increased demand results from genuine economic expansion. When the increased demand for cash balances instead represents a reallocation of wealth from investment and consumption to cash reserves in a stagnant or shrinking economy (i.e., an economy-wide decision to idle assets until conditions are ripe for their re-deployment), there's no need to increase the money supply, since a lower level of cash will be needed as a medium of exchange in the (now smaller) economy.
Reply to this commentLinkReport AbuseThe government does not need to pick positive-net-present-value projects for spending to be stimulative.
If the government were to expand the size of the military, that would be stimulative. Even though military spending is practically never a positive return on investment.
Reply to this commentLinkReport AbuseDepends on what you mean by "stimulative". If you mean, "gooses short-term nominal GDP figures", you may be right (although there are arguments against that, some of which Ponnuru and Beckworth relate). If you mean, "makes the nation as a whole wealthier rather than poorer", you are wrong. I personally don't believe that the government should be engaged in short-term make-work programs at the expense of long term national wealth.
Reply to this commentLinkReport AbuseThe argument for goosing short-term GDP is that you increase employment. That increases business opportunity, as people have a chance to spend again which means new customers for businesses. Then you gradually take stimulus spending away as the private sector takes up the slack.
It is called a smooth transition. Unlike what is being forced upon us by Republican politicians. The idea that increasing unemployment by firing a bunch of public sector workers will increase business opportunity is totally nuts. More people employed = more business opportunity = gradual withdrawal of stimulus. The private sector is perfectly capable of employing the vast majority of unemployed, but it needs a kick start to get going again.
Reply to this commentLinkReport AbuseThat's just bootstrapping. Everything that flows from an uneconomical investment is also uneconomical. Our ability to consume is ultimately dependent on our production. A negative-net-present-value project reduces our wealth (i.e., we expend more resources on it than we get out of it). That net loss of wealth/resources means that we have less to consume or invest. You can't magically turn a bad investment into a good one by extrapolating a few steps. The principle is the same as the broken-window fallacy, with the loss of wealth resulting from the bad investment in place of the loss of wealth resulting from the broken window.
Sophisticated Keynesians acknowledge that they're just engaged in spreading the wealth in the interest of social stability, and that in so doing they are reducing the size of the pie long-term.
Reply to this commentLinkReport AbuseEverything that flows from an uneconomical investment is also uneconomical?
I don't think so. If someone robs a bank (no value is created there, I think you must agree) and spends the money building a house, the construction worker who goes to the restaurant is getting value for his money, whether or not the source of his money did not earn the money by providing value.
And you are right that what I am proposing is bootstrapping. A a computer scientist, I understand the importance of bootstrapping to get a computer started. And it turns out, that it is also important to get out of a recession in a reasonable period of time.
You know what is reducing our wealth? Everyday that millions of people are unemployed, we lose big time. Those people could be producing something. If your interest is wealth creation, you want them to be producing something as soon as possible. Proposals that extend the amount of time they are unemployed result in a huge amount of value lost FOREVER. You aren't going to get that value back.
It is funny to me that you are talking about the dangers of losing wealth, yet seem to be ignoring the enormous amount of wealth that is lost each and every day such a huge number of people are unnecessarily unemployed. Why is there such a lack of urgency on the conservative side with regard to all the wealth that is being lost FOREVER due to unemployment? We are advised to be endlessly patient, while wealth and value is being flushed down the toilet.
There is an old saying. Time is money. And the longer people are unemployed, the more value is lost. FOREVER.
The idea behind stimulus is to decrease the amount of time people are unemployed. And maybe even stop the double dip that is coming.
Getting people back to work is NOT a zero sum game.
Reply to this commentLinkReport AbuseThe point isn't producing "something". The point is producing things in a manner that results in increased wealth.
If a bank is robbed, wealth is neither created nor destroyed (excluding transaction costs, dynamic effects, etc.). The robber may be a better investor than the bank (or the owners of the money), or, more likely, a worse investor. The government will always be a worse investor in the aggregate.
What you don't seem to appreciate is that we only increase our wealth when the unemployed are employed in positive-net-present-value projects, not when they are digging holes and filling them again. And only the private sector can consistently identify positive-net-present-value projects. The only way, therefore, to employ the unemployed in a way that makes us wealthier is to hasten the unwinding of malinvestment and the redeployment of capital by the private sector. And we do that by removing distorting government interference and policy-induced instability. The private sector will invest when there are positive-net-present-value projects to invest in, and not before.
Government stimulus spending will only retard this process by increasing malinvestment. The same goes for private investment coerced by the threat of inflation (i.e., QE II).
Reply to this commentLinkReport AbuseThis is where your understanding of economics falls apart. You have failed to consider the variable of time.
Let us assume that the bank is a better investor than the government. But the bank takes two years to find someone to lend to, because the bank is worried about risky economy conditions and it taking a "wait and see" attitude. Basically, private investors face a prisoners dilemma. If all the banks and investors started lending again, the economy would do well and it wouldn't be such a high risk proposition. But the first lenders to lend during a bad economy face a real risk of losing it all, because the economy is slow.
In this case, the government could actually be the better investor. Because, in this case, an imperfect investment now is better than a perfect investment later.
What you seem to be failing to realize is that money circulates. The dollar I spend today may very well be my income tomorrow. (Okay, not likely that specific dollar, but in aggregate, this is how things work.) When money ceases to circulate, then perfectly capable resources are left idle. This is an enormous waste.
You are so focused on paper returns to investment, that you forget that the real loss is when human beings are idle and not producing value. If a bank takes two years to make a perfect investment, and people are unemployed in the meantime, this is simply a massive waste of resources.
This is why fresh water economists are so stupid. The miss the elementary variable of time. Sure, the banks will EVENTUALLY lend the money. And they may lend the money more efficiently than the government. In the meantime, there is massive waste due to unemployment. And that is the REAL loss.
Money is ultimately psychological. Its ultimate purpose is to create incentives for people to trade and contribute to society. When our economy leaves people in a position when they are not contributing, that is nothing more than a massive waste.
Reply to this commentLinkReport AbuseNo, the concept of net present value incorporates time. An investment NOW is only better than an investment later if it has a greater net present value. Leaving assets idle is better than investing them in ways that have a negative net present value. You're still positing that private parties are acting irrationally by failing to invest when there are no good opportunities, and that the government can make us better off by second-guessing them. But if private parties are leaving capital on the sidelines, it means that leaving capital on the sidelines is optimal in the prevailing circumstances.
Reply to this commentLinkReport AbuseAllesnarf,
Present value incorporates time into the consideration of a single transaction as it relates to a single individual.
What I am talking about here is the circulation of money. If I spend $50,000 on project X, present value incorporates time into considerations of the value of project X to me. But it does not consider the value of the $50,000 to the people I pay. The people I pay will presumably use that money to incentivize the further creation of value. As will the people they pay. And so on. Of course, since that value accrues to someone else, I am not going to put it into my present value calculation.
I am talking about time with respect to the circulation of money in the economy. This is definitely not captured in present value calculations of individual projects. If money is not circulating in the economy to keep everyone who could be productively employed actually productively employed, then we are losing value FOREVER.
And the argument is not that investors are acting irrationally as individuals. Although there is nothing particularly rational about the animal spirits that drive investors to be overly optimistic (think dot-com bubble and real estate bubble) or overly pessimistic as a group. The argument is that there exists a prisoners dilemma that makes it so that rational actions by individuals do not result in the best outcome, due to coordination problems inherent in a prisoners dilemma.
Individually, you are being completely rational if you look around and say, well, this is not a good time to invest because no one else is investing, so there will not be enough jobs and therefore not enough demand for my product. That is completely rational. But rational actions by individuals can lead to irrational results overall, in cases like this, which is a prisoners dilemma. All investors would be better off as a group if they did invest, as this would get the economy going again. But as individuals, if you invest during a bad economy when no one else is, you are going to lose money.
Reply to this commentLinkReport AbuseThere's no intrinsic value in the circulation of money. The mere circulation of money (a close-to-pure example would be gambling transactions) will not change total societal wealth. The effect of a given transaction on wealth can be positive, neutral, or negative, and we can't merely assume that transactions generally create, rather than destroy, value and wealth. Let's say that Rich Person X takes a million dollars and invests it in a negative-net-present value project. He pays his workers, who use the money to go out and buy, say, shoes. And the shoe factory increases production, or retains workers, etc. Does that change our calculus of the effect of that investment? No. What reason do we have to think that investing that time, effort, and wealth in shoes is efficient/desirable? None. Even if we think the shoe production is efficient, what reason do we have to think that it outweighs the loss on the underlying project? None. Artificially retaining resources in shoe-making will delay the movement of that labor and capital to more productive uses. Investment in the negative-net-present-value project thereby perpetuates malinvestment throughout the economy.
The only way we can know which activities are desirable/efficient and which are not is through the unfettered free market. When we artificially induce people to make bad investments, the follow-on effects will themselves be bad investments, because they will be an extrapolation of a sub-optimal allocation of resources.
You make a more interesting Keynesian argument in your last two paragraphs, where you posit that the failure to invest is only rational in the context of a psychologically-induced collective-action problem. This is an old debate, and we're not going to solve it here, but I don't buy it. Demand is always infinite. It's just a matter of finding the right mix of products and services, and the right price points. Taking our market as we find it, and building organically, will result in more wealth over the long run than forcing people into decisions that don't reflect their best judgment.
Moreover, this argument doesn't support government stimulus spending, since government projects will be losers in all circumstances, and the composition of demand induced by government spending will be too different from the demand of a natural economy for the former to morph into or stimulate the latter. At best, this argument counsels monetary or tax-cut stimulus.
Reply to this commentLinkReport AbuseIt is quite clear that when an investors, as a group, spend too much time deciding what to invest in (perhaps due to worries that the timing for investment isn't right) it is quite clear that lack of circulation in the economy potentially has very real costs.
Lack of circulation is bad. People need money in order to facilitate trade.
Here is a thought experiment. Imagine 2 people are unemployed and have different specialized skills. They should be able to make themselves better off through trade. But, without money, such trades are not likely to happen, and to the extent that they do happen, certainly not to an optimal degree. The transaction costs of barter are very high.
Circulating the money that exists in the economy at a reasonable speed is in fact very important to keep people producing value efficiently.
Unnaturally high unemployment is a symptom of an inefficiency in the system.
Reply to this commentLinkReport AbuseThe point is not that investors never act sub-optimally. The point is that there is nothing that can be done that will improve on their performance when unfettered by government-induced distortion. Nothing.
The point about the circulation of money is ridiculous. You're mixing apples and oranges: money as medium of exchange with money as store of wealth. If X and Y want to trade with each other, then yes, they will find it much easier if they have something to use as a medium of exchange and short-term store of value. But each one still has to have the wealth to buy the other's good or service. The fact that Z is sitting on cash that represents his accumulated wealth has no effect on X and Y. If they have the accumulated wealth to buy each other's services, then that wealth is either in the form of cash or something convertible to cash.
Circulation of money is not valuable in itself. It's a symptom, not a cause, of a healthy economy.
Reply to this commentLinkReport AbuseAllesnarf,
Well, the point is, they each do have the "wealth" to buy each others services. Their wealth consists of the ability to perform a service.
What is missing is action and a mutually beneficial exchange.
Reply to this commentLinkReport AbuseSurely you don't seriously believe that A and B will fail to enter into a mutually beneficial transaction because C is sitting on cash? C has nothing to do with it. Your hypothetical bears no relation to reality. If a threshhold number of people in the community need A's service, then they will buy it, and pay A cash. Then A can buy B's service. Someone who doesn't have cash can liquidate assets if he value's A's service more than the assets. The notion of an entire community sitting on their hands because no one has cash is ludicrous. It has never happened in history, and never will.
Reply to this commentLinkReport AbuseAnd this is where you fail to understand hidden costs. You say:
"If someone robs a bank (no value is created there, I think you must agree) and spends the money building a house, the construction worker who goes to the restaurant is getting value for his money, whether or not the source of his money did not earn the money by providing value."
But the Parable of the Broken Windows tells us that there was a cost to stealing this money. The money that goes to building the thief's house will not not be lent by the bank for someone else to build their house. It will not be available for the depositor to get his money out and go to arestaurant. So no NET value has been created. Every dollar stolen was a dollar not spent/invested by the rightful owner.
The same is true with the Federal Government. Every dollar borrowed for Solyndra is a dollar borrowed from the private sector that isn't invested in some other growth opportunity (unless of course the money isn't borrowed, but turned into new money by the Fed- at which point the dollar spent is a dollar of inflation that makes investment that much less attractive to investors).
Reply to this commentLinkReport AbuseA broken window can stimulate the economy. IF that money would have not been in circulation otherwise and resources were totally idle as a result.
Yes, if the alternative to the broken window is the worker doing something useful, this is better. But if there is nothing else to do, then fixing the broken window is a gain. Because if the workers spends that money SOONER than the bank would of on something he needs, then the economy gets going again.
TIME TIME TIME.
Okay. It is all about TIME. That variable exists and is extremely important. But it isn't in your mental model. And it is obviously important if you take a second to think about it.
Reply to this commentLinkReport AbuseSo how has goosing the short term GDP worked so far? We had a rather large goosing I might add. The government paying someone to dig a hole and fill it up again is stimulative to the guy digging the hole but little else. It creates no wealth (to the point above). The Keynesian notion that we have so much control over fiscal stimulus is just crazy. It's usually wildly off-mark (when there is a direction). The timing is almost always off. And the notion that it gets gradually withdrawn . . . is self evident.
Monetary policy has the advantage here. However, Beavis once said to Buthead - you can't polish a t*rd. If we have an economy beset with regulation, incentives against productivity and a tax system that discourages investment - I don't care what you have for monetary or fiscal policy. I'm investing my money elsewhere. But that's just crazy supply side people talkin' I just don't think it is nearly as complicated as some hope it to be.
Reply to this commentLinkReport AbuseHaven't we dispensed with this simplistic (and inaccurate) argument yet?
Solyndra ought to be a perfect example of why this doesn't work. $500 Billion dollars to make a thousand or so jobs for only one year. And that $500 Billion was money directed at feelgood boondoggles instead of real, growth-oriented business.
The Federal Government doesn't invent money from thin air, it borrows that money from private investors. Usually, when companies get a return on investment, it's because something of value was created. But with government treasuries, companies are getting ROI in return for the government shoveling money down rat hole after rat hole. This doesn't improve the economy. The economy will not sustain any growth until their only ROI comes from taking acceptable risks to create goods and services.
Making worthless jobs does NOT stimulate the economy. As the awesome Hayek v Keynes video stated, "If every worker were staffed in the army and fleet we’d have full employment and nothing to eat."
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