An Economist's Mea Culpa: I Relied on Reinhart and Rogoff

Here is a link to my 22d column on Quartz: “An economist’s mea culpa: I relied on Reinhart and Rogoff.”

Let me also reprint here from my update to “Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit and Politics” in the light of recent events:

You can see what I have to say in the wake of Thomas Herndon, Michael Ash and Robert Pollin’s critique of Carmen Reinhart and Ken Rogoff’s work on national debt and growth in my column “An economists mea culpa: I relied on Reinhart and Rogoff.” (You can see my same-day reaction here.) Also, on the substance, see Owen Zidar’s nice graph in his post “Debt to GDP & Future Economic Growth.” I sent a query to Carmen Reinhart and Ken Rogoff about whether any adjustments are needed to the two figures from the paper with Vincent Reinhart that I display below, but it is too soon to have gotten a reply. I think that covers most of the issues that recent revelations raise. 

 

Note that I have revised “What Paul Krugman got wrong about Italy’s economy.” [My post “Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit and Politics”] is now the go-to source for what I originally said there, relying on “Debt Overhangs, Past and Present” (which has Vincent Reinhart as a coauthor along with Carmen Reinhart and Ken Rogoff). 

One final thought. Given the spotlight they put on Reinhart and Rogoff, and the spotlight that is therefore on them as well, Thomas Herndon, Michael Ash and Robert Pollin may not be as careful as they should be. Am I mistaken in what I said in this tweet:

Herndon, Ash & Pollin report 11% p-value for 30-60% debt GDP vs. BOTH 60-90% and >90% bins, but don’t report p-value for 60-90% vs. >90% !

One way or the other, they should report the p-value for the 60-90% bin vs. the above 90% bin alongside the test they do report, which is less germane to the controversy about the 90% threshold. They should have made the results of the 60-90% vs. above 90% statistical test impossible to miss. How easy is it to find their report of that statistic in their paper?

Note on Comments on this Blog: I want to encourage more commentary on my blog. I need to approve each comment unless you are whitelisted. But if you send me a tweet to let me know you need a comment approved, I will get to it quicker, and normally approve it and whitelist you. I do try to enforce a certain level of civility and decorum (including a language filter), but on substance, I want a robust debate. For Quartz columns, the link I post on my blog (usually the day after the column appears) is a good place to make comments.

Thomas Herndon, Michael Ash, Robert Pollin and Mike Konczal: Researchers Finally Had a Chance to Replicate Reinhart-Rogoff, and There Are Serious Problems. →

I thought it important to put this up right away, since I have referenced the correlations in the Carmen Reinhart, Vincent Reinhart and Ken Rogoff paper “Debt Overhangs, Past and Present.” It is likely that the later paper I relied on has some of the same problems as the earlier paper that Mike Konczal discusses based on Thomas Herndon, Michael Ash, and Robert Pollin’s paper “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” In particular, I would like to know how the figures from “Debt Overhangs, Past and Present,” that I copied over in my post “Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit, and Politics” are affected by the emendations of Thomas Herndon, Michael Ash, and Robert Pollin. I would be grateful for any help in figuring this out. 

We Don't Talk Enough About the Story Outside the Model

Tomas Hirst interviewed me for his newly upgraded aggregator website Pieria. The site includes me as one of its “experts.” Here is the link to the interview on Pieria. It appeared yesterday. I highly recommend taking a peek at the new Pieria: here is the homepage.

The full text of the interview is below. Q is Tomas, A is Miles. This interview is closely related to Noah Smith’s post “What is Economic Equilibrium.”

Q: Has the financial crisis prompted a renewed interest in debating and challenging the economic orthodoxy of the “Great Moderation”?

A: The blogosphere was there before the crisis and was helping that conversation to grow, but the crisis certainly brought more people in. Indeed Scott Sumner said on his blog that he was motivated to start blogging because of the crisis. I think people are thinking about a wider range of things.

There are always fashions in economic research, but perhaps not surprisingly there’s more time being devoted to looking at what was going on. People have been working on models where having collateral matters, for example, which show that when the value of houses goes down it’s harder to borrow and lend.

Q: Have the events of the past few years changed the way that you think about policy responses to a crisis?

A: The Great Depression and the Japanese “Lost Decade” certainly made me think about issues surrounding the zero lower bound a lot. It’s true that I wasn’t thinking about the idea of electronic money and negative nominal rates at the time, although I had seen a piece by Greg Mankiw in which he toys with the idea of getting rid of the zero lower bound.

So I was thinking about quantitative easing but then I shifted to thinking about new ideas. It’s too bad that people are simply taking the zero lower bound as a given. I think it will be a hugely important discussion to get people to realise that it’s not some law of nature, it’s an artefact of our paper currency policy.

Q: Some people might consider moving to a world in which we had negative nominal interest rates rather uncharted territory compared with more traditional stimulatory policies such as increasing government spending. Do you think there is a role for more conventional policy moves to pull economies out of a slump?

A: As Reinhart. Reinhart and Rogoff have said, national debt above 90% of GDP has a negative impact. Obviously that’s just a stylised fact just like the fact that you tend to have a long-lasting slump after a financial crisis but I think it’s fairly proven that there are problems with having the national debt at too high a level.

Although you could say that stimulating the economy by massive fiscal stimulus is better understood, some of what we understand is that that has downsides in terms of national debt. Being well understood doesn’t always mean that it’s a better policy.

I would say in that context the conservative policy would be national lines of credit. It is something that is in the range where we understand what it would do, although there is some debate over just how much stimulus it would provide. My guess is that it would have a similar impact on demand as handing people that amount of money.

Policies such as bringing forward already planned government spending would also be a quite conservative option. You could, for example, accelerate the restocking of certain types of military equipment that you know you are going to have to buy later anyway.

As soon as you’re doing types of government spending that you wouldn’t be doing otherwise then that’s a fairly long-term addition to the national debt with probably pretty serious negative consequences.

Q: Are you worried about possible unintended consequences of negative nominal interest rates and electronic money?

A: It depends really on how much you believe in monetary neutrality and monetary superneutrality.

If you believe in approximate monetary neutrality then we’ve already seen negative rates before. It is just low real interest rates. It’s only untried if you think that nominal illusion is important.

I have no doubt that it could be confusing to people at first but the main thing we know is that it would mark a return to the type of effective monetary policy that gave us the “Great Moderation”. If you take away the zero lower bound then monetary policy can keep the economy on target and you get the separation between fiscal policy and keeping the economy at its natural level of output.

That is very helpful in terms of the political economy as it’s a wholly different debate to how much you want to redistribute and how you value different kinds of government spending. It becomes very difficult when you try to mix those things up with trying to keep output at its natural level.

Q: What do you make of the argument that there is a case for raising interest rates in a downturn in order to raise inflation expectations and improve confidence in the economy, as some have suggested?

A: I think that’s a huge mistake. It’s a theoretical error that comes from the fact that people are so used to defining and modelling equilibria that they don’t realise that each of these models has to have a story outside the model for how you got to equilibrium.

As far as I know that’s true without exception. Yet we don’t talk enough about the story outside the model. The reason for this is that it can’t be formalised in the same way.

When people don’t think about how you get to an equilibrium they come to conclusions that are just wrong.

In the real world raising rates would be very contractionary. You can have a model in which there are multiple equilibria but I’m pretty sure that raising rates is not the way to move from the equilibrium we’re in to a better one. I can’t imagine the expectations of people in the real world being such that they would see the Federal Reserve or the Bank of Japan raising rates and think that the economy is suddenly going to do great.

Even if it’s theoretically possible, it would only be one of the possibilities. In terms of way that people like John Taylor have been arguing this point, it seems as though he believes rates should go up and is looking for any reasons that could support this conclusion even if they don’t all come from the same theory.

Q: Does any of your current work touch on this subject?

A: Bob Barsky, Rudi Bachmann and I have a paper in progress that’s related to this. Here’s the model that I’ve worked with a lot, which Bob Barsky also got excited about, and then we recruited Rudi:

Let’s simplify it by leaving aside Q-theory and having no adjustment cost for investment. Now I have a delay condition for investment that says “I want to accelerate investment if the net rental rate is greater than the interest rate”.

So I have a graph of output on the horizontal axis and on the vertical axis I’ve got the net rental rate and the real interest rate. I have a net rental rate curve, which we call a KE curve because I think Sargent called it that. There’s no mystery that the rental rate goes up with output. When the economy is booming you’re going to be more eager to rent some capital by leasing office space or rent some

machines.

The other curve is a monetary policy rule. When I think in continuous time, the number one thing I need for the stability of monetary policy is for it to be steeperthan the net rental rate. However, you’ve got a problem when you get down to the zero lower bound as it’s tough to keep interest rates steeper than rental rates. So you can easily get multiple equilibria.

If you have zero gross investment, that would be a low level of output. Suppose that level of output gives you a net rental rate below zero. That would be an example of a stable equilibrium with zero gross investment. If you did nothing eventually the capital stock would deplete to the point where the net rental rate would come above zero and the economy would restart, but that could be an awfully long slump.

The other thing that can happen is that you have some fiscal stimulus that could get you past the unstable equilibrium in the middle and you could jump up to the good equilibrium again. The very existence of the good equilibrium depends upon monetary policy so you might need a combination of monetary and fiscal policy.

Yet you can get out of it just through monetary policy. If you don’t have a zero lower bound then you can keep cutting the interest rate until it does get past the net rental rate. Moreover, you wouldn’t have fallen into the bad equilibrium in the first place if you had electronic money and no zero lower bound.

What I think is happening in people’s thinking is that they have observed that you have higher interest rates during a boom. That, however, is about the net rental rate and not about the monetary policy. In fact, when you have these two upwards-sloping curves it is precisely by cutting interest rates that you achieve higher interest rates as the economy recovers.

It’s theoretically possible that the economy could miraculously jump to the good equilibrium with no impulse whatsoever and that could coincide with a rise in the interest rate. But in terms of causality it’s still the miraculous restoration of confidence that caused the jump, not the higher interest rate.

Why Austerity Budgets Won't Save Your Economy

Here is a link to my 20th column on Quartz: “Why Austerity Budgets Won’t Save Your Economy.”

The link has the abbreviated title “Austerity is Bad Economic Policy”:

http://qz.com/69302/austerity-is-bad-economic-policy/

To interpret that abbreviated title, let me claim that austerity plus electronic money is so dramatically different from austerity alone, that it would not be called “austerity."

Show Me the Money!

blog.supplysideliberal.com tumblr_inline_mjxq2wVWib1qz4rgp.png

“Here is a link to my 18th column on Quartz: "The Stanford economists are so wrong: A tighter budget won’t be accompanied by tighter monetary policy.” I honestly couldn’t think of a good working title of my own before my editor Mitra Kalita gave it the title it has on Quartz. But it finally came to me what I wanted my version of the title to be: the main theme is short-run monetary policy dominance, so my title is “Show Me the Money!”

The heart of this column is a discussion of the paper I wrote with Susanto Basu and John Fernald: “Are Technology Improvements Contractionary?”

Quartz #1—>More Muscle than QE: With an Extra $2000 in Their Pockets, Could Americans Restart the US Economy?

Link to the column on Quartz

I received clarification from my editor Mitra Kalita, that, after 30 days, it is legally OK to put up the full text of my Quartz columns on my blog. So I plan to post the full text of my previous Quartz columns on supplysideliberal.com a couple of times a week until I catch up. Today, I am posting my very first Quartz column. Links to all my other columns can be found here. 

If you want to mirror the content of this post on another site, that is possible for a limited time if you read the legal notice at this link and include both a link to the original Quartz column and the following copyright notice:

© September 24, 2012: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

Lehman Brothers’ bankruptcy on Sept. 15, 2008 marked the height of the financial crisis. It is more than four years later, and still the economy is limping along. Economists debate why, but surely political paralysis in policy response has played a role. Two kinds of politics are at work: bitter politics in Congress about the long-run direction of the country—and the ballooning national debt—that have prevented a stronger fiscal policy response, and politics inside the Federal Reserve that have prevented a stronger monetary policy response.

With the Fed’s announcement last week of QE3—purchases of long-term Treasuries and mortgage-backed assets until the economy looks up—it may appear we are already set for enough stimulus, but given the low power of quantitative easing tools, the promised purchases ($85 billion per month through the end of the year and $40 billion per month thereafter) are actually small relative to the task at hand. What seems like dramatically decisive action is really a half measure that nevertheless represents a big win for the doves in the Fed given the strength of the opposition they have faced from the hawks.

To avoid these political landmines, what is needed is a new tool to get the economy moving. I propose something revolutionary:  Let’s give the American people some money. Not free money, though.

In a recent academic paper “Getting the Biggest Bang for the Buck in Fiscal Policy”and on my blog, supplysideliberal.com, I outline a proposal to provide $2,000-lines of credit to every taxpayer, accessed through a government-issued credit card.  The interest rate would be 6% per year, the money could be paid back over the course of 10 years, and the credit limit would gradually fall as the economy recovered and the stimulus from this extra borrowing power was no longer needed.

Compare these “Federal Lines of Credit” (FLOC’s) to tax rebates. Every dollar of a tax rebate is a dollar added to the national debt. But most of the funds people borrow using these government-issued credit cards would eventually be repaid—particularly since the government can enforce repayment through payroll deduction. The unemployed would have their payments deferred, but once the economy is moving again, most people would have jobs with paychecks so they could repay. A few still wouldn’t be able to repay, but the total amount of stimulus (the “bang”) for each dollar ultimately added to the national debt (“the buck”) would be much greater than with tax rebates.

One of the closest historical precedents was the veterans’ bonus of 1936, which was in part a loan to World War I veterans. This has been analyzed recently by Berkeley Ph.D. student Joshua Hausman. Hausman finds that the bonus had effects as large as those usually associated with tax rebates. The circumstances were not identical, but if the results carry over, Hausman’s analysis suggests that the stimulus effects of Federal Lines of Credit would be at worst only a little smaller than the stimulus from a $2,000 per person tax rebate. (Economic theories of how tax rebates get their oomph from the effects of ready cash suggest the same thing.) The trouble with a $2,000 per person tax rebate is that the U.S. government can’t afford it. But if 90% or more of everyone eventually repays, a $2,000 per person line of credit would ultimately cost less than $200 per person. With a good deal like that for getting the economy back in gear, maybe even Republicans and Democrats can agree on it.

Miles on HuffPost Live: Debt, Electronic Money, Federal Lines of Credit, and a Public Contribution Program

Link to HuffPost LIve Segment “Owning Our Debt”

I am still a novice at TV and video appearances, and so stumbled over some of my words and had some trouble with my lighting, but I thought this segment of HuffPost Live went well. I had a chance to talk about debt, electronic money, Federal Lines of Credit and my idea for a Public Contribution Program.  My main goal was to get across the substance of my Quartz column “What Paul Krugman got wrong about Italy’s economy,” including my reply to Paul Krugman’s response, which you can see in my post “Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit, and Politics.”

The segment was inspired by Robert Solow’s essay “Our Debt, Ourselves.”

My other appearance on HuffPost Live is here: 

I also had one TV appearance on CNBC’s Squawkbox:

Finally, I have had two radio interviews, whichj allowed me to explain electronic money and Federal Lines of Credit much better than I could on HuffPost Live: 

Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit, and Politics

Paul Krugman’s graph of the debt/GDP ratio against interest rates

Paul Krugman’s graph of the debt/GDP ratio against interest rates

Update: You can see what I have to say in the wake of Thomas Herndon, Michael Ash and Robert Pollin’s critique of Carmen Reinhart and Ken Rogoff's work on national debt and growth in my column “An economists mea culpa: I relied on Reinhart and Rogoff.” (You can see my same-day reaction here.) Also, on the substance, see Owen Zidar’s nice graph in his post “Debt to GDP & Future Economic Growth.” I sent a query to Carmen Reinhart and Ken Rogoff about whether any adjustments are needed to the two figures from the paper with Vincent Reinhart that I display below, but have not yet received a reply to that query. I think that covers most of the issues that recent revelations raise.

Note that I have revised “What Paul Krugman got wrong about Italy’s economy.” This post is now the go-to source for what I originally said there, relying on “Debt Overhangs, Past and Present” (which has Vincent Reinhart as a coauthor along with Carmen Reinhart and Ken Rogoff). My original passage is in an indented block a little above the colorful pictures your eye will be drawn to below.

In a world where people wrote frankly, Noah Smith has written the response to my Quartz column “What Paul Krugman got wrong about Italy’s economy” that Paul Krugman should have written: 

instead of what Paul actually wrote in response to my column:

(The brief summary of my column is that electronic money could help the UK and the Federal Lines of Credit could help both Italy and the UK stimulate their economies without the problems that might arise from adding substantially to their debt by a simple increase in government spending, as indicated by my original title: “How Italy and the UK Can Stimulate Their Economies Without Further Damaging Their Credit Ratings.”)

Noah follows an earlier Paul Krugman column “Debt, Spreads and Mysterious Omissions,” in using the graph above to distinguish between Italian debt and US or UK or Japanese debt by pointing out that individual euro-zone countries are not able to borrow in their own currency in the same way the US, the UK or Japan can. Paul used this distinction to minimize the danger to the US of high debt levels; here is the first sentence of “Debt, Spreads and Mysterious Omissions”: 

Binyamin Applebaum reports on a new paper by Greenlaw et al alleging that bad things will happen to America, because debt over 80 percent of GDP leads to high interest rates, and is skeptical – but not skeptical enough. 

Paul explains that an important argument that the US may be OK revolves around the suggestion that Japan can get away with the debt levels at the rightmost extreme of the graph above because: 

…what really matters is borrowing in your own currency – in which case the US and the UK are, in terms of borrowing costs, like Japan rather than Greece. That’s certainly what the De Grauwe (pdf) analysis suggests.

Even the quickest look at the data suggests that there’s something to this argument; for example, taking data from the paper itself, and dividing the countries into euro and non-euro, we get a scatterplot like this:

There is no hint in Paul’s earlier piece, “Debt, Spreads and Mysterious Omissions” of a claim that we should not worry about high debt levels for euro-zone countries, and even less reason to worry about US debt. A reader could be forgiven for coming away from “Debt, Spreads and Mysterious Omissions” thinking Paul thought that maybe high debt levels might be worrisome for countries that cannot borrow in their own national currency (such as Greece and Italy), but not for countries that can borrow in their own currency.  

Noah joins Paul in taking me to task for relying too much on Carmen Reinhart, Vincent Reinhart and Ken Rogoff’s paper  “Debt Overhangs, Past and Present”:

Krugman has a good point: The “90%” thing is not well established; it is obviously just Reinhart and Rogoff eyeballing some sparse uncontrolled cross-country data and throwing out an off-the-cuff figure that got big play precisely because it was simple and (to deficit scolds) appealing. The 90% number alone is not a justification for worrying about debt.

But unlike Paul, Noah notes that all I need to argue for the main point of my column is that less debt is better than more debt:

But I feel that this argument over debt levels is mostly a distraction. The important thing, which is being overlooked, is that Miles has come up with a really interesting policy tool to increase the amount of stimulus per unit of debt incurred. That tool is Federal Lines of Credit, or FLOCs - basically, the idea that government should lend people money directly.

Paul is so used to–and intent on–arguing that getting out of recessions is so important that it is worth incurring additional debt to do so, that he seems to miss my point that it is possible to stimulate economies to escape recessions while incurring much less debt than a straight increase in government spending would incur.

I am actually on record agreeing with Paul (and Noah) that the Great Recession was so serious that it was worth a massive increase in debt to escape it if that were the only available way to stimulate the economy. In “What Should the Historical Pattern of Slow Recoveries after Financial Crises Mean for Our Judgment of Barack Obama’s Economic Stewardship”:

So the fact that Barack did not push for a bigger stimulus package really is an indictment of his economic leadership. According to the reported statement by Larry Summers, it was a political judgement that a bigger stimulus was not politically feasible. I am not at all convinced that a bigger stimulus was politically impossible. It would not have been easy, I’ll grant that, but I was amazed that Barack managed to get Obamacare through. If, instead, Barack had used his political capital and the control the Democrats had over both branches of Congress during his first two years for a bigger stimulus, couldn’t he have done more? …

Notice that in all of this, I am treating a larger stimulus of a conventional kind as the best among well-discussed policy options when Barack took office in 2009. So I am backing up Paul Krugman’s criticisms of Barack’s policies at the time. However, given what we know now we could do even better, as I discuss in my post “About Paul Krugman: Having the Right Diagnosis Does Not Mean He Has the Right Cure.”

 A similar judgment might well hold for Italy, as Paul argued in “Austerity, Italian Style” (the piece that kicked off this current debate with Paul), except: 

  1. We all agree that Italy’s debt problem is worse than the debt problem for the US. 
  2. Much more importantly, a policy option (National Lines of Credit) is now on the table (at least for discussion in the op/ed pages) that could stimulate the Italian economy with much less addition to debt than a straight increase in spending–a policy option that was not on the table for the US in 2009.

Astute readers will have noticed that in “What Should the Historical Pattern of Slow Recoveries after Financial Crises Mean for Our Judgment of Barack Obama’s Economic Stewardship” I relied on a stylized fact from Carmen Reinhart and Ken Rogoff’s book This Time is Different: Eight Centuries of Financial Folly. If I am led astray, it is because of my enormous respect for Ken Rogoff’s judgment, but in this case, I would be very surprised if Paul had not at some point in his New York Times columns relied on the Reinhart and Rogoff stylized fact that recessions have tended to last a long time after financial crises in more or less the same way I did. (Though I know Ken Rogoff, I don’t think I have ever been fortunate enough to meet either Carmen or Vincent Reinhart yet.) But of course, the meaning of the Reinhart and Rogoff stylized fact that across many countries recessions have historically lasted a long time after financial crises is just as much up for grabs as the meaning of the Reinhart, Reinhart and Rogoff stylized fact that across many countries GDP growth has been low during periods when debt to GDP ratios have been high.

For the record, despite, Paul’s title “Another Attack of the 90% Zombie,” I do not think I unduly emphasized the 90% figure itself. Here is what I actually wrote: 

And national debt beyond a certain point can be very costly in terms of economic growth, as renowned economists Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff convincingly show in their National Bureau of Economic Research Working Paper “Debt Overhangs, Past and Present.”

Where do the United Kingdom and Italy stand in relation to the 90% debt to GDP ratio Reinhart, Reinhart and Rogoff identify as a threshold for trouble? (It is important to realize that their 90% threshold is in terms of gross government debt. That is, it does not net out holdings by other government agencies. )

In context in relation to Italy, this means “Surely, in practice, some level of the existing debt to GDP ratio for Italy should make us worry about adding to Italy’s national debt. Can we get some idea of whether we should worry about Italian debt or not?”

Let’s look at Reinhart, Reinhart and Rogoff’s stylized fact about debt to GDP ratios and realized economic growth in a little more detail to see if there is enough suggestive evidence that we should be concerned about adding to Italy’s national debt. Here is Diagram 1 from “Debt Overhangs, Past and Present”:  

In this sample of 26 high-debt episodes, there has never been a case when a country had both a debt/GDP ratio higher than 90% and high real interest rates beat its own national GDP growth rate average during that period of time. Figure 4 gives more detail for specific episodes:

Niklas Blanchard writes this about “Debt Overhangs, Past and Present” in his post in this debate with Krugman (see this full account of my discussion with Niklas):

There is a lot not to like about the Reinhart, Reinhart, and Rogoff study, and Krugman nails much of it; it doesn’t deal with causation. I’m actually kind of confused as to why Miles mentions the study (although he may enlighten me in the comments). However; more importantly, it doesn’t specify 90% debt: GDP as a regime change to a new steady state, or as a transitory experience resulting from something like a recession, or a war. In normal times, the regime change itself is the cause of the turbulence, not the subsequent destination (like going over a waterfall). There is ample evidence that suggests that countries with high transitory debt loads are able to deal with them without incident — provided they return to robust nominal growth. Japan deals with it’s sky-high debt load through financial repression and ultra-tight monetary policy. The cost of this type of action is that the government steals wealth from households.

In retrospect, I should have avoided the word “threshold,” with its suggestion of a sudden change. I never intended to suggest there was a sudden regime shift. Of course, the 90% debt/GDP ratio is a somewhat arbitrary level that Carmen, Vincent and Ken use to cut their data. But, looking at the whole set of 26 historical episodes above that debt/GDP ratio, there seems ample grounds to be worried about the effects additional national debt might have on Italy’s situation–and I don’t think it is amiss to be worried about the effects additional national debt might have on the situation in the UK or the US. There is no evidence from a randomized controlled trial available for the effects of national debt. So I don’t know how to judge whether we should be worried about the effects of national debt for countries in various situations other than from theory–which I will leave for other posts and columns–or by trying to glean what insights we can from case studies (which is what attempts to find natural experiments would be in terms of sample size), from exercises like the one Carmen, Vincent and Ken conducted in “Debt Overhangs, Past and Present,” or from correlations such as those shown in Paul’s graph above, which suggests that we should be more worried about high debt/GDP ratios for countries that cannot borrow in their own national currency.

Unlike Paul, Noah grapples with my National Lines of Credit proposal–or “Federal Lines of Credit” for the US. (You can see my posts on Federal Lines of Credit collected in my Short-Run Fiscal Policy sub-blog: http://blog.supplysideliberal.com/tagged/shortrunfiscal.) Noah writes:

However, I do have some skepticism about FLOCs. First of all, there is the idea that much of the “deleveraging” we see in “balance sheet recessions” may be due to behavioral effects, not to rational responses to a debt-deflation situation. People may just switch between “borrow mode” and “save mode”. In that case, offering them the chance to take on extra debt is not going to do much. Second, and more importantly, I worry that FLOCs might draw money away from infrastructure spending and other government investment, which I think is an even more potent method of stimulus; govt. investment, like FLOC money, is guaranteed to be spent at least once, but unlike FLOCs it can increase public good provision, which is a supply-side benefit.

In answer to Noah’s first bit of skepticism, the main point of National Lines of Credit is to encourage more spending by that fraction of the population that will spend as a result of being able to borrow more, without adding to the national debt by sending checks to people like those in “save mode” who won’t spend any more. If people don’t draw on their lines of credit from the government, it doesn’t add to the national debt. And even if people draw on their lines of credit from the government to pay off more onerous debt, this is likely to both (a) make them better credit risks–that is, more likely to have the means to pay the government back and so not add to the national debt and (b) make them feel more secure, and so possibly get them to switch at least a little bit from “save mode” to “spend mode.”

On infrastructure spending, I should say more clearly than I have in the past that spending more on fixing roads and bridges would likely be an excellent idea for the US on its own terms, because of the supply-side benefits. But if it crowded out a Federal Lines of Credit program, one has to consider that Federal Lines of Credit can get more than a dollar’s worth of first-round addition to aggregate demand (which is then multiplied by whatever Keynesian multiplier is out there) per dollar budgeted for loan losses, while spending on infrastructure gives exactly one dollar worth of first-round addition to aggregate demand (which is then multiplied by whatever Keynesian multiplier is out there) per dollar budgeted for that spending. The spending on roads and bridges has to have enough of a positive effect on later productivity and tax revenue to outweigh its less potent stimulus per dollar budgeted. The other big problem with additional infrastructure spending is that, alas, it cannot be turned on and off quickly. The legal, administrative and regulatory process for spending on roads and bridges is just too slow to be of much help in short recessions, or if one wants to hasten a recovery that has already built up a good head of steam. So our current situation is one of the few in which spending on roads and bridges would be a fast enough mode of stimulus. Most of the time, roads and bridges should be seen primarily as a valuable supply-side measure when infrastructure is in the state of disrepair seen in the US.  

I said that Noah, unlike Paul, grapples with my National Lines of Credit proposal. Indeed, Paul shows no evidence of having read the second half of my article. One theory is that he really didn’t read the second half. Most favorably, Paul could be saving discussion of Federal Lines of Credit (and electronic money, which I also discuss in “What Paul Krugman got wrong about Italy’s economy”) for other posts. The most intriguing theory (that is not as positive as the idea that Krugman posts on FLOC’s and electronic money are coming, and one that I would not give all that high a probability to) is that Paul likes my proposals enough that he wanted to point people to those proposals, and too much to criticize them, but thinks they are too controversial to implicitly endorse by discussing them without criticizing them. If so, I am grateful to Paul for that backhanded support. Noah has a theory (that does does not preclude this theory that Paul is intentionally flagging my proposals while keeping some distance): 

That said, I think the FLOC idea is an interesting one. Why have most stimulus advocates ignored it? My guess is that this is about politics. In an ideal world, pure technocrats (like Miles) would advise politicians in an honest, forthright fashion as to what was best for the country, and the politicians would take the technocrats’ advice. In the real world, it rarely works that way. For every technocrat who just wants to increase efficiency, there’s a hundred hacks and politicos who are only thinking about distributional issues - grabbing a bigger slice of the pie. These hacks are very willing to use oversimplified narratives and dubious sound bytes to embed their ideas in the public mind. And that kind of thing really seems to be effective.

This means that politics’ response to policy is highly nonlinear - give the enemy an inch, and they take a mile. It also means the response is highly path-dependent; precedent matters.

So Krugman et al. may be ignoring FLOCs and other stimulus engineering tricks because of political concerns. If they concede for a moment that debt is scary, it will just shift the Overton Window toward Republican types who are deeply opposed to any sort of stimulus, and would oppose Miles’ FLOCs just as lustily as they opposed the ARRA.

In other words, finding optimal, first-best technocratic solutions might be far less important than simply embedding “AUSTERITY = BAD!!!” in the public consciousness.

My own politics are more centrist (to the extent they fit within the US political debate at all. (See my post “What is a Partisan Nonpartisan Blog?” as well as the mini-bio at my sidebar and Noah’s early review of my blog, “Miles Kimball, the Supply-Side Liberal.”) From that point of view, I have argued in “Preventing Recession-Fighting from Becoming a Political Football” (my response to the Mike Konczal post criticizing Federal Lines of Credit that Noah mentions) that Federal Lines of Credit have substantial political virtues in providing a way out of the current political deadlock between the Republican and Democratic parties over economic policy.

Many thanks to Noah for clarifying this debate with Paul, as well as to Niklas Blanchard, whose two bits I discussed in my post a few days ago, and to Paul himself for engaging with me in debate, at least at one level.

Update: With Noah’s permission, let me share an email exchange about the post above:

Miles: Did you like my response? 

Noah: I did! It was quite thorough.

I think the criticisms of FLOCs are still basically three:
Criticism 1 (mine): There is a limited amount of political will for increased spending. And because of the supply-side benefits of infrastructure, that finite will is better spent on infrastructure even than on the most cost-effective pure stimulus.
Criticism 2 (Mike Konczal’s): FLOCs have different distributionary consequences than other stimulus approaches, since FLOC borrowers will be responsible for repaying the stimulus borrowing, not taxpayers.
Criticism 3 (Mike Konczal’s): It will be very difficult to handle the inevitable FLOC defaults. Whether they are forgiven or collected aggressively, it will make some people very angry.
Criticism 4 (everyone else’s): FLOCs may get good “bang for the buck”, but they won’t get much bang in total, because people are in “deleveraging” (or “balance sheet rebuilding”) mode.
I think that these are not inconsiderable obstacles to the FLOC idea…
Miles: I don’t understand 4. Here is what I think it means. FLOC’s can be scaled up to get more impact, but they will have decreasing returns since people have consumption that is concave in amount of credit provision. Even though the costs are also concave in the headline amount of credit provision, this means that a FLOC program can only be so big. So ideally we want other things as well–infrastructure and electronic money.  Sounds good.  
On 1, I would be glad if the debate were between FLOC’s and infrastructure spending.  
On 2 and 3, Mike only gets one of these at a time at full force: making the amount of credit provision proportional to last-years adjusted gross income dramatically reduces the repayment problem (and the size of the program can be adjusted to compensate for the lower MPC), but this makes it distributionally less favorable.  
Noah: No, I think you may be misunderstanding 3. No matter how much FLOC lending is done, x% of people will default on their FLOC loans. What the government then does to that x% - cancels their debt, sues them, or refers them to collections agencies - is going to be a political bone of contention. It’s an image problem (evil govt. suckering people into borrowing money they can’t afford to pay back), not an efficiency problem.

Miles: I agree. That is why FLOC’s need to be paired with National Rainy Day Accounts that most likely make it unnecessary to ever use FLOC’s again after the first time.

I added the link about National Rainy Day Accounts just now. As a conceptually similar idea to FLOC’s and National Rainy Day Accounts for individuals, see what I have to say about helping the states spend more now (to stimulate the economy) and less later in “Leading States in the Fiscal Two Step.”

Miles on HuffPost Live: The Wrong Debate and How to Change It

“The Wrong Debate”

“The Wrong Debate”

Yesterday I was on HuffPost Live for the first time. I had a chance to make the case for electronic money and for Adam Ozimek’s idea of region-based visas. Here is the link again: “The Wrong Debate." 

There were a couple of things I wanted to make sure to get in, so I wrote a couple of notes beforehand. Here are those two notes:

  • We actually have two problems: the economic slump and the long-run debt problem. We need solutions to each problem that don’t make the other one worse. For that, we need new tools in the economic toolbox. The old tools won’t cut it. In my Quart column "What the heck is happening to the US Economy?” I propose some new tools. Just to tick off the names, to get to full economic recovery without making our debt problem worse, I propose in that column electronic money, Federal Lines of Credit, and US Sovereign Wealth Fund. To Solve our long-run debt problem in a way that achieves both the core Democratic and core Republican goals [and I should have added, does not throw the economy back into recession], I propose a Public Contribution Program. These are new ideas.
  • With two big exceptions, the Federal Reserve has actually steered the economy very well for the last few decades. Greenspan ignored the warnings of my colleague Ned Gramlich about the housing bubble and [the Fed as a whole] kept underestimating the problems [the housing bubble and its collapse] would cause. But that’s water under the bridge. The big problem now is that the Fed is afraid to lower short-term interest rates for fear of causing massive storage of paper currency. The Fed should be going to Congress today to ask for the authority it needs to deter massive storage of paper currency so it can cut short-term rates and bring the economy roaring back.  Because that involves making paper money subordinate to money in bank accounts, and making money in bank accounts “the real thing,” this is called “electronic money” in the blogosphere. But for most of the people, most of the time, it wouldn’t look any different from the way things are now.

Of course, these lines mutated when I was actually on the spot, but I did get a chance to say them in my first two at-bats.

I knew the question about immigration policy (my third bit) was coming, so I didn’t need to mention it in the first instance. And I was confident I could say what I wanted to about that more extemporaneously, since I was just coming off of Immigration Tweet Day.

Off the Rails: How to Get the Recovery Back on Track

Here is a link to my 14th column on Quartz: “Off the Rails: What the heck is happening to the US economy? How to get the recovery back on track." 

This column gives a better overall picture of my economic policy stance than any other single post so far. From the conclusion:

Franklin Roosevelt famously said:

The country needs and, unless I mistake its temper, the country demands bold, persistent experimentation. It is common sense to take a method and try it: If it fails, admit it frankly and try another. But above all, try something.

We at such a moment again. The usual remedies have failed. It is time to try something new. Any one of these proposals could make a major difference. In combination, they would transform the world.

Joshua Hausman: More Historical Evidence for What Federal Lines of Credit Would Do

This is the second guest post by Joshua Hausman on supplysideliberal.com.

An excellent historical analogy to Miles’s Federal Lines of Credit proposal are the 1931 loans to World War I veterans that I discussed in a guest blog post in August. As I described then, in 1924, Congress promised to pay World War I veterans a large bonus in 1945. When the Depression threw many out of work, veterans lobbied for early payment of the bonus. Congress acquiesced in 1931 by allowing veterans to borrow up to 50 percent of the value of their bonus. The main chapter of my dissertation focuses on the larger payment to veterans that occurred in 1936. In this blog post, I summarize my paper and discuss its possible implications for the success of a Federal Lines of Credit program.

Background

Despite their ability to take loans after 1931, veterans continued to demand immediate cash payment of the entire, non-discounted, value of their bonus. Tens of thousands camped out in Washington, DC from May to July 1932 to lobby Congress and the President for immediate payment (see picture). Rather than agree to their demands, President Hoover allowed General Douglas MacArthur to use soldiers and tanks to evict the veterans from Washington. Soldiers burned down veterans’ shacks in Anacostia. This forcible eviction provoked a political reaction that helped propel Franklin Roosevelt to victory the next year. 

  • Although popular history often emphasizes Roosevelt’s New Deal spending, FDR was in fact a deficit hawk, who raised taxes as much as he increased spending. Consequently, Roosevelt opposed payment of the bonus. But eventually, in January 1936, widespread popular support led Congress to override Roosevelt’s veto and authorize payment.

In June 1936 the typical veteran received $550, more than annual per capita income and enough money to buy a new car. In aggregate, the Federal government issued 3.2 million veterans bonds worth $1.8 billion or 2% of GDP. As a share of the economy, bonus payments were roughly the same size as the American Recovery and Reinvestment Act (the Obama stimulus) in 2009.

This payment had a loan component analogous to a Federal Lines of Credit program since it allowed veterans access to money in 1936 that they were supposed to receive in 1945. Furthermore, taking the money as cash in 1936 came with an interest rate penalty: veterans were issued bonds in $50 denominations and could cash as many or as few of them as they desired. If they held the bonds, they would receive 3 percent interest every year until 1945. Just as one pays interest when one borrows money from a bank, veterans had to forgo interest if they chose to cash their bonus in 1936.

But the 1936 legislation also was an outright gift, since it increased the present value of veterans’ lifetime income. In particular the legislation forgave interest on loans that they had taken against the bonus, and gave veterans in 1936 the same nominal sum they had been supposed to receive in 1945. In my paper, I calculate that for the typical veteran roughly half the bonus amount received in June 1936 was an increase in present value lifetime income.

Effects of the bonus

Out of the $1.8 billion of bonds issued to veterans through June 30, 1936, $1.2 billion were cashed in June and July 1936. A further 200 million were redeemed in late summer and fall. Thus 80 percent of the dollar value of the bonds was cashed in 1936. This in itself suggests large effects from giving veterans access to cash; more generally, it suggests that a program giving individuals access to low interest rate loans, as Federal Lines of Credit would do, can be quite popular. 

My paper explores whether and how veterans spent this money. The primary source of evidence is a household consumption survey administered by the Works Progress Administration and the Bureau of Labor Statistics in 1935 and 1936. By exploiting variation in when households were surveyed and in the likelihood that a household included a veteran, I estimate a marginal propensity to consume (MPC) out of the bonus of 0.7, meaning that out of every dollar of bonus bonds received, the typical veteran spent 70 cents. This result is confirmed by other, independent, sources of evidence. 

Interestingly, an MPC of 0.7 is as large as that measured from the 2001 tax rebates and 2008 stimulus payments, programs that did not have a loan component. If veterans’ spending were only influenced by the part of the bonus that represented a change in the present value of their lifetime income, then it would be almost impossible to explain the amount of spending I observe. An MPC of 0.7 out of the total bonus implies a MPC out of the increment to lifetime income of about 1.4 (since the increment to lifetime income was roughly half the bonus amount). This is implausible. Instead, the much more likely explanation is that veterans’ spent more in 1936, not only because their lifetime income was higher, but because the bonus meant access to a low interest rate loan at a time when liquidity constraints were pervasive.

Further evidence on the bonus’s effects comes from differences in the proportion of the population made up of veterans across states and cities. This variation meant significant geographic variation in bonus payments received. The figure at the top of this post juxtaposes the change in new car purchases from 1935 to 1936 in a state against the number of veterans per capita as measured in the 1930 census in that state. The slope implies that for every additional veteran in a state, roughly 0.3 more new cars were sold in 1936. In the paper, I show that this result is robust to controlling for a variety of different possible confounding variables. 

A third source of evidence on veterans’ spending behavior is an unpublished survey by the American Legion that asked 42,500 veterans how they planned to use their bonus. Veterans told the American Legion that they planned to consume 40 cents out of every dollar and to spend an additional 25 cents out of every dollar on residential and business investment. Evidence from the 2001 and 2008 Bush tax rebates suggests that such ex ante surveys are likely to significantly understate the total cumulative spending response (see section 5 of my paper for more on this argument). Thus, the prospective MPC of 0.4 measured in the American Legion Survey is consistent with an actual MPC that was significantly higher. 

Aggregate time series are also consistent with a large spending response. GDP grew 13.1 percent in 1936, more rapidly than in any other year of the 1930s. In the paper, I estimate that the bonus contributed 2.5 to 3 percentage points to this growth.

Conclusion

My results are encouraging evidence for the efficacy of Federal Lines of Credit, since they suggest that even when a large portion of a transfer payment is a loan (roughly half in the case of the veterans’ bonus), the MPC can be high. 2012 is not 1936, of course, and particular features of the 1936 economy may have contributed to unusually high spending from the bonus, specifically on durables. Still, at a minimum, my results suggest that further research on the efficacy of Federal Lines of Credit is desirable. 

Sources

The Bonus March photo is from http://www.loc.gov/exhibits/treasures/images/at0058f2as.jpg

All other material is taken from my job market paper, with sources documented there. One other paper, Telser (2003), examines the 1936 bonus in detail. Telser studies a variety of time series and concludes that the bonus “brought a large measure of recovery to the economy’‘ (p. 240).

Bill Clinton on the National Debt

I liked what Bill Clinton said about the national debt at the 2012 Democratic Convention. (Here is a transcript of his speech.)

Now, let’s talk about the debt. Today, interest rates are low, lower than the rate of inflation. People are practically paying us to borrow money, to hold their money for them.

But it will become a big problem when the economy grows and interest rates start to rise. We’ve got to deal with this big long- term debt problem or it will deal with us. It will gobble up a bigger and bigger percentage of the federal budget we’d rather spend on education and health care and science and technology. It — we’ve got to deal with it.

I like this passage in his speech because he is careful to discuss the fact that interest rates are temporarily low, something I discussed in my post “What To Do When the World Desperately Wants to Lend Us Money.”

What Should the Historical Pattern of Slow Recoveries after Financial Crises Mean for Our Judgment of Barack Obama's Economic Stewardship?

Photo of Kenneth Rogoff and Carmen Reinhart from the New York Times

Photo of Kenneth Rogoff and Carmen Reinhart from the New York Times

In 2003, Carmen Reinhart and Kenneth Rogoff started writing a book about the aftermath of financial crises: This Time is Different: Eight Centuries of Financial Folly. Their book’s finding that returning to the previous level of per capita GDP takes a long time after serious financial crises has become part of the political debate. In both the Democratic Convention and in the debates, part of the argument that Barack has done a good job, under the circumstances, has relied on the idea that recoveries should be expected to be especially slow after serious financial crises. Noah Smith ably discusses the merits of the  Republican counterattack on the Reinhart-Rogoff finding in his post Reinhart-Rogoff vs. Bordo-Haubrich (with grandstanding by John Taylor). Carmen Reinhart and Ken Rogoff’s own defense of their finding is very useful, especially if you haven’t read their book. They are focused only on the historical evidence in their response. They do not directly engage in the political debate.    

I take the Reinhart-Rogoff finding very seriously, and will treat it as a good historical generalization in this post. But I want to point that–even stipulating that returning to the previous level of per capita GDP has historically taken a long time after serious financial crises–the implications of this Reinhart-Rogoff finding for the political debate are much more less clear than the Democratic argument would suggest. In particular, as Carmen and Ken acknowledge in their recent defense of their finding, what happens after a serious financial crisis is not some immutable law of nature, but depends on the policy response. And the key question for the political debate is not if the policy response of the Obama administration’s policy response was better than the policy response to serious financial crises has been historically, but whether the Obama administration’s policy response was as good as it should have been given what was known at the time. The very existence of This Time is Different: Eight Centuries of Financial Folly (published in September 2009 and surely existing in draft form quite a bit earlier)within a time period relevant for Obama Administration policy making should set the bar higher. 

In particular, in the light of the Reinhart-Rogoff finding that he should have had access to, one can make the argument that Barack should have known he needed to do more than the policies he chose in order to get a robust recovery. Indeed, (as I also cited in my post “Why George Osborne Should Give Everyone in Britain a New Credit Card”) in his excellent Atlantic article, “Obama Explained,” James Fallows wrote:

If keeping the economy growing was so central for Obama, why was the initial stimulus “only” $800 billion? “The case is quite compelling that if more fiscal and monetary expansion had been done at the beginning, things would have been better,” Lawrence Summers told me late last year. “That is my reading of the economic evidence. My understanding of the judgment of political experts is that it wasn’t feasible to do.” Rahm Emanuel told me that within a month of Obama’s election, but still another month before he took office, “the respectable range for how much stimulus you would need jumped from $400 billion to $800 billion.” In retrospect it should have been larger—but, Emanuel says, “in the Congress and the opinion pages, the line between ‘prudent’ and ‘crazy spendthrift’ was $800 billion. A dollar less, and you were a statesman. A dollar more, you were irresponsible.”

Barack certainly had access to Larry Summers’s advice. And I would be surprised if Larry Summers’s advice at the time didn’t incorporate Larry’s awareness of what Carmen and Ken had found. So the fact that Barack did not push for a bigger stimulus package really is an indictment of his economic leadership. According to the reported statement by Larry Summers, it was a political judgement that a bigger stimulus was not politically feasible. I am not at all convinced that a bigger stimulus was politically impossible. It would not have been easy, I’ll grant that, but I was amazed that Barack managed to get Obamacare through. If, instead, Barack had used his political capital and the control the Democrats had over both branches of Congress during his first two years for a bigger stimulus, couldn’t he have done more? 

The bottom line is that (asking a lot of Mitt’s protean ability to shapeshift) if Mitt were willing to distance himself far enough from the Republicans in Congress and the Republican orthodoxy, it would be quite possible to use the Reinhart-Rogoff finding to attack Barack’s economic stewardship. Barack should have known the economy needed more stimulus, and in fact his closest economic advisor knew that the economy needed more stimulus! Mitt could then claim that Barack was so set on forcing through health care reform that he took his eye off the more urgent task of ensuring economic recovery. (I remember Peggy Noonan, without specifying what economic policy should have been taken, forcefully making the argument at the time that Barack was putting too high a priority on health care reform relative to fostering economic recovery.) It is a tricky argument for a Republican to make, saying that with the Republicans dead set against both an adequate stimulus and Obamacare, Barack should have focused on the fight for an adequate stimulus rather than for health care reform, but it is a logically cogent one. (I have to confess to my own ignorance about the extent to which Mitt’s own statements about the stimulus package in 2009 would also cause him trouble in making this argument. Given Mitt’s willingness to emphasize at different times a different one of his contradictory statements over others, did he ever say anything then that could be spun as having warned that the stimulus wasn’t big enough–or should have been the same size but focused on things that most economists would agree would have been more effective at raising aggregate demand?)

Aside from the political argument itself, the issues I raise should be part of history’s judgement of Barack Obama. In particular, I take exception to Joe Biden’s claim in the vice presidential debate with Paul Ryan that “no president could have done better” than Barack has done. I suspect, in fact, that Bill Clinton would have done better if he could have been president again. It is quite possible that Hillary Clinton would have done better–in part because she might have been more gun-shy about health care reform and so have focused more intensely on the more immediate economic issue. And Mitt might well have done better had he won the presidency in 2008 (in part because he would have faced less intense Republican opposition to needed stimulus)–though it is hard to know if he would have taken the right policy direction.

Notice that in all of this, I am treating a larger stimulus of a conventional kind as the best among well-discussed policy options when Barack took office in 2009. So I am backing up Paul Krugman’s criticisms of Barack’s policies at the time. However, given what we know now we could do even better, as I discuss in my post “About Paul Krugman: Having the Right Diagnosis Does Not Mean He Has the Right Cure.”

Update:

About Paul Krugman: Having the Right Diagnosis Does Not Mean He Has the Right Cure

An illustration from the Paul Krugman bio on the site “NNDB: Tracking the Entire World”

An illustration from the Paul Krugman bio on the site “NNDB: Tracking the Entire World”

This is the second time in less than a month that Paul Krugman’s picture has headed one of my posts. (The other time is here.) That is no accident. Paul is the true monster of the economics blogosphere–as well as in the beleagured redoubts of non-electronic economic journalism that remain.  I use the word “monster” in the positive and enviable sense of having a large reach and influence with the words that he writes. (Please, may I some day grow up to be a monster? See the illustration from Where the Wild Things Are.) 

In his recent post, “Smuggish Thoughts (Self-Indulgent),” Paul writes this:

I got obsessed with Japan in the 1990s, and I think can fairly claim to have started the whole modern liquidity-trap literature. I approached the Japan problem the way I approach just about all economic problems, building a stylized, minimalist model (big pdf) that seemed to make sense of the available facts and yielded strong conclusions. But does this style of analysis work in the real world?

Well, events provided an acid test. If you believed in the little models I and others were using, you made some very striking predictions about how the world would work post-crisis–predictions that were very much at odds with what other people were saying. You predicted that trillion-dollar deficits would not drive up interest rates; that tripling the monetary base would not be inflationary; that cuts in government spending, rather than helping the economy by increasing confidence, would hurt by depressing demand, with bigger effects than in normal, non-liquidity trap times.

And the people on the other side of these issues weren’t just academics, they were major-league policy makers and famous investors.

And guess what: the models seem to work. It appears that I wasn’t just a successful self-marketer, that I really did and do know something.

Basically, I agree with Paul’s assessments here–his diagnosis of what happened. But I do not agree with his prescription. As near as I can make out (and I am happy to be corrected on this), his number one recommendation has been a large increase in government spending to provide Keynesian stimulus, and his number two recommendation has been for the Fed to promise future inflation above its normal 2% target.

That secondary recommendation I discussed in my earlier post on Paul Krugman. I will not repeat everything I said there, but let me say a few words about the relevant scientific issue. The issue I have with Paul’s analysis there is that he seems to approach the approximate Wallace neutrality that is likely in the real world–which can account for the facts he mentions above–for the perfect Wallace neutrality of his simple model, which would imply that large scale asset purchases by the Fed (as in QE1, QE2, QE3 and Operation Twist) will not work in any direct way, so that the Fed’s only option for stimulating the economy is to promise (or hint at) inflation above 2% in the future.

In relation to Paul’s primary recommendation of a massive increase in government spending in the short run, my main objection is that (assuming we are not willing to contemplate national bankruptcy), every dollar the Federal government ultimately adds to the national debt is a dollar that has to be paid for by taxes further down the road, or by cuts in government spending further down the road that will be hard to bear, given the aging of the population. Except in the case of spending now that can genuinely serve instead of spending in the future, we have to be very concerned about the cost of stimulative spending.

Let me give a simple numerical example to make the point. After the economy gets fully back on its feet, I expect the interest rate to be something like 4% per year in real terms. Suppose we added $2 trillion more to the debt to stimulate the economy and then wanted to keep that extra debt from growing further in real terms so that the growth of GDP could gradually reduce the debt-to-GDP ratio. To do that, we would have to pay the real interest on that extra debt: $2 trillion * 4% per year = $80 billion per year. If GDP by then is a little higher than now, at $16 trillion per year, that is a ½ % addition to the spending to GDP ratio. A lot of the big arguments between Republicans and Democrats are about differences in government spending on the order of about 3% of GDP. So ½ % of GDP difference in government spending due to extra interest payments is actually a very big deal.

So it is a great advantage to simulate the economy by measures that add less to the national debt, the Federal Lines of Credit which I lay out in my second post “Getting the Biggest Bang for the Buck in Fiscal Policy” and have discussed at great length in the other short-run fiscal policy posts on this blog.

(It seems plausible to me that large scale asset purchases by the Fed also have this property of stimulating the economy while adding relatively little to the national debt in the end. I would be glad to see a careful analysis of the likely round-trip financial costs to the Fed of pushing interest rates down and asset values up by buying long-term government bonds and mortgage-backed securities now to stimulate the economy, and pulling interest rates up and asset values down later by selling them to rein the economy in–or alternatively raising interest on excess reserves later.) 

It matters how we approach the problems that we face. Paul Krugman deserves a lot of credit for getting the basic diagnosis of our problems right, but he needs to be just as serious about identifying the best possible solutions. Traditional Keynesian remedies or promises of inflation may work to stimulate the economy, but what if there is a better remedy, with fewer undesirable side effects? It is my contention that there is a better remedy, that would have the same effectiveness at lower cost: Federal Lines of Credit. And that is in addition to the possibility that the Fed has already found a better approach in large scale asset purchases, if only it pushes hard enough on its string.  

Update: A commenter on Twitter (I’ve lost track of the tweet) points out that the government can stabilize the debt to GDP ratio if it pays only the interest rate minus the growth rate of the economy on the debt each year, rolling over the rest, including rolling over the part of interest payments equal to the growth rate. That makes the long-run picture look less stark than the calculation I make if the interest rate is less than 3% above the growth rate of the economy. For example, approached that way, if the interest rate is only 1.5% above the growth rate of the economy, then the $2 trillion in extra debt would mean a permanent ¼ % of GDP less spending or a permanent ¼% of GDP less taxes.

My First Column on the Atlantic's New Website "Quartz": "More Muscle than QE3: With an Extra $2000 in their Pockets, Could Americans Restart the U.S. Economy?"

Screen shot of the illustration for my column “More Muscle than QE3: With an Extra $2000 in their pockets, could Americans restart the U.S. economy?” on the Quartz website.

Screen shot of the illustration for my column “More Muscle than QE3: With an Extra $2000 in their pockets, could Americans restart the U.S. economy?” on the Quartz website.

I am one of the columnists on the Atlantic’s new world business website Quartz (qz.com). I expect to have columns appear there approximately weekly, plus some quick reactions to breaking economic events.

At Quartz, I am working with Mitra Kalita and Lauren Brown.

My Platform, as of September 24, 2012

Detroit Metro Times mockup of the card for my Federal Lines of Credit Proposal

This is an update of my post “Miles’s Best 7 “Save-the-World” Posts, as of July 7, 2012”– a title with a bit of gentle self-mockery at my own presumption. This time, inspired by the U.S. presidential campaign, I want to think of my most important policy recommendations as a kind of shadow political platform. I have neither the odd talents, the drive, nor the sheer stamina required to be a political candidate. But if I were a political candidate, this is the platform I would run on. 

Let me organize some key posts for each policy area. Within each policy area, I have arranged them in a recommended reading order. Many of the proposals are the proposals of others, but if I put a post in this list, it is something I have signed on to, with whatever caveats are in my post.

There are three areas where I don’t have as much in the way of specific proposals (with the one exception of Charter Cities), but the posts hint at an approach. I have signaled these by using the word “perspectives” in the area heading.

Until I do another update, you will be able to access this post at any time by the “‘Save the world’ posts” link at my sidebar. Or you should be able to reach it by using the searchbox further down on the sidebar.

Short Run Fiscal Policy

Long Run Fiscal Policy

Monetary Policy

Immigration Policy and Helping the Poor

Perspectives on Long Run Economic Growth and Human Progress

Global Warming

Labor Market and Education Policy

Health Care

Perspectives on Finance

Bipartisanship in Governing and Proper Conduct During Political Campaigns

Foreign Policy, etc.

General Perspectives