July 22, 2002
Paul Krugman Tells Bush What To Do
Paul Krugman gives his view--a reasonable, sensible, and probably correct view--about what the government ought to be doing vis-a-vis the economy: another round of interest rate cuts to try to eliminate any danger of deflationary psychology taking hold, corporate reform, and a fiscal policy twist to stimulate the economy now with higher deficits and restore confidence in the long-run soundness of the government's tax and spending plans with surpluses later.
He then points out that this government will adopt such a program only when pigs fly. Put it this way: Bush didn't listen to his economic advisers when they pointed out the long-run fiscal requirements of Social Security and Medicare, he didn't listen to his economic advisers on the steel tariff, and he didn't listen to his economic advisers on the farm bill. What imaginable reason could there be to think that he will listen to his economic advisers--who are now, in all probability, telling him things very close to what Krugman is saying--now?
...Given the definitely iffy economic outlook, shouldn't Mr. Greenspan be thinking seriously about another interest rate cut? True, rates are already very low. But if there's one thing we've learned from Japan's experience, it is that when you face the risk of a deflationary trap -- still not the most likely scenario, but not as unlikely as it seemed a few months ago -- it makes no sense to "save your ammunition," holding interest rate cuts in reserve. The time to fight deflation is before it has time to get built into the nation's psychology. True, the Fed has been concerned that another cut would panic the markets. But now that the markets have panicked on their own, there's nothing to lose.
What about the rest of the government? Corporate reform is essential; if investors cannot be reassured that they are being treated fairly, they will take their money and go home. But we can't count on reform to provide an immediate boost to the economy; trust, once lost, cannot be restored in a moment. What else can the government do?
Let's ignore the politics and look at the situation objectively. On one side, thanks in part to the end of the bull market the long-run federal budget outlook has worsened to an extent that has surpassed the expectations of even the biggest pessimists (like yours truly). Realistically, we are looking at a decade of deficits, which will eventually pose serious problems for Social Security and Medicare. On the other hand, with the recovery still wobbly, this is no time for fiscal austerity -- if anything, right now the federal government ought to be pumping more money into the economy than it is. The obvious answer to this seeming dilemma is to loosen the reins now, but prepare to tighten them once the economy has fully recovered. For example, the Bush administration could move quickly to aid distressed state governments, avoiding harsh (and contractionary) cuts in essential programs. Meanwhile, to assuage worries about the long-run fiscal position, it could put on hold future tax cuts that were written into law back when visions of surplus sugarplums were still dancing in our heads. And after the administration takes these responsible steps, thousands of pigs will fill the skies over Washington.
Look at it this way: The Bush administration's economic plans have not changed significantly since the fall of 1999, when they were introduced as a way to ward off a challenge from Steve Forbes. Back when the tax cut that eventually became law was announced, "Dow 36,000" was climbing the best-seller lists. The economic environment has changed completely; the administration's plans haven't changed a bit. Our economic problems are real, but by no means catastrophic. What scares me is the utter inflexibility of the people who should be solving those problems.
July 23, 2002
Living With Bears
By PAUL KRUGMAN
t looks as if the authors of "Dow 36,000" — remember that? — may have had one digit too many in their title. Let's just hope it was an extra 3, not an extra 0.
The bull market is now well and truly over. In fact, if you adjust for inflation the S.&P. 500 — a much better measure than the overused Dow — is now below its level in late 1996, when Alan Greenspan gave his famous "irrational exuberance" speech.
So what should the responsible officials — Mr. Greenspan, George W. Bush and whatshisname, the Treasury secretary — be doing?
A good first step would be to stop trying to talk up the market by extolling the economy's fundamental strength. For one thing, it reeks of desperation. For another, stocks are still richly valued compared with earnings. Most important, the fundamentals aren't actually all that great. Doubts about corporate governance are growing, not fading away. State and local governments are in a desperate fiscal crisis. And even before the sudden plunge in the markets, the data were pointing not to a boom but to a "jobless recovery," in which the economy grows too slowly to make much if any dent in the unemployment rate.
Indeed, the report prepared in support of Mr. Greenspan's recent testimony projected no significant decline in unemployment this year, and not much decline next year. And in the face of plunging markets we have to worry whether even that forecast is overly optimistic.
Given the definitely iffy economic outlook, shouldn't Mr. Greenspan be thinking seriously about another interest rate cut? True, rates are already very low. But if there's one thing we've learned from Japan's experience, it is that when you face the risk of a deflationary trap — still not the most likely scenario, but not as unlikely as it seemed a few months ago — it makes no sense to "save your ammunition," holding interest rate cuts in reserve. The time to fight deflation is before it has time to get built into the nation's psychology.
True, the Fed has been concerned that another cut would panic the markets. But now that the markets have panicked on their own, there's nothing to lose.
What about the rest of the government? Corporate reform is essential; if investors cannot be reassured that they are being treated fairly, they will take their money and go home. But we can't count on reform to provide an immediate boost to the economy; trust, once lost, cannot be restored in a moment. What else can the government do?
Let's ignore the politics and look at the situation objectively. On one side, thanks in part to the end of the bull market the long-run federal budget outlook has worsened to an extent that has surpassed the expectations of even the biggest pessimists (like yours truly). Realistically, we are looking at a decade of deficits, which will eventually pose serious problems for Social Security and Medicare.On the other hand, with the recovery still wobbly, this is no time for fiscal austerity — if anything, right now the federal government ought to be pumping more money into the economy than it is.
The obvious answer to this seeming dilemma is to loosen the reins now, but prepare to tighten them once the economy has fully recovered. For example, the Bush administration could move quickly to aid distressed state governments, avoiding harsh (and contractionary) cuts in essential programs. Meanwhile, to assuage worries about the long-run fiscal position, it could put on hold future tax cuts that were written into law back when visions of surplus sugarplums were still dancing in our heads.And after the administration takes these responsible steps, thousands of pigs will fill the skies over Washington.
Posted by DeLong at July 22, 2002 09:28 PM | TrackBack
Look at it this way: The Bush administration's economic plans have not changed significantly since the fall of 1999, when they were introduced as a way to ward off a challenge from Steve Forbes. Back when the tax cut that eventually became law was announced, "Dow 36,000" was climbing the best-seller lists. The economic environment has changed completely; the administration's plans haven't changed a bit.
Our economic problems are real, but by no means catastrophic. What scares me is the utter inflexibility of the people who should be solving those problems.
What's missing from here, in an interesting way, is any proposals about the external value of the US dollar. Since I seem to remember Krugman called the top on the greenback a while ago, I thought he might have had something to say on this ...
Posted by: Daniel Davies on July 23, 2002 12:28 AMAnd if you go to www.janegalt.net, you'll see her 'Krugman watch', which will rack this up as another Bush-hostile column.
BTW, Brad, what is 'trackback'?
Posted by: Barry on July 23, 2002 04:28 AMGreat Daniel! You're close to the root of the problem. Krugman doesn't understand where the deflation is coming from. It's a monetary deflation which is hurting the broad economy. NOt the other way around.
Where was Krugman in 1997? It began in 1997 when Greenspan witheld desired liquidity from the banking system in the hopes of taming "irrational exuberance". I read over and over how Greeenspan should have "popped the bubble" in 97. He didn't just make a speech! He did try to pop the bubble by witholding money from the banking system. Gold dove and commodities followed. But when stock prices stayed high, even with his medicine, Greenspan decided that he had succeeded in squaring this circle.
The 1997-2001 deflation is creeping steadily through the system. It's a monetary deflation. It's crushing debtors. Bankruptcies had already reached a record in 1999. Until Krugman figures this out he will be in the dark.
Posted by: Eric M on July 23, 2002 07:00 AMIs there any evidence AGAINST the notion that tinkering with tax codes introduces destabilizing, investment-postponing uncertainty into the private sector; or that raising taxes (in the form of taking away cuts already scheduled) dampens and distorts economic activity?
When these are done with social engineering in mind, the goals seem consistent with the action. But when one seeks to support an ailing private sector, these nostrums seem counter-productive on their face.
Posted by: George Zachar on July 23, 2002 08:03 AMEric: In all fairness, in 1997, Krugman was suggesting drastic monetary easing, albeit that the context was Asia. I'm not sure which series you're getting the monetary deflation from; wasn't the puzzle between 1997-2001 that monetary aggregates were growing so quickly without seemingly fuelling CPI inflation.
George: Yes, plenty, mainly from emerging market countries admittedly, but something like the policies you criticise would certainly be part of any IMF programme for the USA, and for all their manifold faults, IMF programmes are actually very good news for emerging market countries as long as they are not in a crisis.
Posted by: Daniel Davies on July 23, 2002 08:18 AM>>wasn't the puzzle between 1997-2001 that monetary aggregates were growing so quickly
You are right that far from being a useful measure, the monetary aggregates predicted inflation that neer appeared.
I appreciate Krugman coming around to the deflation problem, but he is many years too late. I doubt that he relies on monetary aggregates though.
The change in money supply proved to be an inadequate measure of what was happening to the dollar, whereas the dollar price of gold accurately measured the demand for dollars. The dollar price of gold fell because demand for dollars was increasing, capital was needed to fuel the young companies getting started on Wall Street and elsewhere, and the Fed failed to provide the dollars needed.
Posted by: Eric M on July 23, 2002 08:42 AMAlthough I find the notion of a 'left wing' economist arguing for lower insterest rates ironic, I agree that Krugman has a good point. I disagree that this is Bush's call. In fact, I suspect that our fearless leader is more than releived that he doesn't have to make the call.
Greenspan's problem is political. He knows he must cut rates, but how does he do it without being accused of pandering to the rich by propping up the market? Any interest rate cut in this political atmosphere will not be viewed as injecting liquidity. It will be seen as pushing stock prices.
The other danger in cutting rates now is to continue to over inflate the real-estate bubble - the money flying out of equities seems to be flooding real estate.
I am starting to sign on to the Greenspatzian Ka-Poom deflation-inflation theory outlined in itulip.com.
Posted by: Suresh Krishnamoorthy on July 23, 2002 08:56 AMGeorge - we've already seen a large dose of whackiness and social engineering, with the Bush tax schemes. Nobody on the right is in a moral position to criticize altering it, on the grounds of 'uncertainty', or 'social engineering', unless they are on the record as having opposed it, back in 2000.
Posted by: Barry on July 23, 2002 11:36 AMThanks for clarifying that, "Barry".
Posted by: George Zachar on July 23, 2002 12:42 PMSorry, George, I didn't mean to be harsh, but I can't let you get away with casually locking in a policy with claims of 'uncertainty'. That's just a variation on 'what's mine is mine forever, what's yours is negotiable'.
Similarly for the 'social engineering' claim. The Bush tax cuts are a huge social engineering project.
Posted by: Barry on July 23, 2002 02:01 PMBy definition, the threat of shifting investments' payoff matrix downward [via the tax code], introduces uncertainty into the investment process. That, by definition, causes some investments to not be made, and alters others, usually into a scaled back mode.
And it is certainly fair to characterize any national govt policy as "social engineering", although that term is usually meant in the sense of the State expanding its sway over peoples' lives, not vice versa.
Posted by: George Zachar on July 23, 2002 02:42 PMWell George, there was the per child income tax credit. It cost a ton and has a negligible economic effect. Growth after all would have been the best thing for children and parents alike.
Posted by: Eric M on July 23, 2002 04:41 PMAre you saying the Bush-inspired tax cut was inadequate or sloppily crafted?
Posted by: George Zachar on July 23, 2002 05:32 PMGeorge, read Krugman's columns, in the NYT. They're worth reading.
Posted by: Barry on July 24, 2002 04:05 AMConveying a perspective at odds with Krugman doesn't mean I haven't read him.
Posted by: George Zachar on July 24, 2002 06:59 AMGeorge: But asking what was "sloppily crafted or inadequate" about the Bush tax plan when Krugman has repeatedly explained it in his columns does convey the impression you haven't read him. If you have an argument in favour of abolishing estate tax as the best stimulus to the economy, let's hear it; don't be coy and demand that other people carry out needless tasks of Krugman exegesis.
Posted by: Daniel Davies on July 24, 2002 07:42 AMI was simply asking Eric M to clarify his statement. I totally agreed with his point that "Growth after all would have been the best thing for children and parents alike".I suspected he meant that the kink in the tax code that he cited was an example of social engineering. I was prepared to agree with him.I didn't ask "what was" sloppy/inadequate. I asked if he, Eric, meant that he felt the Bush tax cut was "inadequate or sloppily drafted". I was prepared to agree with him on that as well.I'm not playing troll, honest.
Posted by: George Zachar on July 24, 2002 08:04 AMGiven Krugman's position on Japan, I understand why he might be concerned with the possibility of a "deflationary trap" (he means a Keynesian liquidity trap, right???). As far as I understand it, his concern is that the Fed won't be able to lower the prime rate enough to rescue the "nation's psychology" should the economy take an unexpected nose-dive and Greenspan is forced on the offensive.
Several points/questions.
Why should it matter to Krugman whether the stimulus is fiscal or monetary? To the point, why attack Bush for his tax cuts when advocating equally inflationary fiscal policies (the tax cuts are coming at the expense of future social welfare programs, not present social spending, right?)? This isn't a defense of Bush's tax cuts in any way -- it's a genuine question. Is Krugman expressing an unstated position on the morality of Bush's income tranfer to the uber-rich, or are there (and what are they?) good economic grounds for his preference?
Secondly, Krugman's working assumption appears to be that public confidence in the private sector can be improved by increasing the public sector debt in the short term, but that this same action will weaken investor confidence (in the private sector) in the long term. Is this "complex" view of how individuals perceive markets a conventional part of the neo-Keynesian (???) view of markets, etc.?
Posted by: david on July 24, 2002 03:21 PMDavid: I think Krugman's fundamental critique of the Bush tax cuts were a) they were targeted like a laser on a *very* small percentage of the population (it's not a moral point so much as the empirical fact that Bill Gates can't spend us out of recession all on his own) and b) they are amazingly back-loaded; the cash comes in a few years' time rather than right now.
Posted by: Daniel Davies on July 25, 2002 01:09 AMYes, Daniel. Additionally, that they were proposed using ridiculous economic projections, to hide the fact that they'd guarantee a deficit.
Posted by: Barry on July 25, 2002 05:41 AM