Expectations, Monetary Policy, and Austerity

Mike Konczal has a piece at Wonkblog arguing that we are witnessing a great natural experiment that will help us determine whether expansionary monetary policy can offset contractionary fiscal policy:

We rarely get to see a major, nationwide economic experiment at work, but so far 2013 has been one of those experiments — specifically, an experiment to try and do exactly what Beckworth and Ponnuru proposed. If you look at macroeconomic policy since last fall, there have been two big moves. The Federal Reserve has committed to much bolder action in adopting the Evans Rule and QE3. At the same time, the country has entered a period of fiscal austerity. Was the Fed action enough to offset the contraction? It’s still very early, and economists will probably debate this for a generation, but, especially after the stagnating GDP report yesterday, it looks as though fiscal policy is the winner.

Paul Krugman agrees.

Ryan Avent responded, noting that most monetary policy advocates were encouraged by the recent Fed actions, but almost no one argued that they would be sufficient.

Ryan Avent's post is worth reading in full, but I would add one thing. Market monetarists (and other monetary policy advocates) believe that the most important aspect of monetary policy is the expectations channel and the explicit statements from the Federal Reserve. What Ben Bernanke says is as important as what the FOMC does. With that in mind, it is worth looking at Bernanke's actual comments about fiscal tightening. Here is what he said about the fiscal cliff:

I hope it won't happen, but if the fiscal cliff occurs, as I've said many times, I don't think the Fed has the tools to offset that event.

And here is what he said about the sequester:

Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant.

What Bernanke was saying was that the public shouldn't expect the Federal Reserve to increase monetary stimulus in a manner sufficient to offset fiscal tightening and keep nominal spending on track. For those who believe the expectations channel is paramount, the fiscal tightening of 2013 should damage the recovery, because Ben Bernanke said it would.

The joke is that Ben Bernanke agrees with Mike Konzcal that monetary policy can't offset fiscal tightening. The market monetarists just believe they are both wrong.

I don't want to pretend this doesn't set a really high bar for falsifiability of market monetarist ideas, it does. I also agree with Mike Konzcal, that as a practical matter, active fiscal stimulus combined with a federal reserve that tolerates higher inflation is probably a more credible way to boost nominal spending expectations. But as a theoretical matter I don't think the first few months of 2013 settle anything.

You go to the sequester with the Democratic Party you have

Ezra Klein has a good piece on the decision by the Democratic party to allow a bill that would ease the pain of sequestration for the FAA:

Recall the Democrats’ original theory of the case: Sequestration was supposed to be so threatening that Republicans would agree to a budget deal that included tax increases rather than permit it to happen. That theory was wrong. The follow-up theory was that the actual pain caused by sequestration would be so great that it would, in a matter of months, push the two sides to agree to a deal. Democrats just proved that theory wrong, too.
...
It is worth noting how different the Democrats’ approach to sequestration has been to the GOP’s approach to, well, everything. Over the past five years, Republicans have repeatedly accepted short-term political pain to win the leverage necessary for long-term policy gain. That’s the governing political principle behind their threats to shut down the government, breach the debt ceiling, and, for that matter, accept sequestration. Today, Democrats showed they’re not willing to accept even a bit of short-term pain for leverage on sequestration. They played a game of chicken with the Republicans, and they lost. Badly.

For the most part, I agree with this analysis. But its worth pointing out that the different tactics adopted by the Democrat and Republican parties reflect different underlying philosophies of government, and longer term strategic aims.

The basic philosophy of the Democratic party is that capitalism basically works but under-produces public goods, over-produces negative externalities, can become unstable if not properly regulated, and can lead to gross inequality. Their governing philosophy is that government can effectively overcome these problems through a combination of regulation, the pricing of externalities, the subsidization of public goods, and the provision of a progressive social safety net.

The Republican party has a political philosophy that is less concerned about the weaknesses of capitalism. But more importantly, they also believe that government is incapable of solving these problems effectively. And this is what they focus on politically. Republicans seek to demonstrate that government is wasteful, corrupt, and ineffective at solving problems, and so the less government the better. This is a good strategy because Americans are generally more skeptical of government than other wealthy, democratic countries.

With this is mind, it is easy to see why the Democrats aren't going to be very good at the type of political chicken the Republicans have mastered. By allowing FAA delays to continue, the Democrats help the Republicans (albeit, in a small way) make the case that government is incompetent and doesn't work. Now I don't want to let the Democrats off the hook. It strikes me that it was probably worth it to hold the line in this particular case, as Klein notes:

The result is that sequestration is no longer particularly politically threatening, but it’s even more unbalanced: Cuts to programs used by the politically powerful will be addressed, but cuts to programs that affects the politically powerless will persist.

This is a really horrible outcome, and the most vulnerable in our society will suffer because of these cuts.

But a big lesson is that these types of standoffs are stacked against the Democratic party, and they should do everything to try to avoid them.

One could imagine an alternate universe with a more aggressively leftist Democratic party. This party could have been the one in summer 2011 that was refusing to raise the debt ceiling (and pay wealthy bondholders), unless the government increased stimulus spending. This would be a party willing to more aggressively harm the interests of the business class, in order to secure benefits for the poor. But that would be a different Democratic party than the one we have, and probably one less likely to secure large majorities.

Effective, non-corrupt governance is hard, and most places throughout history and the world have been/still are terrible at it. A few countries in the world, for a brief moment in time, have managed to build effective institutions and establish good norms of governance. The United States is one of them. The Democrats have shouldered the burden of continually demonstrating this. And as long as they do, they will always be the center-left technocrats who cave on these issues.

Did the Bush Tax Cuts Make it More Difficult to Deal with the Recession?

A number of political commentators have spent the week evaluating the presidency of George W. Bush. I agree with the liberal consensus that, all said and done, Bush was a really bad president. But I find one aspect of the liberal critique unpersuasive. A number of commentators claim that the Bush tax cuts hampered our ability to respond to the 2008 financial crisis with appropriate fiscal stimulus. For example, Jonathan Chait:

His massive increase of the structural budget deficit, which ballooned to over a trillion dollars before President Obama took office, left the United States less fiscally equipped to respond to the economic crisis . . . (emphasis mine)

And Dylan Matthews:

It’s also worth noting that Bush was increasing the deficit at a time when the economy was expanding — which is exactly the opposite of what Keynesians believe makes sense, and which also made it more difficult for the country to respond to the recession. (emphasis mine)

This could be true for two reasons, both of which seem unsupported: 1) the accumulated debt could have created economic barriers to more fiscal stimulus; or 2) the accumulated debt could have created political barriers to more fiscal stimulus.

Despite high debt levels, the U.S. government would have no trouble enacting a deficit financed stimulus plan. Interest rates are some of the lowest they have ever been, and there has been no appearance of the dreaded "bond vigilantes" demanding greater fiscal prudence. Nor has there been any evidence of looming hyperinflation. Some have cited economic studies suggesting that higher debt leads to slower growth. But Excel problems with Reinhart & Rogoff's study aside, the bigger issue is that (as they note) their empirical work doesn't demonstrate that high debt causes slow growth. Overall, there is just little evidence that extra debt racked up by the Bush tax cuts were a real economic barrier to more aggressive fiscal stimulus.

Whether or not the Bush tax cuts made fiscal stimulus more difficult politically is a tougher question to answer definitively, but there are a few facts that suggest it didn't. When Obama was trying to pass the American Recovery and Reinvestment Act ("the stimulus"), he faced exceptionally strong opposition from Republicans. As Mike Grunwald recounts in his great book "The New New Deal", the basis of the opposition was political--the Republicans didn't want to deal with Obama and came up with a strategy to reject any plan he brought forward. As a result, the bill passed the house with no Republicans votes, and only narrowly avoided the filibuster with the support of three Republicans. One could argue that the Republicans were mainly concerned with debt levels, but both House and Senate Republicans had stimulus plans around the same size as Obama's. During the 2008 election, Mitt Romney had the largest stimulus plan. This suggests that Republicans weren't primarily concerned with debt, and so in an alternate universe where the Bush tax cuts never happened, it is unlikely likely that they would have supported a bigger stimulus.

But could Obama's stimulus have been bigger without the Bush tax cuts? As Grunwald describes, the size of the stimulus was originally constructed based on assumptions that underestimated the size of the collapse. However, ultimately the bill was capped by four senators (Nelson (D), Snowe (R), Specter (R), Collins (R)) who negotiated together to keep the bill at $800 billion dollars. How did they decide on that number? It's hard to say, but based on Grunwald's reporting the number was just basically something they all agreed to. Nowhere in the reporting do I remember aggregate U.S. debt levels being their main consideration, rather they were focusing on the size of this particular bill. Furthermore, all four of these Senators voted in favor of the Bush Tax cuts (except one "no" vote by Snowe on the 2003 cuts), so its hard to credit their decision to cap the stimulus as being based on fiscal prudence.

Two years, and a few smaller stimulus bills, later, the Republicans retook the house. During the lame duck session, congress passed the cumbersomely named Tax Relief, Unemployment Insurance, and Job Creation Act of 2010, along bipartisan lines (with most of the "no" votes coming from Democrats). The bill basically traded a temporary extension of the Bush tax cuts, in exchange for extending unemployment insurance, adding a payroll tax cut, and extending a bunch of items from the stimulus package. This was the only major bipartisan stimulus effort that was successfully enacted during Obama's tenure. And its arguable that it was made possible by the Bush Tax cuts, whose expiration forced the Republicans to the table. It's possible that, absent the Bush tax cuts, Obama still could have come up with a deal, but it would have been much harder to thread the needle between Democrats, who opposed the higher end tax cuts, and Republicans, who weren't interested cooperating with Obama. At the very least, the expiring Bush tax cuts framed the deal-to-be nicely and brought everyone to the table.

A few weeks later, the Republicans took over the House and have largely refused to deal with Obama. Stimulus has been out of the question. Obama may have been less eager to turn toward deficit reduction if the aggregate debt level was lower, but I'm skeptical for a few reasons reasons. First, most of Obama's focus has been on reforming entitlement programs, whose long term actuarial balances aren't really affected by the Bush tax cuts. Second, even with lower aggregate debt, debt/GDP ratio would have still shot up in 2008-10 (though not as high) and deficits would still have been very large. It's likely that their still would have been public pressure to reduce deficits. The idea of austerity always seemed like more of an ideological bias than a practical response to economic conditions. Third, even without Obama's rhetorical support for balanced budgets, I doubt he could have made a stimulus deal with the House Republicans.

The Bush tax cuts were bad policy. They were regressive. They increased deficits exactly when they shouldn't have (during a period of strong economic growth). The Heritage Foundation and the Bush Administration claimed they would pay for themselves, and they didn't, revealing flaws in supply-side economic thinking. When the economy finally recovers, and interest rates return to normal levels, that borrowing will have to be paid for.

But they didn't create the financial collapse. And they didn't hamper our ability to use fiscal stimulus to promote recovery. The response to the financial collapse was the result the political conditions of 2009-2011.

Update:  A response from 4:17am

Decline of House GOP Influence

Robert Costa had a good piece yesterday on the self proclaimed "Gang of Six" house conservatives who are attempting to build momentum to block immigration reform:

King and his crew are not driving the negotiations, and they increasingly feel like outsiders within their own party. “The meetings of the Gang of Eight and the secret meetings in the House of Representatives — the people who have been standing up for the Constitution and the rule of law haven’t been invited to those meetings,” King tells the assembled group of reporters. The other huddlers — Michele Bachmann (Minn.), Lou Barletta (Pa.), Mo Brooks (Ala.), Louie Gohmert (Texas), and Dana Rohrabacher (Calif.) — nod and grimace. 

I think we will all look back on 2011-12 as the high point of house Republican obstruction. As I have written about before, the house Republicans were quite successful at preventing further fiscal stimulus, slowing overall government spending, and making climate change legislation a non-starter.

But from the very beginning, Boehner has been steadily losing power. Conservatives were constantly concerned that he was going to "sell them out" during negotiations with the White House. Over time, the White House lost faith that he was actually speaking for the house conservatives and could deliver votes. This culminated in a series of dangerous budget standoffs and a mechanism intended to force bipartisan agreement--sequestration--actually being enacted.

Over the past 20 years, conservatives moved the Republican party to the right, encouraged discipline, and consolidated power within the leadership. To do this, they primaried Rockefeller Republicans, placed term limits on subcommittee and committee chairmanships, and instituted the "Hastert Rule"--a policy of the Republican leadership to not bring a bill to the floor unless it had the support of the majority of the Republican caucaus. The idea was to prevent legislation from being passed with mostly Democratic votes.

This came to a head at the end of 2012, when John Boehner, in order to avoid going over the "fiscal cliff", allowed a bill to come to the floor that did not have the support of the majority of the Republican caucaus. The bill passed with mostly Democratic votes, and conservatives flipped out (even though it was technically a tax cut for all but the highest-income Americans). Since that vote, Boehner has brought a few more items to the floor that did not have majority Republican support (Violence Against Women Act, Hurricane Sandy Relief). This has created the precedent for what is now being called the "Boehner Rule":

However, sometimes the Republican leadership in the House really does want something to pass. For these bills, as George Washington University’s Sarah Binder has said, the speaker has instituted a “new Boehner Rule”: Make the Senate go first. After all, given the 60 vote Senate (thanks to filibusters on everything) and a 55 Senator Democratic majority, nothing can get through that chamber without support from both parties. That is, it will generally require some sort of deal between most or all of the Democrats and at least some of the more moderate Republicans. After a bill passes in the Senate, Speaker Boehner calls up that product for a vote and, at least so far, has been able to get a similar result in the House—that is, lots of Democrats and enough Republicans to put it over the top. Hastert Rule violated, replaced by the Boehner Rule.

Furthermore, in order to mollify conservatives, Boehner has agreed to stop negotiating with Obama. The hardline Republicans love this, but in reality it cuts the house GOP out of the legislative process. Now major pieces of legislation are hammered out by bipartisan-minded Senators (Manchin-Toomey, Gang of Eight), passed through the Senate, and then sent over to the house.

The question is will Boehner allow a vote on these two major Senate bills? He's in a real bind. On the one hand, these deals are to the left of a hypothetical deal negotiated by Obama and Boehner (who is further to the right than most Republican senators). On the other hand, he has committed himself to not negotiating with Obama. In 2011-12 he was able to try to spin breakdowns in negotiations as the product of Obama's unwillingness to compromise. But once these bills have been passed (in a bipartisan fashion) by the Senate, he can't really make this argument.

In the Costa article, Michelle Bachman is quoted as saying “why aren’t we just introducing one bill that says we need to fully secure the borders?” This is her plan. Ignore public opinion, avoid the politically possible, and pass bills through the house that will never pass the Senate.

But Boehner is more politically savvy than she is, and recognizes that refusing to grant a vote to a Senate-approved measure will make the house Republicans look even more obstructionist and could be very damaging during the mid-terms. Obama has capitalized on Boehner's dillema, by framing the issue rhetorically around the idea that "they deserve a vote".

Its begun to appear that house conservatives have undermined their own influence. By failing to support Boehner's efforts to bargain with Obama, they have created a very challenging position for the Republican leadership. Either accept the obstructionist label and refuse to allow a vote, or let it pass with mostly Democratic votes.

Rand Paul and Voting Rights

I really liked this Jamelle Bouie post on Rand Paul's speech at Howard University. But to understand some of the current political alignments in America, its worth comparing Paul's stances on voting rights and gun rights. Here he is on voting rights (via Dave Weigel):

Paul tried to explain the larger context—something a Howard student, who has to take an African-American studies course in order to graduate, might have known already. "It's important to know the history of what happened," said Paul. "Democrats in the South were very, very harsh. They did have tests at the polls." But "I think if you liken using a driver's license to a literacy test, you demean the horror of what happened in the '40s and the '50s—maybe from 1910 to 1960s in the South. It was horrific. No American is favor of that. No Republican is in favor of that. But showing your driver's license to have an honest election? I don't think that's unreasonable." (emphasis mine)

Here he is on gun rights:

I oppose legislation that undermines Americans' constitutional right to bear arms. I worry that legislation mandating more regulations on law-abiding citizens will lead to an infringement on the ability to exercise constitutional rights without being subject to government surveillance.

When it comes to the right to bear arms, any regulation that potentially limits the ability of individuals to acquire guns is suspect and viewed as infringing on the constitutional right to bear arms. But when it comes to voting, he just doesn't have the same level of concern, and applies a more pragmatic "reasonableness" test. 

Now the reverse is certainly true, Democrats care more about the right to vote than the right to bear arms. But that is (in part) why groups like African-Americans support the Democrats in such large numbers. African-Americans really care about the right to vote and are very sensitive (for valid and obvious historical reasons) to legislation--that is facially race-neutral--being used as a tool of disenfranchisement. Rand Paul (and Republicans generally) don't have the same concerns, and you can see that from the pragmatic argument he is making above. At the same time, the core constituencies of the Republican party are really worried about their guns being taken away by the government, so much so that they oppose a lot of pragmatic efforts to reduce gun violence. 

If Rand Paul wants to attract African-American voters to the Republican party, while maintaining his libertarian ideology, he need to apply the same level of concern to voting rights as he does to gun rights.

Obama's Budget and Chained-CPI

There is a lot of good commentary about why Obama putting chained-CPI in his budget is bad politics. But I think one of my main concerns is that it (partially) adjusts expectations about where the "liberal" and "conservative" positions are on this issue.

Obama put chained-CPI in his budget not to state a policy preference, but rather to endorse what he believes could be the outline for a fair proposal. This isn't really what a budget is for. A budget is for laying out a broad policy vision that makes clear your general spending and taxing priorities. If you want to let the public know you endorse compromising some of your goals to achieve other ones, you leak that information to the press during budget negotiations. This is exactly what Obama did last December during the fiscal cliff talks.

Obama is the President, but he is also the de facto leader of the Democratic party. By putting chained-CPI in his budget, he has shifted the party's stance on entitlement spending to the right. Its not inconceivable that Republicans are going to be able to paint any Democratic candidate who runs in 2016 on a platform of not cutting entitlement programs as an extremist. "Even Obama was willing to endorse chained-CPI" could be an effective attack.

I've generally been in favor of a lot of the compromises Obama has made over the last four years, but to announce the compromise you are willing to make ahead of time as part of a budget is both a tactical and strategic error.

The Politics of Immigration Reform

Ezra Klein blogged recently that the politics of immigration reform may actually be positive-sum, with both Democrats and Republicans gaining from its passage. Brian Beutler disagrees, arguing instead that either the Democrats or Republicans will be hurt by its passage (probably Republicans), and even though both parties think they will benefit, one them is simply wrong.

I'm more inclined to agree with Beutler, but I think it may be a little more complicated. Currently Hispanic citizens overwhelming vote for Democrats. If immigration reform passes, than there will eventually be more Hispanic citizens who will also generally vote for Democrats. At the same time, the Republicans perceive that Hispanic citizens don't vote for them because their hostility to immigration reform reflects a latent racism. They seem to feel that they could win back some of these Hispanic voters by dispelling this image. However, most Republicans understand that even if this happens they will be unlikely to "win Hispanic voters" outright (i.e. receiving over 50% of the Hispanic vote).

The ideal outcome for Democrats politically is for immigration reform to pass. The ideal outcome for Republicans politically is for immigration reform not to pass, but to fail in a way that makes it seem like Republicans aren't virulently hostile to undocumented immigrants or Hispanics generally. That way they may make some gains in the Hispanic vote (maybe a few percentage points), but won't add large numbers of new Hispanic voters to the populace.

That is the political context against which I view comments like these by Ted Cruz:

President Obama is pushing a path to citizenship as a "poison pill" to prevent meaningful immigration reform, Sen. Ted Cruz (R-Texas) charged Monday.

"The part that I’ve got deep concerns about is any path to citizenship for those who are here illegally," Cruz said during an interview with Sean Hannity. "I think that is profoundly unfair to the millions of legal immigrants who have followed the rules, who have waited in line.

"I think the reason that President Obama is insisting on a path to citizenship is that it is designed to be a poison pill to scuttle the whole bill, so he can have a political issue in 2014 and 2016. I think that's really unfortunate," continued Cruz.

Cruz is trying to kill the path to citizenship (which is essentially what comprehensive immigration reform is), but making it seem like it's actually Obama who is scuttling the bill. Even Rubio seems to be stalling the bill, claiming that everyone is agreeing to things too quickly. 

Now immigration reform may pass, lots of business groups on the Republican side favor this policy on substantive grounds, but I think the politics lean against it.

The Tea Party Case for Higher Capital Requirements

This Atlantic Wire piece on the Cypriot bail-in and Tea Party was kind of fun. In it, they quote the Tea Party Patriots:

Like in America, the [financial] sector then used government force to escape the effects of their errors. Unlike in America, they didn’t settle for bailouts from taxpayer dollars – they seized customer’s assets to pay for their mistakes.

The Patriots sense that something is amiss with banking throughout the world. Banks are making mistakes, but taxpayers and depositors are having to pay for these mistakes. Instead, "the banks" should have to pay these mistakes. So why isn't that happening?

In short, banks are severely over-leveraged. Most of the money they lend out for mortgages and to purchase assets comes from lenders (including depositors) rather than from equity shareholders. If by "the banks", the Patriots feel like the owners (shareholders) of the bank ought to pay for the costs of their mistakes, they should endorse higher capital requirements.

You Have to Choose a Monetary Policy

There is a lot I find obnoxious about David Stockman's epic NYT rant/article. The general premise is that since 1933, economic policymaking in the U.S. have been a disaster. In particular, government deficits and federal reserve policy have distorted and destroyed our economic system, and government officials of both parties are unalterably corrupt. As a result, our society has been left "broke--fiscally, intellectually broke."

This assessment is clearly incorrect. Since 1933--when the recovery from the great depression began--America has been incredibly successful. The post-war years saw wide-spread prosperity for a large portion of U.S. citizens and our economy has been both productive and innovative. In the meantime, we defeated Fascism and Communism, establishing liberal democracy as the preeminent form of government in the process, while also becoming a global hegemon. We have also addressed some of the contradictions in our society, the last 50 years have seen the elimination of state enforced racial segregation and the withering of legal restrictions and social norms that prevented women from participating equally in society. Of course, we still face challenges (climate change, wealth inequality, the legacies of racism and sexism, etc.), and the U.S. government has made a number of mistakes during that time period (Vietnam and Iraq come to mind), but no one in their right mind can claim that the U.S. is in a worse position now than it was in 1932, or that the last 80 years have been one large ponzi scheme.

My own counter-rant aside, one of the things that bothers me most about Stockman's rant is his views of monetary policy. He doesn't explicitly call for a gold standard, but seems to suggest that taking us off the gold standard was the beginning of the end of America. Most economists view the interwar gold standard as a disastrous policy that lead to the great depression, and Roosevelt's ending of it as crucial to the recovery. Stockman chooses not to address those arguments, and doesn't even call for a return to gold, instead he says:

It would require, finally, benching the Fed’s central planners, and restoring the central bank’s original mission: to provide liquidity in times of crisis but never to buy government debt or try to micromanage the economy. Getting the Fed out of the financial markets is the only way to put free markets and genuine wealth creation back into capitalism. 

This seems to suggest that he doesn't support free banking, but what would our system of monetary policy be? Would the government return to the gold standard, adjusting the money supply so that a dollar is worth a certain amount of gold? In which case, what are the advantages of the gold standard? Does he think depressions were better or worse during the period of the gold standard? Does he believe gold has some intrinsic quality that makes it advantageous? His answers to these questions might be yes, but he doesn't go into this at all!

Where I believe he is trying to hide the ball, is in implicitly pretending that the gold standard is less interventionist than the current inflation targeting regime. This doesn't make a whole lot of sense to me. Any form of monetary policy involves the government declaring a monopoly over the supply of currency and establishing a regime for determining how much of that currency will be available at any given time. These regimes could have more strict or more flexible rules, but the intervention occurs when the government establishes monetary policy, at which point it should just try to establish the least bad regime possible. Remaining on the gold standard should be thought of as just as interventionist as going off it.