TW: Have mentioned this before but states do not have the ability to print money and run fiscal deficits like the federal government (if the Confederates had won then they might have but I digress...). When state governments cut their spending they create a pro-cyclical dynamic whereby just when the private sector is contracting the states are contracting concurrently creating a vicious circle. Hence the need for federal stimulus (hello Hooverites!!!). Imagine if the Federal government were similarly constrained, taxes would either be shooting up or spending significantly reduced right into the teeth of a severe demand contraction. A vicious circle would ensue leading without question into GD 2.0.
From David Rosenburg Merrill Lynch economist:
"...The focus and headlines remains exclusively on what the Federal government is doing to boost the economy. But few write about what the state and local governments are doing to stay solvent – cutting back on spending at an
unprecedented rate. Indeed, what seems to be forgotten is that after consumer spending, the lower level of government, with a 13% share of GDP, is the most important part of the economy – this is a sector that represents our teachers, law enforcement, fire prevention, and health and social assistance. The state and local government sector employs 20 million, or 15% of the total, compared with 13 million in manufacturing, 8 million in financial services, less than 7 million in construction and fewer than 3 million at the federal level. Fiscal gaps have now opened up in 42 states, and, when added to the shortfalls at the start of the year, they to a whopping $80 this offsets more than 60% of the fiscal tailwind. And in 2010, the amount of fiscal tightening from the states/local governments is expected to total $85 billion which bites into 30% of the stimulus we will see at the federal level..."
Showing posts with label Depression. Show all posts
Showing posts with label Depression. Show all posts
Monday, March 23, 2009
Monday, December 8, 2008
Averting a Depression Another Primer
TW: Mark Thoma, a very good economics blogger, pulls together highlights from another economist's, Bruce Bartlett, piece in Forbes. It helps if you are trying to wrap your arms around where we are and more importantly where we need to go policy wise over the next few months. To repeat what has become a mantra on this blog, we need government spending not something else at this point.
From Thoma/Forbes/Bartlett:
"Every day that goes by makes clearer the parallels between the current financial crisis and the one that led to the Great Depression. Then, as now, the core problem was one of deflation... What few people understood at the time was that the Federal Reserve was primarily responsible for the deflation...
In its initial stages, the Fed might have been able to prevent a full-blown depression by being a lender of last resort. It should have been aggressive about buying every financial asset it could lay its hands on and created as much money as necessary to do so. But it ... was passive and, as the value of financial assets collapsed, banks closed and vast amounts of wealth simply vanished.
The money simply disappeared, because there was no federal deposit insurance in those days. According to ... Milton Friedman and Anna Schwartz, the nation's money supply fell by one-third between 1929 and 1933, which induced a 25% fall in price levels...
As prices fell, businesses were forced to sell goods for less than they cost to produce. They couldn't cut costs easily because that meant reducing wages, which workers naturally resisted. Layoffs were the only way to cut costs, but this meant workers didn't have any income with which to buy goods, since there was no unemployment compensation either. This created a downward spiral that proved very difficult to stop. ...
The decline in wealth also reduced spending, and the fall in prices had the effect of magnifying debts. Debtors were forced to repay loans in dollars worth 25% more than those they borrowed in the first place. Farmers ... were especially hard hit. In effect,... they took out loans that were worth X number of bushels of wheat and ... they needed 25% more bushels to repay. ...
When the rate of deflation exceeds the nominal interest rate,... no one is going to lend money at a negative nominal rate; they will just hold on to it. When this happens, we have what economists call a liquidity trap, and the Fed cannot inject liquidity into the economy to stop the deflation. ...
Another problem that policymakers back then didn't grasp is that the money supply's effectiveness depends on how quickly people spend it; something economists call velocity. If velocity falls because people are hoarding cash, it may require a great deal more money to keep the economy operating. ...
This is essentially the problem we have today. Unlike in the 1930s, the Fed is not allowing the money supply to diminish. ... But velocity is collapsing. Banks, businesses and households are all hoarding cash, not spending except for essentials. This is bringing on the deflation that is crippling the economy. ...
The problem today is that velocity is falling faster than the Fed can pump up the money supply by buying financial assets... What Keynes figured out is that when conditions such as these exist, the federal government must step in to raise spending in the economy and thereby increase velocity. This means running a budget deficit, but that is only part of the solution. ...
We also know from the experience with tax rebates in 1974, 2001 and 2008 that this doesn't do any good, either. People mostly save the money...
Keynes argued that the only thing that will really work is if the federal government uses its resources to purchase goods and services. It must buy "stuff"--concrete, computers, paper, glass, steel--anything as long as it is tangible. In other words, the government must spend the way households do, by buying things. ... This is what ends an economic crisis. Unfortunately, it was not until World War II that the federal government spent enough on real resources ... to make Keynes' theory work in practice.
The challenge for Congress and the Obama administration will be to devise a spending program that draws a significant amount of real resources out of the economy fast enough. A massive public building program would be one way, but that will take more time to gear up than we may have. ... We need something today that can affect the economy within months. ...
For what it's worth, Keynes didn't know what to do in this situation, either. He suggested building pyramids and burying bank notes in deep mine shafts that had been filled in. As people tried to dig up the money, they would be forced to employ labor and purchase equipment that would raise spending and thereby growth. In the end, it took the greatest war in history to make Keynes' theory work. ...
We ... have the advantage of important institutions like deposit insurance and much better leadership at the Fed. But in the end, there is a limit to what the Fed can do by itself. At some point, government spending must be the engine that pulls the economy out of recession...
But it must be the right kind of spending. It must draw real resources out of the economy--that is the only kind of spending that will work. ..."
http://economistsview.typepad.com/economistsview/2008/12/what-would-keyn.html
http://www.forbes.com/opinions/2008/12/04/depression-deflation-velocity-oped-cx_bb_1205bartlett.html
From Thoma/Forbes/Bartlett:
"Every day that goes by makes clearer the parallels between the current financial crisis and the one that led to the Great Depression. Then, as now, the core problem was one of deflation... What few people understood at the time was that the Federal Reserve was primarily responsible for the deflation...
In its initial stages, the Fed might have been able to prevent a full-blown depression by being a lender of last resort. It should have been aggressive about buying every financial asset it could lay its hands on and created as much money as necessary to do so. But it ... was passive and, as the value of financial assets collapsed, banks closed and vast amounts of wealth simply vanished.
The money simply disappeared, because there was no federal deposit insurance in those days. According to ... Milton Friedman and Anna Schwartz, the nation's money supply fell by one-third between 1929 and 1933, which induced a 25% fall in price levels...
As prices fell, businesses were forced to sell goods for less than they cost to produce. They couldn't cut costs easily because that meant reducing wages, which workers naturally resisted. Layoffs were the only way to cut costs, but this meant workers didn't have any income with which to buy goods, since there was no unemployment compensation either. This created a downward spiral that proved very difficult to stop. ...
The decline in wealth also reduced spending, and the fall in prices had the effect of magnifying debts. Debtors were forced to repay loans in dollars worth 25% more than those they borrowed in the first place. Farmers ... were especially hard hit. In effect,... they took out loans that were worth X number of bushels of wheat and ... they needed 25% more bushels to repay. ...
When the rate of deflation exceeds the nominal interest rate,... no one is going to lend money at a negative nominal rate; they will just hold on to it. When this happens, we have what economists call a liquidity trap, and the Fed cannot inject liquidity into the economy to stop the deflation. ...
Another problem that policymakers back then didn't grasp is that the money supply's effectiveness depends on how quickly people spend it; something economists call velocity. If velocity falls because people are hoarding cash, it may require a great deal more money to keep the economy operating. ...
This is essentially the problem we have today. Unlike in the 1930s, the Fed is not allowing the money supply to diminish. ... But velocity is collapsing. Banks, businesses and households are all hoarding cash, not spending except for essentials. This is bringing on the deflation that is crippling the economy. ...
The problem today is that velocity is falling faster than the Fed can pump up the money supply by buying financial assets... What Keynes figured out is that when conditions such as these exist, the federal government must step in to raise spending in the economy and thereby increase velocity. This means running a budget deficit, but that is only part of the solution. ...
We also know from the experience with tax rebates in 1974, 2001 and 2008 that this doesn't do any good, either. People mostly save the money...
Keynes argued that the only thing that will really work is if the federal government uses its resources to purchase goods and services. It must buy "stuff"--concrete, computers, paper, glass, steel--anything as long as it is tangible. In other words, the government must spend the way households do, by buying things. ... This is what ends an economic crisis. Unfortunately, it was not until World War II that the federal government spent enough on real resources ... to make Keynes' theory work in practice.
The challenge for Congress and the Obama administration will be to devise a spending program that draws a significant amount of real resources out of the economy fast enough. A massive public building program would be one way, but that will take more time to gear up than we may have. ... We need something today that can affect the economy within months. ...
For what it's worth, Keynes didn't know what to do in this situation, either. He suggested building pyramids and burying bank notes in deep mine shafts that had been filled in. As people tried to dig up the money, they would be forced to employ labor and purchase equipment that would raise spending and thereby growth. In the end, it took the greatest war in history to make Keynes' theory work. ...
We ... have the advantage of important institutions like deposit insurance and much better leadership at the Fed. But in the end, there is a limit to what the Fed can do by itself. At some point, government spending must be the engine that pulls the economy out of recession...
But it must be the right kind of spending. It must draw real resources out of the economy--that is the only kind of spending that will work. ..."
http://economistsview.typepad.com/economistsview/2008/12/what-would-keyn.html
http://www.forbes.com/opinions/2008/12/04/depression-deflation-velocity-oped-cx_bb_1205bartlett.html
Sunday, December 7, 2008
The Way To Not Avert a Depression
TW: I follow Pethokoukis as a way to keep track of reasonable right-wing economists. I did not care for these suggestions to averting a depression. They represent more or less unaltered right-wing dogma of the sort deployed extensively since 2001 by W. Bush. Somehow deploying more W. Bush economic policies does not seem a valid policy response.
From Pethokoukis at US News World Report advocates:
"...Tax cuts can work much faster. Withholding schedules can be changed. Payroll tax deductions stopped. In addition, there should be a tax holiday for corporate taxes along with a big rate cut. All this would boost confidence and let individuals and business keep more of what they earn. Fear is killing this economy."
TW: I agree tax cuts can be implemented faster than some but not all spending initiatives (i.e. aid to states to prevent layoffs and service cuts could be implemented relative rapidly as well, if the states know the aid is coming they can avoid the cuts in the first place). But what about the lag once a tax cut is implemented. Conservatives seem to have the belief that tax cuts are magic wands that move the invisible hands of the beloved free market. In reality firms would integrate a future tax cut into their planning but amidst plummeting demand why would they hire more workers and build more plants? Hence why would a corporate tax cut actually help anything anytime soon.
Implementing payroll tax reductions for lower and middle class earners might have some value but as I have mentioned earlier we are in a scenario where the rational decision for an individual is to hoard one's nuts. Reducing payroll taxes would likely merely induce more hoarding (which is largely what happened with last summer's stimulus checks).
The fundamental purpose of government induced spending in a demand driven contraction to ensure someone actually spends, not saves. Yes there will be a lag which is why it will be so painful to watch W. Bush sit on his hands for the next six weeks. Obama must hit the ground running come January 20th.
http://www.usnews.com/blogs/capital-commerce/2008/12/5/november-jobs-report-533000-reasons-for-obama-to-change-direction.html
From Pethokoukis at US News World Report advocates:
"...Tax cuts can work much faster. Withholding schedules can be changed. Payroll tax deductions stopped. In addition, there should be a tax holiday for corporate taxes along with a big rate cut. All this would boost confidence and let individuals and business keep more of what they earn. Fear is killing this economy."
TW: I agree tax cuts can be implemented faster than some but not all spending initiatives (i.e. aid to states to prevent layoffs and service cuts could be implemented relative rapidly as well, if the states know the aid is coming they can avoid the cuts in the first place). But what about the lag once a tax cut is implemented. Conservatives seem to have the belief that tax cuts are magic wands that move the invisible hands of the beloved free market. In reality firms would integrate a future tax cut into their planning but amidst plummeting demand why would they hire more workers and build more plants? Hence why would a corporate tax cut actually help anything anytime soon.
Implementing payroll tax reductions for lower and middle class earners might have some value but as I have mentioned earlier we are in a scenario where the rational decision for an individual is to hoard one's nuts. Reducing payroll taxes would likely merely induce more hoarding (which is largely what happened with last summer's stimulus checks).
The fundamental purpose of government induced spending in a demand driven contraction to ensure someone actually spends, not saves. Yes there will be a lag which is why it will be so painful to watch W. Bush sit on his hands for the next six weeks. Obama must hit the ground running come January 20th.
http://www.usnews.com/blogs/capital-commerce/2008/12/5/november-jobs-report-533000-reasons-for-obama-to-change-direction.html
Saturday, December 6, 2008
The D Word
TW: Lets get this on the table, a depression. We need to get comfortable with it. Depressions are not the end of the world just very big bumps in the road. Reich is one of the first to go there in direct terms. Most media including bloggers are tipping toeing around it. One can safely assume it will turn into a trend now. The reason Reich and many others are getting jumpy is that the underlying numbers are far worse than the headline 6.7% unemployment and 500K jobs lost in November. More accurate unemployment reflecting under-employeds and non-job seeking but likely interested unemployeds would be 11% or 12%. Furthermore, the downward revisions on the Sept/Oct jobless were very high.
I was wondering the other day what is classified as a depression. I was somewhat surprised to find little on the topic. It appears to be one of those things that has taken on the mantle of a proper noun, something so bad as to avoid its utterance in proper company.
Recession and depression are two terms to describe economic contraction with the latter being worse obviously. But how much? Per the source attached below, a depression represents an economic contraction (as measured by GDP) of greater than 10%. The good news is that we are definitely not in that territory (yet). I believe we are down a net of 1% or so through Q3. The problem is that the big drop has occurred from late September on. I have seen estimates of a 3%-5% annualized drop in Q4 with expected significant contraction to continue well into next year. But those estimates are evolving rapidly and recently in only one direction.
I was also interested to read that prior to the Great Depression of my grandparents' generation that what we call recessions today were historically referred to as depressions as well. Post the Great Depression the nomenclature evolved to create a softer term for less drastic contractions, but previously all contractions were called depressions. Another point to recall is that the Great Depression truly earned its moniker. The Great Depression was really two depressions, a 33% contraction in the late '29 to early '33 period and another bonus contraction of 18% from mid '37 to mid '38.
Just as all recessions are not created equally not all depressions are either. So this one should it evolve into a depression will be different as well, but depression economics are different than normal times so beware those proposing laissez-faire policies. Stay tuned for more policy discussion. My fundamental point is that in these times one should get one's terms straight in order to confront reality whilst averting hyperbole.
http://robertreich.blogspot.com/2008/12/shall-we-call-it-depression-now.html
http://economics.about.com/cs/businesscycles/a/depressions_2.htm
I was wondering the other day what is classified as a depression. I was somewhat surprised to find little on the topic. It appears to be one of those things that has taken on the mantle of a proper noun, something so bad as to avoid its utterance in proper company.
Recession and depression are two terms to describe economic contraction with the latter being worse obviously. But how much? Per the source attached below, a depression represents an economic contraction (as measured by GDP) of greater than 10%. The good news is that we are definitely not in that territory (yet). I believe we are down a net of 1% or so through Q3. The problem is that the big drop has occurred from late September on. I have seen estimates of a 3%-5% annualized drop in Q4 with expected significant contraction to continue well into next year. But those estimates are evolving rapidly and recently in only one direction.
I was also interested to read that prior to the Great Depression of my grandparents' generation that what we call recessions today were historically referred to as depressions as well. Post the Great Depression the nomenclature evolved to create a softer term for less drastic contractions, but previously all contractions were called depressions. Another point to recall is that the Great Depression truly earned its moniker. The Great Depression was really two depressions, a 33% contraction in the late '29 to early '33 period and another bonus contraction of 18% from mid '37 to mid '38.
Just as all recessions are not created equally not all depressions are either. So this one should it evolve into a depression will be different as well, but depression economics are different than normal times so beware those proposing laissez-faire policies. Stay tuned for more policy discussion. My fundamental point is that in these times one should get one's terms straight in order to confront reality whilst averting hyperbole.
http://robertreich.blogspot.com/2008/12/shall-we-call-it-depression-now.html
http://economics.about.com/cs/businesscycles/a/depressions_2.htm
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