Posts Tagged ‘Larry Summers’

Writing in today’s Washington Post, former Obama economist Larry Summers put forth the strange hypothesis that more red ink would improve the federal government’s long-run fiscal position.

This sounds like an excuse for more Keynesian spending as part of another so-called stimulus plan, but Summers claims to have a much more modest goal of prudent financial management.

And if we assume there’s no hidden agenda, what he’s proposing isn’t unreasonable.

But before floating his idea, Summers starts with some skepticism about more easy-money policy from the Fed.

Many in the United States and Europe are arguing for further quantitative easing to bring down longer-term interest rates. …However, one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to undertake with rates reduced by yet another 25 or 50 basis points. It is also worth querying the quality of projects that businesses judge unprofitable at a -60 basis point real interest rate but choose to undertake at a still more negative rate. There is also the question of whether extremely low, safe, real interest rates promote bubbles of various kinds.

This is intuitively appealing. I try to stay away from monetary policy issues, but whenever I get sucked into a discussion with an advocate of easy money/quantitative easing, I always ask for a common-sense explanation of how dumping more liquidity into the economy is going to help.

Maybe it’s possible to push interest rates even lower, but it certainly doesn’t seem like there’s any evidence showing that the economy is being held back because today’s interest rates are too high.

Moreover, what’s the point of “pushing on a string” with easy money if it just means more reserves sitting at the Fed?

After suggesting that monetary policy isn’t the answer, Summers then proposes to utilize government borrowing. But he’s proposing more debt for management purposes, not Keynesian stimulus.

Rather than focusing on lowering already epically low rates, governments that enjoy such low borrowing costs can improve their creditworthiness by borrowing more, not less, and investing in improving their future fiscal position, even assuming no positive demand stimulus effects of a kind likely to materialize with negative real rates. They should accelerate any necessary maintenance projects — issuing debt leaves the state richer not poorer, assuming that maintenance costs rise at or above the general inflation rate. …Similarly, government decisions to issue debt, and then buy space that is currently being leased, will improve the government’s financial position as long as the interest rate on debt is less than the ratio of rents to building values — a condition almost certain to be met in a world with government borrowing rates below 2 percent. These examples are the place to begin because they involve what is in effect an arbitrage, whereby the government uses its credit to deliver essentially the same bundle of services at a lower cost. …countries regarded as havens that can borrow long term at a very low cost should be rushing to take advantage of the opportunity.

Much of this seems reasonable, sort of like a homeowner taking advantage of low interest rates to refinance a mortgage.

But before embracing this idea, we have to move from the dream world of theory to the real world of politics. And to his credit, Summers offers the critical caveat that his idea only makes sense if politicians use their borrowing authority for the right reasons.

There is, of course, still the question of whether more borrowing will increase anxiety about a government’s creditworthiness. It should not, as long as the proceeds of borrowing are used either to reduce future spending or raise future incomes.

At the risk of being the wet-blanket curmudgeon who ruins the party by removing the punch bowl, I have zero faith that politicians would make sound decisions about financial management.

I wrote last month that eurobonds would be “the fiscal version of co-signing a loan for your unemployed alcoholic cousin who has a gambling addiction.”

Well, giving politicians more borrowing authority in hopes they’ll do a bit of prudent refinancing is akin to giving a bunch of money to your drug-addict brother-in-law in hopes that he’ll refinance his credit card debt rather than wind up in a crack house.

Considering that we just saw big bipartisan votes to expand the Export-Import Bank’s corporate welfare and we’re now witnessing both parties working on a bloated farm bill, good luck with that.

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There’s an old saying that insanity is doing the same thing over and over again while expecting different results. This certainly is a good description of Keynesians, who relentlessly push more government spending as some sort of magic potion for the economy – notwithstanding a record of failure.

The latest example if Larry Summers, the former economist for the Obama White House, who says Europeans need to make government bigger.

Here is some of what he writes for today’s Washington Post.

European efforts to contain crisis have fallen short. …Much of what is being urged on and in Europe is likely to be not just ineffective but counterproductive to maintaining the monetary union, restoring normal financial conditions and government access to markets, and reestablishing economic growth. The premise of European policymaking is that countries are overindebted and so unable to access markets on reasonable terms, and that the high interest rates associated with excessive debt hurt the financial system and inhibit growth. The strategy is to provide financing while insisting on austerity, in hopes that countries can rein in their excessive spending enough to restore credibility, bring down interest rates and restart economic growth.

The good news is that Summers recognizes that there has been “excessive spending.” The bad news is that he uses the wrong definition of austerity.

Many European nations seem to think higher taxes are a sign of fiscal conservatism (see this post by Veronique de Rugy for a good discussion of this confusion). Summers accepts that approach, and says that policy makers should choose a Keynesian policy instead.

Unfortunately, Europe has misdiagnosed its problems in important respects and set the wrong strategic course. …Europe’s problem countries are in trouble because the financial crisis underway since 2008 has damaged their financial systems and led to a collapse in growth. High deficits are much more a symptom than a cause of their problems. And treating symptoms rather than underlying causes is usually a good way to make a patient worse. …The right focus for Europe is on growth; in this dimension, increased austerity is a step in the wrong direction.

There’s more good news. Summers is right in stating that Europe suffers from low growth. And I agree with him that the European version of austerity – higher taxes – is not a solution.

But, as always, there is a catch. Summers has the wrong approach on how to encourage growth. He wants Keynesian spending, and here is his defense.

 Skeptics will rightly wonder how a prescription for more spending by countries that already have trouble borrowing can be correct. The answer lies in the difference between borrowing by individuals and countries. Normally, an individual helps his creditors by borrowing less; but a person who stops borrowing to finance commuting to his job does his creditors no favor. A country’s income is determined by spending, so a country that pursues austerity to the point where its economy is driven into a downward spiral does its creditors no favor.

Sounds semi-reasonable. After all, everyone understands that it is important to get to their place of employment. Sometimes you spend money to make money.

But here’s the problem. Can anyone name anything in so-called stimulus schemes that actually increase a nation’s productive capacity? As we saw with Obama’s failed stimulus, lots of money gets distributed, but the main purpose seems to be buying votes and creating dependency.

What about jobs? A miserable failure.

Adding insult to injury, you probably won’t be surprised to learn that American taxpayers are supposed to pick up the lion’s share of the tab for the new spending in Europe since Summers wants the IMF to be the sugar daddy.

Going forward, the IMF and international community should condition further support not merely on individual countries’ actions but on a common European commitment to growth.

This approach is illogical, as explained in this video.

And let’s consider the historical record. Nations that have tried this type of “stimulus” have not fared well. Big spending increase under Hoover and Roosevelt failed in the 1930s. Japan tried several Keynesian packages and failed in the 1990s. Bush failed in 2008 and Obama failed in 2009.

Germany did not go with a big program of government spending, and they did better than the United States. The same is true about Canada. But the real success story is the Baltic nations. They imposed real spending restraint, not the fake austerity found in places such as the United Kingdom.

And even though it caused some short-term pain since there’s a short-term cost when labor and capital get redeployed to more productive uses, the Baltic nations are now in much better shape that the European nations that have floundered because they limited themselves to the no-win choice of Keynesianism and tax hikes.

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The two main political parties are sniping at each other about the just-concluded tax deal, largely because Republicans are happy and Democrats are displeased that all of the 2001/2003 tax cuts are being extended for all taxpayers.

Almost nobody is paying attention to the new spending that is in the agreement, however, most notably the 13-month extension of unemployment benefits. And to the extent anybody is paying attention, a small handful of fiscal conservatives wanted to offset that new spending by reducing spending someplace else.

That sentiment is laudable, but somebody should be pointing out that this policy actually is bad news for workers. Here are some excerpts from a Wall Street Journal story, which reports on a study from the San Francisco Federal Reserve Bank.

A recent study by the Federal Reserve Bank of San Francisco found the unemployment rate at the end of 2009 would have been nearly half a percentage point lower—9.6%, instead of 10%—if jobless benefits hadn’t been extended beyond their usual 26 weeks to as much as 99 weeks. …The extension of jobless benefits is likely to worsen that trend for at least several months. For one, individuals not actively searching for work or willing to take available jobs may claim they are unemployed in order to receive benefits. That could artificially boost the size of the labor force, which is used to determine the unemployment rate. Another concern, as the San Francisco Fed notes, is that the extension of jobless benefits may “reduce the intensity” with which the unemployed search for work. Longer term, this could lead to a higher level of structural unemployment in the economy as workers’ skills erode.

Some leftists may think this is propaganda from free-market purists, yet the San Francisco Fed certainly does not have a reputation for libertarian views. Nonetheless, perhaps it would be a good idea to see what some other people have to say. Here’s what one well-known economist wrote in a textbook.

Public policy designed to help workers who lose their jobs can lead to structural unemployment as an unintended side effect. . . . In other countries, particularly in Europe, benefits are more generous and last longer. The drawback to this generosity is that it reduces a worker’s incentive to quickly find a new job. Generous unemployment benefits in some European countries are widely believed to be one of the main causes of “Eurosclerosis,” the persistent high unemployment that affects a number of European countries.

Was this Milton Friedman? Ludwig von Mises? Nope, the author of this mean-spirited right-wing bile is Paul Krugman. And here’s something else written by an economist about the impact of unemployment benefits.

Empirical evidence shows that two causes are welfare payments and unemployment insurance. …unemployment insurance increases the measure of unemployment by inducing people to say that they are job hunting in order to collect benefits. The second way government assistance programs contribute to long-term unemployment is by providing an incentive, and the means, not to work. Each unemployed person has a “reservation wage”—the minimum wage he or she insists on getting before accepting a job. Unemployment insurance and other social assistance programs increase that reservation wage, causing an unemployed person to remain unemployed longer. …Unemployment insurance also extends the time a person stays off the job. Clark and I estimated that the existence of unemployment insurance almost doubles the number of unemployment spells lasting more than three months. If unemployment insurance were eliminated, the unemployment rate would drop by more than half a percentage point, which means that the number of unemployed people would fall by about 750,000. This is all the more significant in light of the fact that less than half of the unemployed receive insurance benefits, largely because many have not worked enough to qualify.

Who wrote this? A Tea Party fanatic? A knuckle-dragging GOP Congressman? Hardly, this passage was penned by Larry Summers, the outgoing Chairman of Barack Obama’s National Economic Council.

Given their partisan leanings, you won’t be surprised that Krugman and Summers now semi-disavow their academic writings on this issue, claiming that somehow their analysis does not apply in the current situation. But the bottom line is that incentives matter. If you pay people to remain unemployed, they will have less reason to find a job. The only real issue is the degree to which unemployment benefits increase joblessness.

This doesn’t imply that lawmakers should do nothing about unemployment, but it does suggest that their focus should be on pro-growth policies that will facilitate job creation. Permanently lower tax rates would help, as would reduction in government spending so that more resources would be available for the economy’s productive sector. Trade liberalization and deregulation also would be a good idea.

Unfortunately, all these ideas reduce the power of the political elite, so they are not nearly as popular in Washington as unemployment benefits.

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