Monetary vs. Fiscal Policy: Expansionary Monetary Policy Does Not Raise the Budget Deficit

Monetary policy and fiscal policy are not equally good as ways to stimulate the economy. Traditional monetary policy (that is, lowering the short-term interest rate) has two key advantages over traditional fiscal policy:

  • It does not add to the national debt
  • Because many governments have–however controversially–been willing to let monetary policy be handled by an independent central bank, it is not doomed to be tangled up in politics to the same extent that discretionary fiscal policy inevitably gets tangled up in long-running political disputes about taxing and spending.

My subtitle “Expansionary Monetary Policy Does Not Raise the Budget Deficit” is a quotation from Alan Blinder’s October 25, 2010 Wall Street Journal op-ed “Our Fiscal Policy Paradox,” where Alan also points to the political difficulties of using discretionary fiscal for macroeconomic stabilization:

The practice of monetary and fiscal policy is fraught with difficulties, but the central concept is straightforward, compelling and, by the way, 75 years old: The government should push the economy forward when unemployment is high and slow it down when inflation threatens.
To do so, governments normally have two principal sets of weapons. Fiscal policy means moving some taxes or elements of public spending up or down to either propel or restrain total spending. In the United States, such decisions are made politically, by Congress and the president. Monetary policy normally (but not now) means lowering or raising short-term interest rates to either speed up growth or slow it down. That power, of course, resides in the technocratic Federal Reserve….
There are plenty of powerful weapons left in the fiscal-policy arsenal. But Congress is tied up in partisan knots that will probably get worse after the election….
But what about using monetary policy? Chairman Ben Bernanke and his Federal Reserve colleagues are not paralyzed by politics. They have not fallen victim to misleading advertising claiming that past policies have not helped. And expansionary monetary policy does not raise the budget deficit. So why the hesitation?

Monetary Policy. My view is that we need tools for macroeconomic stabilization that (a) can be applied technocratically and (b) do not add greatly to national debt when they are used to stimulate the economy. Monetary policy fills that bill, once it is unhobbled by eliminating the zero lower bound. Here is what I wrote in my column “Why Austerity Budgets Won’t Save Your Economy”:

For the US, the most important point is that using monetary policy to stimulate the economy does not add to the national debt and that even when interest rates are near zero, the full effectiveness of monetary policy can be restored if we are willing to make a legal distinction between paper currency and electronic money in bank accounts—treating electronic money as the real thing, and putting paper currency in a subordinate role….
Without the limitations on monetary policy that come from our current paper currency policy, the Fed could lower interest rates enough (even into negative territory for a few quarters if necessary) to offset the effects of even major tax increases and government spending cuts.

The Costs of National Debt. That column is also important in giving some of the best arguments I know for worrying about the national debt now that it is hard to argue that national debt slows economic growth. (On the effect of national debt on economic growth, see my two columns with Yichuan Wang “After Crunching Reinhart and Rogoff’s Data, We Found No Evidence High Debt Slows Growth” and Examining the Entrails: Is There Any Evidence for an Effect of Debt on Growth in the Reinhart and Rogoff Data? and the other work they flag.) Here is what I had to say about the costs of debt in "Why Austerity Budgets Won’t Save Your Economy“:

…lenders are showing no signs of doubting the ability of the US government to pay its debts. But there can be costs to debt even if no one ever doubts that the US government can pay it back.
To understand the other costs of debt, think of an individual going into debt. There are many appropriate reasons to take on debt, despite the burden of paying off the debt:
  • To deal with an emergency—such as unexpected medical expenses—when it was impossible to be prepared by saving in advance.
  • To invest in an education or tools needed for a better job.
  • To buy an affordable house or car that will provide benefits for many years.
There is one more logically coherent reason to take on debt—logically coherent but seldom seen in the real world:
  • To be able to say with contentment and satisfaction in one’s impoverished old age, “What fun I had when I was young!”
In theory, this could happen if when young, one had a unique opportunity for a wonderful experience—an opportunity that is very rare, worth sacrificing for later on. Another way it could happen is if one simply cared more in general about what happened in one’s youth than about what happened in one’s old age.
Tax increases and government spending cuts are painful. Running up the national debt concentrates and intensifies that pain in the future. Since our budget deficits are not giving us a uniquely wonderful experience now, to justify running up debt, that debt should be either (i) necessary to avoid great pain now, or (ii) necessary to make the future better in a big enough way to make up for the extra debt burden. The idea that running up debt is the only way to stimulate an economic recovery when interest rates are near zero is exactly what I question… If reforming the way we handle paper currency made it clear that running up the debt is not necessary to stimulate the economy, what else could justify increasing our national debt? In that case, only true investments in the future would justify more debt: things like roads, bridges, and scientific knowledge that would still be there in the future yielding benefits—benefits for which our children and we ourselves in the future will be glad to shoulder the burden of debt.

National Lines of Credit: I write about the importance of stabilization policy that can be applied technocratically, without getting tangled up in politics in the context of my other main proposal for stabilization policy: National Lines of Credit (or equivalently "Federal Lines of Credit”). The key post there is “Preventing Recession-Fighting from Becoming a Political Football.” In any case, I think National Lines of Credit would get less tangled up in politics than regular traditional fiscal policy, but it would also be possible to set them up so that they were initiated in an explicitly technocratic way. Here is the relevant passage from my working paper “Getting the Biggest Bang for the Buck in Fiscal Policy”:

The lack of legal authority for central banks to issue national lines of credit is not set in stone. Indeed, for the sake of speed in reacting to threatened recessions, it could be quite valuable to have legislation setting out many of the details of national lines of credit but then authorizing the central bank to choose the timing and (up to some limit) the magnitude of issuance. Even when the Fed funds rate or its equivalent is far from its zero lower bound at the beginning of a recession, the effects of monetary policy take place with a significant lag (partly because of the time it takes to adjust investment plans), while there is reason to think that consumption could be stimulated quickly through the issuance of national lines of credit. Reflecting the fact that national lines of credit lie between traditional monetary and traditional fiscal policy, the rest of the government would still have a role both in establishing the magnitude of this authority and perhaps in mandating the issuance of additional lines of credit over the central bank’s objection (with the overruled central bank free to use contractionary monetary policy for a countervailing effect on aggregate demand).

Though not as good as monetary stimulus, National Lines of Credit are also much better than traditional fiscal policy in yielding a high ratio of stimulus to the amount ultimately added to the national debt.

National Rainy Day Accounts. There is a related mode of stabilization policy that I consider superior to National Lines of Credit. The National Rainy Day Accounts described in this passage of my working paper “Getting the Biggest Bang for the Buck in Fiscal Policy” would not add to the national debt at all: 

It is also worth pointing out that, in principle, national lines of credit in times of low demand could be superseded in the long run (at least in part) by a modest level of forced saving in times of high demand,  with the funds from these “national rainy day accounts” released to households in time of recession (and also perhaps in the case of one of a well-defined list of documentable personal financial emergencies).

The National Rainy Day Accounts also have household finance benefits for people who have difficulty saving for emergencies without some external discipline. The main limitations of National Rainy Day Accounts as stabilization policy is (a) that they require advance preparation and (b) the resources of National Rainy Day Accounts might sometimes be exhausted before getting enough stimulus.

Lars Christensen: Beating the Iron Law of Public Choice

In his post “Beating the Iron Law of Public Choice: A Reply to Peter Boettke,” Lars Christensen gives this description of the supposed Iron Law of Public Choice

the Iron Law of Public Choice – no matter how much would-be reformers try they will be up against a wall of resistance. Reforms are doomed to end in tears and reformers are doomed to end depressed and disappointed.

Lars gives this ancestry for the Iron Law of Public Choice: 

The students of Public Choice theory will learn from Bill Niskanen that bureaucrats has an informational advantage that they will use to maximizes budgets. They will learn that interest groups will lobby to increase government subsidies and special favours. Gordon Tulluck teaches us that groups will engage in wasteful rent-seeking. Mancur Olson will tell us that well-organized groups will highjack the political process. Voters will be rationally ignorant or even as Bryan Caplan claims rationally irrational.

 But at the end of the day, I agree with Lars when he says

ideas – especially good and sound ideas – can beat the Iron Law of Public Choice.

Quartz #20—>Why Austerity Budgets Won't Save Your Economy

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Link to the Column on Quartz

Here is the full text of my 20th Quartz column, Here is a link to my 20th column on Quartz: “Why Austerity Budgets Won’t Save Your Economy.” now brought home to supplysideliberal.com. It was first published on April 1, 2013. 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:

© April 1, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

“Austerity” in the title means “Naked Austerity,” in line with the hashtag #nakedausterity that I introduced on Twitter:

Definition for #nakedausterity : Tax increases and/or government spending cuts unaccompanied by other measures to maintain aggregate demand.

The point of the hashtag is this:

When you are worried about debt, #nakedausterity is not the answer.

Don’t miss the discussion of the costs of national debt toward the end of the column.


Austerity is in vogue. For some time now, countries in Europe have been raising taxes and cutting government spending because they are worried about their national debt. They have hit on the word austerity to describe these tax increases and government spending cuts. The US is now following suit.

But the trouble with austerity is that it is contractionary—that is, austerity tends to slow down the economy. In bad economic times, people can’t get jobs because businesses aren’t hiring, and businesses are not hiring because people aren’t spending. So in bad economic times, it adds insult to injury when the government does less spending, less hiring, and taxes more money out of the pockets of those who would otherwise spend.

The contractionary effect of austerity creates a dilemma, not only because a slower economy is painful for the people involved—that is, just about everyone—but also because tax revenue falls when the economy slows down, making it harder to rein in government debt. This dilemma has fueled a big debate.  There are four basic positions:

1. Arguing that austerity can actually stimulate the economy, as long as it is implemented gradually. That is the position John Cogan and John Taylor take in their Wall Street Journal op-ed, “How the House Budget Would Boost the Economy,” which I questioned in my column, “The Stanford economists are so wrong: A tighter budget won’t be accompanied by tighter monetary policy.”

2. Arguing that debt is so terrible that austerity is necessary even if it tanks the economy. This is seldom argued in so many words, but is the implicit position of many government officials, both in Europe and the US.

3. Arguing that the economy is in such terrible shape that we have to be willing to increase spending (and perhaps cut taxes) even if it increases the debt. This is the position taken by economist and New York Times columnist Paul Krugman. Indeed, Krugman is so intent on arguing that the government should spend more, despite the effect on the debt, that in many individual columns he appears to be denying that debt is a serious problem.  A case in point is his reply, “Another Attack of the 90% Zombie,” to my column emphasizing the dangers of Italy’s national debt, “What Paul Krugman got wrong about Italy’s economy.”  (In addition to this column, I responded on my blog.)

4. Arguing that there are ways to stimulate the economy without running up the national debt.  This is what I also argue in my column on Krugman. For the US, the most important point is that using monetary policy to stimulate the economy does not add to the national debt and that even when interest rates are near zero, the full effectiveness of monetary policy can be restored if we are willing to make a legal distinction between paper currency and electronic money in bank accounts—treating electronic money as the real thing, and putting paper currency in a subordinate role. (See my columns, “How paper currency is holding the US recovery back” and “What the heck is happening to the US economy? How to get the recovery back on track.”) As things are now, Ben Bernanke is all too familiar with the limitation on monetary policy that comes from treating paper currency as equivalent to electronic money in bank accounts. He said in his Sept. 13, 2012 press conference:

If the fiscal cliff isn’t addressed, as I’ve said, I don’t think our tools are strong enough to offset the effects of a major fiscal shock, so we’d have to think about what to do in that contingency.

Without the limitations on monetary policy that come from our current paper currency policy, the Fed could lower interest rates enough (even into negative territory for a few quarters if necessary) to offset the effects of even major tax increases and government spending cuts.

The price of debt

Since I see a way to stimulate the economy without adding to the national debt—and even in the face of measures to rein in the national debt—I face no temptation to downplay the costs of high levels of national debt. What are those costs? The most obvious cost of high levels of national debt is that at some point, lenders start worrying about whether a country can ever pay back its debts and raise the interest rates they charge. (This all works through the bond market, giving rise to James Carville’s famous quip: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”) One can disagree with their judgment, but lenders are showing no signs of doubting the ability of the US government to pay its debts. But there can be costs to debt even if no one ever doubts that the US government can pay it back.

To understand the other costs of debt, think of an individual going into debt. There are many appropriate reasons to take on debt, despite the burden of paying off the debt:

  • To deal with an emergency—such as unexpected medical expenses—when it was impossible to be prepared by saving in advance.
  • To invest in an education or tools needed for a better job.
  • To buy an affordable house or car that will provide benefits for many years.

There is one more logically coherent reason to take on debt—logically coherent but seldom seen in the real world:

  • To be able to say with contentment and satisfaction in one’s impoverished old age, “What fun I had when I was young!”

In theory, this could happen if when young, one had a unique opportunity for a wonderful experience—an opportunity that is very rare, worth sacrificing for later on. Another way it could happen is if one simply cared more in general about what happened in one’s youth than about what happened in one’s old age.

Tax increases and government spending cuts are painful. Running up the national debt concentrates and intensifies that pain in the future. Since our budget deficits are not giving us a uniquely wonderful experience now, to justify running up debt, that debt should be either (i) necessary to avoid great pain now, or (ii) necessary to make the future better in a big enough way to make up for the extra debt burden. The idea that running up debt is the only way to stimulate an economic recovery when interest rates are near zero is exactly what I question in my previous column about Italy’s economy. If reforming the way we handle paper currency made it clear that running up the debt is not necessary to stimulate the economy, what else could justify increasing our national debt? In that case, only true investments in the future would justify more debt: things like roads, bridges, and scientific knowledge that would still be there in the future yielding benefits—benefits for which our children and we ourselves in the future will be glad to shoulder the burden of debt.

Quartz #17—>How Italy and the UK Can Stimulate Their Economies Without Further Damaging Their Credit Ratings

Link to the Column on Quartz

Here is the full text of my 17th Quartz column, “What Paul Krugman Got Wrong About Italy’s Economy,” now brought home to supplysideliberal.com and given my preferred title. It was first published on February 26, 2013. 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:

© February 26, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

The combative title my editor gave this column attracted Paul Krugman’s attention in one of his columns, linked in my reply “Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit and Politics.”

Note that I have a nuanced position toward national debt, which is also articulated in my columns “Why austerity budgets won’t save your economy” and “An economist’s mea culpa: I relied on Reinhart and Rogoff." On Twitter, I have encapsulated this nuanced view into the hashtag #nakedausterity

Definition for #nakedausterity : Tax increases and/or government spending cuts unaccompanied by other measures to maintain aggregate demand.

The point of the hashtag is this:

When you are worried about debt, #nakedausterity is not the answer.

Update: More recently, Yichuan Wang and I examined what the Reinhart and Rogoff data set suggests about the effects of debt on growth and found no evidence for such an effect. Links to all our analysis can be found in our Quartz column "Autopsy: Economists looked even closer at Reinhart and Rogoff’s Data–and the results might surprise you.” Our earlier Quartz column “After crunching Reinhart and Rogoff’s data, we’ve concluded that high debt does not slow growth”, my companion post “After Crunching Reinhart and Rogoff’s Data, We Found No Evidence That High Debt Slows Growth,” and my post “Why Austerity Budgets Won’t Save Your Economy” discuss other reasons one might be concerned about high levels of national debt. 


Editor’s note: This post was updated on April 19, 2013, to reflect an error in the referenced study on debt levels by Carmen Reinhart and Ken Rogoff.

In the last few days, while the US political debate centers on ways to deal with burgeoning debt, UK government debt has been downgraded and investors are demanding much higher yields on Italian debt in the wake of the Italian election results (paywall). As concerns about national credit ratings push economies around the world toward austerity–government spending cuts and tax hikes–some commentators are still calling for economic stimulus at any cost. Joe Weisenthal wrote that David Cameron must spend more money in order to save the British economy. Paul Krugman wrote in “Austerity, Italian Style” that austerity policies simply don’t work. The downside of their prescription of more spending—and perhaps lower taxes—is that it would add to the United Kingdom’s and to Italy’s national debt.

And despite the recent revelation of errors in Carmen Reinhart and Ken Rogoff’s famous study of debt levels and economic growth, which I discuss here and which motivated the update you are reading (the original passage can be found here), there are reasons to think that high levels of debt are worth worrying about.

First, for a country like Italy that does not have its own currency (since it shares the euro with many other countries), Paul Krugman’s own graph shows a correlation between national debt as a percentage of GDP and the interest rate that a country pays.

Gross Debt Ratio

Second, the paper by Thomas Herndon, Michael Ash and Robert Pollin that criticizes Reinhart and Rogoff finds that, on average, growth rates do decline with debt levels. Divide debt levels into medium high (60% to 90% of GDP), high (90% to 120% of GDP), and very high (above 120% of GDP). Then the growth rates are 3.2% with medium-high debt, 2.4% with high debt, and 1.4% with very high debt.  (I got these numbers by combining the 4.2% growth rate for countries in the 0 to 30% debt-to-GDP ratio range from Table 3 with the estimates in Table 4 for how things are different at higher debt levels.) Moreover, contrary to the impression one would get from the column here, Herndon, Ash and Pollin’s Table 4 indicates that the differences between low levels of debt and high levels of debt are not just due to chance, though what Herndon, Ash and Pollin emphasize is that very low levels of debt, below 30% of GDP, have a strong association with higher growth rates. Overall, with the data we have, we don’t know what causes what, so there is no definitive answer to how much we should worry about debt, but ample reason not to treat debt as if it were a nothing.

In an environment in which stimulus is needed, but extra debt is a problem, there should be a laser-like focus on the ratio of stimulus any measure provides relative to the amount of debt it adds. In every one of my proposals for stimulating the economy, I have been careful to avoid proposals that would make a large addition to national debt. So I do not follow Joe Weisenthal and Paul Krugman in their recommendations.

First, instead of raising spending or cutting taxes, the Italian and UK governments can directly provide lines of credit to households, as I have proposed for troubled euro-zone countries and for the UK, as well as for the US. Although there would be some loan losses, the better ratio of stimulus to the addition to the national debt would lead to a much better outcome. In particular, after full economic recovery in the short run, there would be much less debt overhang to cause long-run problems after such a national lines of credit policy than under Weisenthal’s or Krugman’s prescriptions.

But for the UK, it is an even more important mistake to think that monetary policy can’t cut short-term interest rates below zero. Weisenthal quotes a post on Barnejek’s blog, “Has Britain Finally Cornered Itself?” that illustrates the faulty thinking I’m talking about:

Before I start, however, I would like to thank the British government for conducting a massive social experiment, which will be used in decades to come as a proof that a tight fiscal/loose monetary policy mix does not work in an environment of a liquidity trap. We sort of knew that from the theory anyway but now we have plenty of data to base that on.

“Liquidity trap” is code for the inability of the Bank of England to lower interest rates below zero. The faulty thinking is to treat the “liquidity trap” or the “Zero Lower Bound,” as modern macroeconomists are more likely to call it, as if it were a law of nature. The Zero Lower Bound is not a law of nature! It is a consequence of treating money in bank accounts and paper currency as interchangeable. As I explain in a series of Quartz columns (123 and 4) and posts on my blog—that is a matter of economic policy and law that can easily be changed. As soon as paper pounds are treated as different creatures from electronic pounds in bank accounts, it is easy to keep paper pounds from interfering with the conduct of monetary policy. In times when the Bank of England needs to lower short-term interest rates below zero, the effective rate of return on paper pounds can be kept below zero by announcing a crawling peg “exchange rate” between paper pounds and electronic pounds that has the paper pounds gradually depreciating relative to electronic pounds.

In his advice for the UK, Weisenthal should either explain why having an exchange rate between paper pounds and pounds in bank accounts is worse than a massive explosion of debt or join me in tilting against a windmill less tilted against. And for those who read Krugman’s columns, it would take a bad memory indeed not to recall that he gives the corresponding advice of stimulus by additional government spending for the US, which faces its own debt problem. I hope Paul Krugman will join me too in attacking the Zero Lower Bound.

In 1896 William Jennings Bryan famously declared: “… you shall not crucify mankind on a cross of gold.”

In our time it is not gold that is crucifying the world economy (though some would return us to the problems that were caused by the gold standard), but the unthinking worldwide policy of treating paper currency as interchangeable with money in bank accounts. So for our era, let us say: You shall not crucify humankind on a paper cross.

Quartz #14—>Off the Rails: How to Get the Recovery Back on Track

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Link to the Column on Quartz

Here is the full text of my 14th Quartz column, “Off the Rails: What the heck is happening to the US Economy? How to get the recovery back on track,” now brought home to supplysideliberal.com. It was first published on February 1, 2013. 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:

© February 1, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.


GDP fell in the last quarter of 2012. It was only a fraction of a percent, but it means the recovery is on hiatus. Why? Negative inventory adjustments tend to be short-lived, so let me leave that aside, although it definitely made last quarter’s statistics look worse. Of the longer-lived forces, on the positive side,

  • consumer spending rose,
  • home-building rose, and
  • business investment on buildings and equipment rose.

On the negative side,

  • exports fell more than imports, and
  • government purchases fell.

Net exports and government purchases are the big worries going forward as well.

How much the rest of the world buys from the US depends on how other economies are faring. And most of the rest of the world is hurting economically. The Japanese are so fed up with their economic situation that they are on their sixth prime minister in the six and a half years since Junichiro Koizumi left office in 2006.  The European debt crisis is in a lull right now, but could still resume full force at any time. In addition to all of its other problems, the United Kingdom is facing a mysterious decline in productivity, explained in Martin Wolf’s Financial Times article “Puzzle of Falling UK Labour Productivity” and the Bank of England analysis by Abigail Hughes and Jumana Saleheen.

The decline in US government spending comes from the struggle of state and local governments with their budgets and at the federal level from the ongoing struggle between the Democrats and Republicans about the long-run future of taxing and spending. Last quarter saw a remarkable decline in military spending that Josh Mitchell explains this way in today’s Wall Street Journal (paywall).

The biggest cuts came in military spending, which tumbled at a rate of 22.2%, the largest drop since 1972. …

Military analysts said the decline likely was a result of pressure on the Pentagon from a number of areas.

Among them: reductions in spending on the war in Afghanistan as it winds down, a downturn in planned military spending, a constraint placed on the Pentagon budget because the federal government is operating on short-term resolutions that limit spending growth, as well as concern that further cuts may be in the pipeline.

The problem is that, absent a big increase in economic growth, balancing the federal budget in the long run requires big increases in taxes or big reductions in spending. But, although opinions differ on which option is worse, tax increases and spending cuts themselves are enemies of economic growth. So the traditional options for balancing the federal budget in the long run all have the potential to make things much worse.

Our problems are so big they need new solutions. In our current situation, the fact that a proposal is “untried” is a plus, since none of the economic approaches we have tried lately have worked very well. In the last few months I have focused my Quartz columns on explaining how the US and the world can get out of the economic mess we are in with new solutions. A recap:

  1. One of the new solutions is really an old one, that Congress and the President might be timidly tiptoeing toward too little of: dramatically more open immigration. Done right, this is guaranteed to add to long-run economic growth, as more workers make more goods, perform more services, and contribute to solving our long-run budget problems. And it isn’t just the US that would benefit from more open immigration. Ryan Avent has a must-read article in The Economist arguing that “Liberalising migration could deliver a huge boost to global output.”
  2. The long-run budget can be balanced in a way that achieves both the core Republican goals of holding down the size of government and the burden of taxation and the core Democratic goal of taking care of the poor, sick and elderly. Here is how: by using the tax system to back up a program of public contributions to expand the non-profit sector instead of taxes and spending to expand government, or brutal cuts with no compensating way to take care of those in need.
  3. For stimulating the economy, the one current approach that has been working at least halfway is “quantitative easing”: the Fed’s large purchases of long-term government bonds and mortgage-backed securities. But quantitative easing is hugely controversial and has an unfortunate side effect of making our long-run government debt problem worse than if we could stimulate the economy some other way. Establishing a US Sovereign Wealth Fund to do the purchasing of long-term and risky assets would give the Fed room to maneuver in monetary policy, and restrict its job to steering the economy rather than making controversial portfolio investment decisions. And a US Sovereign Wealth Fund could stand as a bulwark against wild swings in financial markets. (In addition to the column linked above, I spoke on CNBC’s Squawkbox about a US Sovereign Wealth Fund.)
  4. Although valuable, a US Sovereign Wealth Fund is a poor second best to electronic money. It is the fear of massive storage of paper currency that prevents the US Federal Reserve and other central banks from cutting short-term rates as far below zero as necessary to bring full recovery. (If electronic dollars, yen, euros and pounds are treated as “the real thing”—the yardsticks for prices and contracts—it is OK for people to continue using paper currency as they do now, as long as the value of paper money relative to electronic money goes down fast enough to keep people from storing large amounts of paper money as a way of circumventing negative interest rates on bank accounts.)  As I argued in “Could the UK be the first country to adopt electronic money,” the low interest rates that electronic money allows would stimulate not only business investment and home building, but exports as well—something that would lead to a virtuous domino effect as the adoption of an electronic money standard by one country led to its adoption by others to avoid trade deficits. If I were writing that column now, I would be asking if Japan could be the first country to adopt electronic money, since Japan’s new prime minister Shinzo Abe is calling for a new direction in monetary policy. For the Euro zone, I argue in “How the electronic deutsche mark can save Europe” that electronic money is not only the way to achieve full recovery, but the solution to its debt crisis as well.
  5. Finally, if electronic money is too radical, the government can stimulate the economy without adding too much to the national debt by giving consumers extra borrowing-power with a government-issued credit card and a $2,000 credit limit to every taxpayer. These Federal Lines of Credit would stimulate the economy at a fraction of the cost of tax rebates. This is a big advantage for countries deep in debt, which includes most major economies. And Lines of Credit are an affordable way to stimulate the economies of European countries such as Spain and Italy that lack an independent monetary policy because they share the euro with many other European countries.

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 are 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.

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.

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

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 ReinhartVincent 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.”

Niklas Blanchard Defends Me Against the Wrath of Paul Krugman, Despite My Lack of Nuance

In response to my latest Quartz column

Paul wrote a post

taking aim at my reliance on Carmen Reinhart, Vincent Reinhart and Kenneth Rogoff’s paper “Debt Overhangs, Past and Present.” I plan to write a reply to Paul at some point. In the meanwhile,  I appreciate Niklas Blanchard coming to my defense in his post

Not surprisingly, I like Niklas’s post. But Niklas also takes me to task for my reliance on the paper “Debt Overhangs, Past and Present.” (Update: Niklas tweeted that his title about lack of nuance was directed at Paul, not me. I interpreted it as my not being careful enough in my discussion of Reinhart, Reinhart and Rogoff.) Among other discussions about the interaction with Paul, you can see my attempt to justify myself to Niklas in these storified tweets:  

For the record, here is the passage in question in my post:

And national debt beyond a certain point can be very costly in terms of economic growth, as renowned economists Carmen ReinhartVincent 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? 

For comparison, here is the abstract for “Debt Overhangs, Past and Present”

We identify the major public debt overhang episodes in the advanced economies since the early 1800s, characterized by public debt to GDP levels exceeding 90% for at least five years. Consistent with Reinhart and Rogoff (2010) and other more recent research, we find that public debt overhang episodes are associated with growth over one percent lower than during other periods. Perhaps the most striking new finding here is the duration of the average debt overhang episode. Among the 26 episodes we identify, 20 lasted more than a decade. Five of the six shorter episodes were immediately after World Wars I and II. Across all 26 cases, the average duration in years is about 23 years. The long duration belies the view that the correlation is caused mainly by debt buildups during business cycle recessions. The long duration also implies that cumulative shortfall in output from debt overhang is potentially massive. We find that growth effects are significant even in the many episodes where debtor countries were able to secure continual access to capital markets at relatively low real interest rates. That is, growth-reducing effects of high public debt are apparently not transmitted exclusively through high real interest rates.

Postscript: In this context I love Noah Smith’s Twitter homepage illustration

Within the Overton Window

Yesterday, I listed some proposals that are not yet easy for politicians to talk about. Today, let me list some policy positions I favor that are sometimes echoed by politicians, and so lie within the Overton window of what can be said without sounding too extreme. Here they are, with links:

  1. Free Trade
  2. Free Speech
  3. Charter Cities
  4. School Choice
  5. The Free Market
  6. Copyright Reform
  7. Honoring Tax Payers
  8. Libertarian Paternalism
  9. Redesigning Mortgages
  10. Laws Against Deception
  11. Taking Care of the Poor
  12. Nonpartisan Redistricting
  13. Medical Reform Federalism
  14. Keeping the Federal Reserve
  15. The Reintroduction of the Deutsche Mark
  16. A Dramatic Reduction in Occupational Licensing
  17. Exporting Jobs to Places They are Desperately Needed
  18. Public Health Interventions in the Area of Food and Drink
  19. Frontloading Federal Transfers to States During Recessions
  20. Going to War If Necessary to Stop Iran from Getting Nuclear Weapons
  21. The End of Income Taxes and Capital Taxes, Replaced by Consumption Taxes (also here
  22. The Careful Use of Subjective Measures of Well Being to Inform Policy (also here)
  23. A Modest Carbon Tax (also here) and Increased Support for Research in Low-Carbon Energy Technology, Without Alarmism
  24. Reorienting Unions and Workplace Law toward Improving the Workplace Experience and away from Politics and from Artificially Pushing Up Wages and Benefits

Together with yesterday’s post, this post gives an update to the post

which in turn is an update of

The Overton Window

A while back, I was intrigued by Chris Dillow’s mention of the “Overton window” in his post “Fiscal Policy and the Overton Window.”

Wikipedia defines the Overton window as follows:

The Overton window is a political theory that describes as a narrow “window” the range of ideas that the public will find acceptable, and that states that the political viability of an idea is defined primarily by this rather than by politicians’ individual preferences.[1]It is named for its originator, Joseph P. Overton,[2] a former vice president of the Mackinac Center for Public Policy.[3] At any given moment, the “window” includes a range of policies considered politically acceptable in the current climate of public opinion, which a politician can recommend without being considered too extreme to gain or keep public office.

The set of ideas politicians feel they can talk about in turn limits the range of ideas that are considered relevant policies for typical political debates. As a result, a great deal of political discussion is about a very narrow range of policies. One of the most important ways that the blogosphere can contribute to the political debate is by talking about attractive policies that politicians are not talking about. That makes those policies more familia–and so safer for politicians to talk about–thereby expanding the Overton window.

I have proposed a many policies that are currently not a big part of the political discussion in our country. It is my hope that additional discussion of these ideas in the blogosphere can expand the Overton window to encompass them as genuine political possibilities. Here are a few, with links:

  1. Electronic Money as a Way to Eliminate the Zero Lower Bound on Monetary Policy
  2. A Public Contribution System as an Alternative to Tax Increases
  3. Federal Lines of Credit as an Alternative to Tax Rebates
  4. A US Sovereign Wealth Fund to Give the Fed Running Room
  5. A Constitutional Amendment to Limit Government Spending to Less than Half of GDP
  6. A Dramatic Increase in Legal Immigration
  7. Year-Round Schooling

For proposals that are more nearly within the bounds of current political debate, see my post “Within the Overton Window,”

Note: This post, plus “Within the Overton Window” constituted a list of "save-the-world posts.“ My most current list of "save-the-world posts” is “Making a Difference: Save-the-World Posts as of December 3, 2013." 

An earlier list of "save-the-world” posts can be found in

My Platform, as of September 24, 2012,

and still earlier in  

Miles’s Best 7 “Save the World Posts,” as of July 7, 2012.

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).

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

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

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 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

Why George Osborne Should Give Everyone in Britain a New Credit Card

The Guardian had a feature “Dear George Osborne, it’s time for Plan B say top economists: Seven leading economists on what Chancellor George Osborne should do to revive the ailing UK economy.” That inspired this post with my advice to the United Kingdom on the Independent’s blog, which I reprint here. Thanks to Ben Chu, Jonathan Portes and David Blanchflower for encouragement. (The links below open in the same window, so use the back button to get back.)

Dear Chancellor of the Exchequer,

Since I am an American citizen, it might be argued that I have no business giving advice to the government of the United Kingdom of Great Britain and Northern Ireland. But the economic troubles we face are worldwide and I believe are amenable to a common solution if any major nation will show the way with a new tool of macroeconomic stabilization that has fallen into our hands.

The basic problem is that fear is causing many households and firms in the private sector who could spend to cut back on their spending, while others who would be glad to spend more cannot get access to credit. Much of the advice from economists has been for governments to spend more. But even governments that have had good credit ratings and have made some attempt to increase spending have felt limited by the addition to national debt that would result from the amount of extra spending that might be needed to restore economic health. For example, 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.”

What is needed—mainly for genuine economic reasons, but also for political reasons—is a way to provide a large amount of stimulus without adding too much to the national debt. In my new academic paper “Getting the Biggest Bang for the Buck in Fiscal Policy,” and on my blog, I propose and discuss a tool for macroeconomic stabilization that can do exactly that. The proposal, which I call “National Lines of Credit,” (or “Federal Lines of Credit” in the US case) is to send government-issued credit cards to all taxpayers that have a substantial line of credit attached—say £2,000 per adult, or £4,000 pounds per couple. The interest rate would be relatively favorable, say 6%, with a 10-year repayment period so that most of the repayment would happen after the economy is back on its feet again. But the government would insist on eventual repayment, except for the very-long-term unemployed or disabled. Insisting on repayment would make the ultimate addition to the national debt small compared to the stimulus provided by these National Lines of Credit.

The paper provides many more details of how National Lines of Credit might work than I should try to include here, but I should mention that a key detail is requiring each household not only to pay down its debt, but also to build up a reserve of savings after the economy has fully recovered. That reserve of savings would be there to help deal with any more distant future crisis. Also, let me say that, depending on the exactly how they are implemented, National Lines of Credit are either distributionally neutral or tend to favor the poor; by contrast, the Bank of England has estimated that its program of buying gilts (which might also be necessary) has had immediate benefits tilted toward the wealthy.

Perhaps just as important as the stimulus provided by a program of National Lines of Credit would be the value of demonstrating that this kind of approach works, if it does, or gaining a greater understanding of the workings of the economy if it doesn’t. The best existing evidence- historical evidence based on the decision to allow World War 1 veterans in the U.S. to borrow against their veterans’ bonuses – suggests that the stimulus effect can be substantial. But the politics of many nations will require more evidence before National Lines of Credit can be implemented there. (Many nations in the Eurozone need a program of National Lines of Credit even more than the United Kingdom does.) Some nation must blaze the trail. If the United Kingdom is willing to take the risk of going first in trying out this new stimulus measure, and it works, it will not only have helped to solve its own economic troubles, it will have earned the gratitude of the world, in a small but still significant echo of the way in which it earned the gratitude of the world by standing against Hitler.

Miles Kimball is an economics professor at the University of Michigan who studies business cycles and the effects of risk on household consumption. He blogs about economics and politics at supplysideliberal.com.

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

Guest blogger    Joshua Hausman’s    graph of the change in car sales in each state between 1930 and 1931, as a function of car sales in 1929, broken into those states with below-median fraction of veterans in the population (blue) and above-median fraction of veterans in the population (red). The fitted lines do not impose equal slopes.    The graph excludes the District of Columbia (DC), since it is a large outlier. Including DC strengthens the case for an effect of being allowed to borrow against the veteran’s bonus on auto sales: DC had a high share of veterans and was the only state to see auto sales actually increase from 1930 to 1931. 

Guest blogger Joshua Hausman’s graph of the change in car sales in each state between 1930 and 1931, as a function of car sales in 1929, broken into those states with below-median fraction of veterans in the population (blue) and above-median fraction of veterans in the population (red). The fitted lines do not impose equal slopes.

The graph excludes the District of Columbia (DC), since it is a large outlier. Including DC strengthens the case for an effect of being allowed to borrow against the veteran’s bonus on auto sales: DC had a high share of veterans and was the only state to see auto sales actually increase from 1930 to 1931. 


Perhaps the best historical analogies to Miles’s Federal Lines of Credit Proposal are 1931 and 1936 policy changes that gave World War I veterans early access to a promised 1945 bonus payment. In 1924, Congress passed a bill promising veterans large payments in 1945. When the depression came, veterans’ groups lobbied congress for immediate payment. Congress partially acquiesced in 1931, giving veterans the ability to borrow up to 50 percent of the value of their promised bonus beginning on February 27. (Prior to this, veterans could take loans of roughly 22.5 percent of their bonus.) For the typical veteran, this meant being able to borrow about $500. For comparison, in 1931 per capita personal income was $517. The loans carried an interest rate of 4.5 percent, but interest did not have to be paid annually. Rather, the amount of the loan plus interest would be deducted from what was due the veteran in 1945. In fact, the interest rate was lowered to 3.5 percent in 1932, and then forgiven entirely in 1936. But there is no reason to think that this was expected at the time.

Despite their ability to take loans, veterans continued to demand immediate cash payment of the entire, non-discounted, value of their bonus. Tens of thousands of veterans camped in Washington, DC from May to July 1932 to lobby for immediate payment. Finally, in 1936, congress granted their wish, giving veterans the choice of taking their bonus in cash or leaving it with the government where it would earn 3 percent interest until 1945. Whereas the 1931 policy change was a pure loan program, the 1936 policy had elements of both a loan and a transfer, since it gave veterans access to the same amount of cash in 1936 that they otherwise would have gotten in 1945, and since part of the 1936 bill forgave interest on earlier loans. A rough calculation suggests that of the typical bonus amount of $550 received in 1936, roughly half was an increase in veterans’ permanent income, while the other half was essentially a loan. 

My ongoing work focuses on evaluating the 1936 bonus, both because it was quantitatively much larger than the 1931 loan payments, and because there is a household consumption survey and a survey of veterans themselves that makes it possible to evaluate the policy’s effects in detail. But the 1931 program is a better analogy for Miles’ Federal Line of Credit proposal. Thus in the rest of this blog post I consider what evidence there is on the 1931 program. 

No single source of evidence is definitive, but several pieces of evidence suggest that loans to veterans boosted consumption in 1931. First, it is significant that veterans eagerly took advantage of the loan program. In the four months following the policy change (March to June 1931), veterans took 2.06 million loans worth an aggregate $796 million, or one percent of GDP. Since there were 3.7 million World War I veterans, these figures suggest that a majority quickly took advantage of the loan program (that is, unless many veterans took multiple loans). Given the 4.5 percent interest rate, and the lack of many attractive investment opportunities in the 1931 economy, it only made sense for veterans to take these loans to consume or to pay down high interest rate debt.

Other evidence points to veterans using some of the money on consumption rather than using it entirely to pay down debt. First, there is an uptick in department store sales amidst what is otherwise a steady downward trend. Seasonally adjusted sales rose 2.9 percent in April, the month when veterans took out the most loans. Since the proportion of veterans in the population varied significantly across states, it is also possible to relate changes in new car sales in a state to the number of veterans in the state, and thus measure the effect of the loan program. Uncovering whether or not there was such a relationship is tricky since the loan program was small compared to the other shocks hitting the economy. In particular, states with more veterans tended to be states in the west, and these states had higher car sales in 1929. In turn, states that had higher car sales in 1929 tended to see larger declines in sales during the Depression. A way to see both the relationship to 1929 sales, and the effect of veteran share is to graph the 1930-31 change in car sales per capita against the level of 1929 car sales. This is done in the figure at the top. The blue dots are states in the lower half of the veteran share distribution (i.e. states with fewer than 2.9 veterans per 100 people) and the red dots are states in the top half of the veteran share distribution. The lines are the fitted values for each set of points. The graphical evidence is hardly definitive, but it is at least consistent with the fact that conditional on pre-depression conditions, being in the top half of the veteran share distribution led to higher auto sales in 1931.

Finally, narrative sources provide some indication of what people at the time thought veterans were doing with the money. News stories are also consistent with veterans spending the money on cars. For example, the Los Angeles Times wrote on March 22, 1931: “The opinion has been ventured that the bonus readjustment would have a beneficial effect upon the motor trade and that a liberal amount of this money would find its way into the pockets of the automobile dealer. The prediction is becoming a fact to a greater extent than was at first anticipated." 

Newspapers also reported veterans spending on other consumer items. The New York Times wrote on April 5, 1931: "That the payment of the soldiers’ bonus has definitely increase purchases of merchandise, particularly men’s wear, was the opinion yesterday of Julian Goldman, head of the Julian Goldman Stores, Inc., which sell goods on the instalment [sic] plan. Mr. Goldman recently returned from an extended trip through the country and reported that managers of his own stores and other merchants attributed a substantial increase in sales to the veterans spending their loan money.” The article goes on to also say that veterans were using their loans to pay back installment debt on previous clothing purchases. 

2012 is not 1931 and a trial of Federal Lines of Credit today would provide much better evidence of its effects. But the 1931 experience is at least encouraging. The balance of evidence suggests that the loan program was popular and that it increased consumption relative to what it otherwise would have been. Of course, the economy still saw large absolute declines in consumption and output in 1931, since the loan program was tiny compared to the negative shocks hitting the economy.  

– Joshua Hausman

Sources

Information on the the bonus legislation and the number and dollar amount of loans is taken from the 1931 Annual Report of the Administrator of Veterans’ Affairs, in particular, p. 42; data on seasonally adjusted department store sales are from

http://www.nber.org/databases/macrohistory/rectdata/06/m06002a.dat

Data on veterans per capita in each state are from the 5% IPUMS sample from the 1930 Census; data on new car sales by state are from the industry trade publication Automotive Industries, data for 1929 sales is from the February 22, 1930 issue, p. 267, for 1930 from the February 28, 1931 issue p. 309, and for 1931 from the February 27, 1932 issue p. 294.

Mark Thoma on the Politicization of Stabilization Policy

Mark Thoma has a new post “Starving the Beast in Recessions” that links to his article in the Fiscal Times: “How GOP Lawmakers have the Fed Over a Barrel.” Mark’s post backs up the concern I expressed in “Preventing Recession-Fighting from Becoming a Political Football” that traditional stimulative fiscal policy–tax cuts or increases in goverment spending–entangles recession fighting in political disputes about the size and scope of government. In that post, I wrote:

By avoiding big changes in taxes or spending, I hope my Federal Lines of Credit proposal can help to depoliticize stabilization policy. 

“Preventing Recession-Fighting from Becoming a Political Football” is a difficult post. For more accessible posts on Federal Lines of Credit, go to my second post “Getting a Bigger Bang for the Buck in Fiscal Policy” or to “My First Radio Interview on Federal Lines of Credit.” I plan to do a set of index posts for my sidebar giving links to all of my posts by topic area soon. At that point, the index post on “Short-Run Fiscal Policy” will link to all of my posts on Federal Lines of Credit.     

Miles's First Radio Interview on Federal Lines of Credit

Bill Greider’s piece in The Nation’s blog on Federal Lines of Credit (see “Bill Greider on Federal Lines of Credit: ‘A New Way to Recharge the Economy”) was syndicated to the Detroit Metro Times (the link under the credit card), which in turn sparked a radio interview with Detroit Public Radio.

I listened back to the podcast myself and thought it turned out well. So I recommend it. It is short and sweet.

By way of clarification on Bill Greider’s piece, The Detroit Metro Times posted this note from me. The reply to Mike Konczal that note describes as forthcoming is already out as my post “Preventing Recession-Fighting from Becoming a Political Football.”

Preventing Recession-Fighting from Becoming a Political Football

Mike Konczal has a recent post “Four Issues with Miles Kimball’s ‘Federal Lines of Credit’ Proposal," announced by this tweet:

New post, where I go feral on@mileskimball, discussing four issues with his “Federal Lines of Credit” policy idea.

Mike’s tweet is the only way I can get a working link to his post. This link may work at some point in the future. Here is Mike’s description of my proposal:

What’s the idea? Under normal fiscal stimulus policy in a recession, we often send people checks so that they’ll spend money and boost aggregate demand. Let’s say we are going to, as a result of this current recession, send everyone $200. Kimball writes, "What if instead of giving each taxpayer a $200 tax rebate, each taxpayer is mailed a government-issued credit card with a $2,000 line of credit?” What’s the advantage here, especially over, say, giving people $2,000? “[B]ecause taxpayers have to pay back whatever they borrow in their monthly withholding taxes, the cost to the government in the end—and therefore the ultimate addition to the national debt—should be smaller. Since the main thing holding back the size of fiscal stimulus in our current situation has been concerns about adding to the national debt, getting more stimulus per dollar added to the national debt is getting more bang for the buck.”

Mike has some praise and four Roman numerals worth of objections. I promised a detailed answer. Other than the comment threads after each post, this is only the second time I have had a serious online criticism of one of my posts, and I will try to accomplish the same sort of thing I tried to accomplish in my answer to the first serious criticism I received from Stephen Williamson: to answer the criticism point by point while at the same time making some important points worth making even aside from this dustup with Mike. The main point I want to make uses the phrases “fiscal policy” and  "stabilization policy,“ which can be given the following rough-and-ready definition:

Fiscal policy: government policy on taxing and spending

Stabilization policy: loosely, recession-fighting (in times of recession) and inflation-fighting (in times of boom).  

More precise definitions of stabilization policy inevitably involve the details of exactly what should be done and when, which are sometimes under dispute; this definition will serve for now. Here is the main point I want to make in this post:

Long-run fiscal policy is unavoidably political, since it involves the tradeoff between the benefits of redistribution and the benefits of low tax rates, but stabilization policy can and should be kept relatively apolitical. The politicization of stabilization policy in the last few years is an unfortunate, and fundamentally unnecessary, turn of events.  

By avoiding big changes in taxes or spending, I hope my Federal Lines of Credit proposal can help to depoliticize stabilization policy. 

The reason a discussion of the politicization of stabilization policy belongs in a reply to Mike Konczal is that my simple summary of his objections to my Federal Lines of Credit proposal of government-issued credit cards to stimulate the economy is that my proposal does not do enough to redistribute toward the poor. Now my views on redistribution are no secret. As I said in my first post, "What is a Supply-Side Liberal,” redistribution is good. In my post “Rich, Poor and Middle-Class,” I made a stronger statement, focusing on helping the poor, which is the important part of redistribution:

I am deeply concerned about the poor, because they are truly suffering, even with what safety net exists. Helping them is one of our highest ethical obligations.

The other type of redistribution, which is more controversial (because the redistributive benefit is smaller and the economic efficiency cost is higher) is taxing the rich in order to help the middle class. Given the fact that redistribution needs to be financed by taxes or by deficit spending, Republicans and Democrats differ substantially on how much redistribution they think should be done of either type. As a result, the political fights over long-run taxing and spending policy are often bitter. My fervent hope is to find ways to avoid having the the blood that is spilled over long-run taxing and spending policy from infecting short-run stabilization policy, which by rights should be less controversial especially in a recession, since recessions are bad for almost everyone. It is a little harder to say that inflation is bad for almost everyone, since inflation benefits debtors at the expense of creditors, but few people on either side of the political divide advocate high inflation as a way to wipe out debts, and most of the other effects of inflation higher than a few percent per year are bad for everyone.

What has made stabilization policy a political football in the last few years is the fact that the Federal Reserve is maxed out on its favorite recession-fighting tool of lowering short-term interest rates. Because currency effectively earns an interest rate of zero, no one is willing to lend money at an interest rate much below zero, so zero is about as low as the Fed can go. In my answer to the first serious criticism I received from Stephen Williamson, I argue that the Fed can still do a lot more to stimulate the economy even when the nominal interest rate is already down to zero, but the Fed has been reluctant to use unfamiliar tools to the full extent possible. And the size of the necessary changes to the Fed’s balance sheet are enough to scare many people (in a way that I argue is unwarranted in my third, and to this date, most-viewed post “Balance Sheet Monetary Policy.”) Indeed, the Fed has become a political target not only because of its sadly necessary role in saving the economy by bailing out big banks, but also because even the Fed’s half-measures have involved big enough changes in the Fed’s balance sheet to scare many people.  

Besides monetary policy, the traditional remedies in stabilization policy have to do with taxing and spending. In particular, the traditional remedies for a recession other than monetary stimulus are tax cuts and spending increases. It is easy to see the problem. Since taxes and spending are also the center of the political debate about long-run policy, any use of taxes or spending to fight recessions arouses justifiable suspicion that the other side will use recession-fighting as an excuse to advance its long-run agenda: for Republicans, lowering taxes in the long run, for Democrats, increasing the amount of redistribution in the long run. 

By contrast, since monetary policy does not touch on what in recent history are the core political debates about taxing and spending, for at least the 30 years from mid 1988 to mid 2008 (when the financial crisis and the Great Recession threw things for a loop) political controversies over monetary policy have been relatively esoteric–not the sorts of things that move the average voter in either party.  

In crafting my Federal Lines of Credit proposal, one of my key objectives was to find a new way of fighting recessions that, like monetary policy in normal times, would be fully acceptable to both political parties. The U.S. economy and the world economy are in trouble, and it is important that politics not get in the way of what needs to be done. So I am pleased to have Mike Konczal say of my proposal “This has gotten interest across the political spectrum.”  The proposal itself is described in my second post “Getting the Biggest Bang for the Buck in Fiscal Policy,” and my recent post “Bill Greider on Federal Lines of Credit: 'A New Way to Recharge the Economy’” is a good way to catch up on the discussion about Federal Lines of Credit since then.   

Now let me turn to Mike’s four issues:

I. Isn’t deleveraging the issue? Is this a solution looking for a problem? From the policy description, you’d think that a big is credit access holding the economy in check.

But taking a look at the latest Federal Reserve credit market growth by sector, you can see that credit demand has collapsed in this recession.

I actually think that credit access has gone down. For example it is a lot harder getting home-equity lines of credit these days than it used to be, even for those whose houses are worth a lot more than their mortgages. But Mike is right that many people are scared enough about the economy that they are trying to pay down their credit card debt. The key point here is that what makes sense from an individual point of view in time of recession–reducing household spending–makes things worse for all of us by reducing the amount of business that firms get and therefore how many workers feel they can hire. So to help out the macroeconomic situation, we want people to lean toward spending more than they otherwise would. Giving every taxpayer access to a federal line of credit at a reasonable interest rate and reasonable terms (say 6%, paid off over 10 years) would cause at least some people to spend more, which is what we want in order to stimulate the economy.

II. This policy is like giving a Rorschach test to a vigilante. No, not that vigilante. I mean the bond vigilantes.

Mike’s point here is that, although in the long-run, people will have to pay back the money they borrowed from the government on their Federal Lines of Credit, the government is out the money in the meantime, and this might add to the official deficit and national debt numbers. So if the folks in the bond market are not smart enough to look past the surface of the deficit and national debt numbers, they might cause long-term interest rates to go up. Here, my answer is simple: the folks in the bond markets are very, very smart. They know the difference between the government being out money forever (as it would be if it used a tax rebate) and the government making loans that will be repaid, say, 90% of the time. As evidence that the “bond vigilantes” look at more than the official debt to GDP ratios, take a look at this list of debt to GDP ratios. (I am using the International Monetary Fund’s numbers from this table, rounded off to the nearest percent. If there are more recent numbers, I am confident they will show the same thing.) Here are the examples that make my point:

Spain: 69%

Germany: 82%

United States: 103%

Japan: 230%

It is right to worry about the future, but currently, Spain is in trouble with the bond vigilantes, while the world is eager to lend money to Germany, the United States and Japan. (See my post “What to Do When the World Desperately Wants to Lend Us Money” about what this eagerness of the world to lend to the U.S. means for U.S. policy from a wonkish point of view that ignores political difficulties.) The reason Spain is in trouble with the bond vigilantes is that the Spanish government is seen to be on the hook for the much of the debts of Spanish banks; this bank debt that may become Spanish government debt sometime in the future does not show up in the official debt to GDP figures, but the bond vigilantes know all about it.  On the other end, one reason that the bond vigilantes are still willing to lend money to Japan at low interest rates is that they know Japanese households do a lot of saving and don’t like to put their money abroad, so a lot of that saving makes its ways into Japanese government bonds, either directly or indirectly.

III. This policy will involve trying to get blood from a turnip. I very much distrust it when economists waive away bankruptcy protection. Especially for experimental, controversial debts that have never been tried in known human history.

As the paper admits, this is a machine for generating adverse selection, as the people most likely to use it are people whose credit access is cut due to the recession. High-risk users will likely transfer their balances from higher rate credit cards to their FOLC (either explicitly or implicitly over time if barred) - transferring a nice chunk of credit risk from the financial industry to taxpayers.

It’s also not clear what happens a few years later when consumers start to pay off the FOLC. Could that trigger another recession, especially if the creditor (the United States) doesn’t increase spending to compensate?

The issue isn’t whether or not the government will be able to collect these debts at some point. It has a long time-horizon, the ability to jail debtors and use bail to pay debts, the ability to seize income, old-age pensions and a wide variety of income, and the more general ability to deploy its monopoly on violence. The question is whether this will be smoother, easier, and more predictable than just collecting the money in taxes. We have a really smooth system for collecting taxes, one at least as good as whatever debt collection agencies are out there. If that is the case, there’s no reason to believe that this will satisfy the bond vigilantes or bring down our debt-to-GDP ratio in a more satisfactory way.

Mike actually raises several issues here. Let me be clear that I am not proposing jailing debtors! I am imagining something like the current system we have for student loans directly from the Federal government. These loans cannot be wiped away by bankruptcy, but no one is jailing former students who can’t pay what they owe on their student loans. When I supposed above that (including interest–I am thinking in present values) only 90% of the money would be repaid, the other 10% is money that the government ultimately gives up on trying to collect because some people can’t pay. To avoid any possible abuses, I think it would be a good idea to specify in the law authorizing Federal Lines of Credit that people’s debts under the program could never be sold to an outside collection agency: only official government employees would be allowed to make collection efforts. Worry about a political firestorm would prevent the government from doing the kinds of things the private collection agencies sometimes do. Almost all repayment would be through payroll deduction from people who are drawing a paycheck, with perhaps some repayment through small deductions from government transfers people receive when those government transfers are above a minimum level. 

Is an expected loan-loss rate of 10% too much? Then it is easy to modify the program to reduce the loan-loss rate without reducing its effectiveness in recession-fighting by allowing those with higher incomes to borrow more and restricting the size of the lines of credit for those with lower incomes.  For those worried about issues with Federal Lines of Credit like those Mike is raising, I strongly recommend reading my relatively accessible academic paper on the proposal: “Getting the Biggest Bang for the Buck in Fiscal Policy.” But now I am going to give you fair warning about what “relatively accessible” means by quoting the somewhat recondite way that I make this point in the paper:

One of the main factors in the level of de facto loan losses would be the extent to which the size of the lines of credit goes up with income. Despite the reduction in additional aggregate demand per headline size of the program that might be occasioned by conditioning on income, de facto loan losses would probably decline by a greater proportion, meaning that conditioning on income might improve the ratio of extra consumption to budgetary cost. Certainly, having the line of credit go up with income might reduce the level of implicit redistribution, which is a consideration I will not try to address here. 

To translate, if we give rich taxpayers bigger lines of credit than poor taxpayers, we will probably get even more bang-for-the-buck from the program–in the sense that there will be more stimulus for each dollar ultimately added to the national debt after most repayment has happened.

I will confess that the only reason I didn’t make this kind of dependence of the size of the line of credit on income the benchmark version of the proposal is that I wanted to sneak in a little income redistribution into the program. But if next year we have a Republican Congress and a Republican President (now trading at a 30% probability on Intrade), stimulating the economy is important enough that it is still a very good thing to do the Federal Line of Credit program with less redistribution than I had in the benchmark version of the proposal, which gives the same-size line of credit to each taxpayer. On the other hand, if next year we have a Democratic Congress and a Democratic President (now trading at a 7.5% probability on Intrade), stimulating the economy is important enough that it is still a very good thing to do the Federal Line of Credit program with lines of credit of the same size not only for every taxpayer but also for non taxpaying adults and to let the debts be extinguished in bankruptcy. Federal Lines of Credit would still give us more bang-for-the-buck than other types of fiscal stimulus that a Democratic Congress and Democratic President might turn to, and regardless of what happens politically, the United States government does have to worry about the bond vigilantes down the road whenever it adds to the national debt in a long-run way. In what I consider the most likely case of divided government, where out of the presidency, the Senate and the House of Representatives, each party holds at least one (now trading at a 62.5% probability on Intrade if one includes the 4.5% probability of “other,” which presumably covers the case when the control of one house of congress depends on how the few independents vote), something in between–perhaps not too far from my benchmark proposal–seems to me what would be politically feasible. 

In the passage I quoted from Mike labeled as his issue III, he also worries about whether the repayment of the loans would cause a recession later on. I have thought that stretching out repayment over 10 years would be enough to avoid this problem, but I view this an issue for the experts. If, as I prefer (see my post “Bill Greider on Federal Lines of Credit: 'A New Way to Recharge the Economy’”), the Federal Reserve determines many of the details of the Federal Lines of Credit Program, I trust the staff of the Federal Reserve Board and the Federal Reserve Banks to come up with a better answer on the appropriate length of time for loan repayment than either Mike or I could.

Finally, we come to Mike’s fourth and last issue, which motivated my discussion above about the value of separating long-run fiscal issues from short-run stabilization policy, so that recession-fighting doesn’t become a political football. What Mike writes to explain his fourth issue is long enough that I will intersperse some comments along the way. From here on, everything in block quotes reproduces Mike’s words. 

IV.Since we’ve very quickly gotten to the idea that we’ll need to jettison legal protections under bankruptcy for this plan to work, it is important to emphasize that this policy is the opposite of social insurance.

As I said above, I am not advocating jailing debtors. I don’t see the fact that student loans are not expunged in bankruptcy as a massive social injustice that causes huge problems; if it is, it would meant that it is a travesty that the Obama administration is only proposing having private student loans wiped away by bankruptcy while leaving public student loans from the government untouched by bankruptcy. I am sure some people think that, and would not be surprised if that is Mike’s view, but I don’t think the average voter would take that view, nor do I criticize the Obama administration for not being willing to go far enough and have all student loans expunged in bankruptcy. 

I don’t see a macroeconomic difference between the government borrowing 3 percent of GDP and giving it away and collecting it through taxes later versus the government borrowing 3 percent of GDP, loaning it to individuals, and collecting it later through debt collectors except in the efficiency and the distribution.

This passage is well-designed to underemphasize the fact that the way in which, say, “3 percent of GDP” is given away is redistributive. Indeed, to the extent that asking everyone to pay the same amount is regressive, giving everyone the same amount as in my benchmark proposal has to count as anti-regressive. There is no question that giving away 3 percent of GDP and collecting it later through progressive taxes would bemore redistributive. Overall, my program is fairly neutral as far as redistribution goes, though as I confessed, I snuck a little redistribution into my benchmark proposal because those with higher incomes would likely repay a bigger fraction of the borrowed money than those with higher incomes.  

The distributional consequences of this proposal aren’t addressed, but they are quite radical. Normally taxes in this country are progressive. Some people call for a flat tax. This proposal would be the equivalent of the most regressive taxation, a head tax. And it also undermines the whole idea of social insurance.

Mike seems to be claiming that the Federal Lines of Credit program overall is regressive. I just don’t see this. Is the government’s student loan program regressive? Just because a program could be made more redistributive than it is, does not mean that on the whole it is regressive.  

Let’s assume the poorest would be the people most likely to use this to boost or maintain their spending. I think that’s largely fair - certainly the top 10 percent are less likely to use this (they’ll prefer to use high-end credit cards that give them money back). This means that as the bottom 50 percent of Americans borrow and pay it off themselves, they would bear all the burden for macroeconomic stability through fiscal policy. Given that the top 1 percent captured 93 percent of the income growth in the first year of this recovery, that’s a pretty major transfer of wealth. One nice thing about tax policy, especially progressive tax policy, is that those who benefit the most from the economy provide more of the resources. This would be the opposite of that, especially in the context of a “"relatively-quickly-phased-in austerity program.”

Let me say quickly that my mention of “austerity” was in the European context, where paying what the bond market demands without a full-scale bailout from a reluctant Germany requires austerity. I made no mention of “austerity” for the U.S., nor do I think “austerity” will be necessary for the U.S., if we follow the kinds of proposals I recommend.

Going back up to the top of this block quote from Mike, again, saying that the bottom 50 percent of Americans “would bear all the burden for macroeconomic stability” ignores the fact that they were able to borrow and use the money when they really needed it during hard economic times. The only way in which this could be a burden is if loaning money on relatively favorable terms (again, say at 6% for 10 years) is an unkind temptation to people who have trouble stopping themselves from spending more now than they should.  I worried about this, which is why I proposed that, by the time the next recession rolls around, we have National Rainy Day Accounts set up that allow people to spend in recessions or during documentable personal financial emergencies money that they have saved up previously. Now requiring someone to save money for later emergencies they might face, and encouraging them to spend some of that money in a national emergency such as a future recession may indeed be a burden. But it is hard for me to see how both proposals–letting people borrow on favorable terms from Federal Lines of Credit and requiring people to save in National Rainy Day Accounts–can be a burden. The only way that allowing people to borrow on favorable terms can be a burden is if they have trouble saving as much as they should, in which case setting up a structure to help them save will help them out. And Mike agrees that “There’s a lot to like about the proposal [Federal Lines of Credit], particularly how it could be used after a recession is over to provide high-quality government services to the under-banked or those who find financial services yet another way in which it is expensive to be poor …" On a more negative note, Mike continues as follows in the text of his fourth issue:

Efficiency is also relevant - as the economy grows, the debt-to-GDP ratio declines, making the debt easier to bear. The most likely borrowers under FOLC [sic], the bottom 50 percent, have seen stagnant or declining wages overall, especially in recessions. A growing economy would keep their wages from falling in the medium term, but this is still a problematic issue - their income is not more likely to grow to balance out the payment burdens than if we did this at a national level, like normal tax policy.

The policy also ignores social insurance’s role in macroeconomic stability, and that’s insurance against low incomes. Making sure incomes don’t fall below a certain threshold when times are tough makes good macroeconomic sense and also happens to be quite humane. This is not that. As friend-of-the-blog JW Mason said, when discussing this proposal, the FOLC [sic] is like "if your fire insurance simply consisted of a right to borrow money to rebuild your house if it burned down.”

Here again, I take Mike’s point that it would be easy to do more redistribution than the modest amount of redistribution in the Federal Lines of Credit proposal as I lay it out. But I view redistribution as the province of long-run fiscal policy (in the broadest sense). Trying to use recession-fighting as a way to also do more redistribution is a recipe for making recession-fighting a political football. If recession-fighting becomes a political football, as it has to an unfortunate extent in the last few years, the recession (or the long tail of unemployment that follows what are officially called “recessions”) wins. And bad economic times are especially hard on those at the bottom of the income distribution. So they can least afford to have recession-fighting become a political football. My hope is that Federal Lines of Credit will make it possible to stimulate the economy when necessary in a way that avoids major changes in taxing and spending that would set off alarms for one or another of the two warring parties in the political debate.

What to Do When the World Desperately Wants to Lend Us Money

Karl Smith has a recent post “Why is the US Government Still Collecting Taxes?: Should Lambs Lay Down with Lions Edition” arguing that we should be dramatically reducing tax collection because interest rates on government bonds are so low that, after correcting for inflation, every dollar in the national debt is shrinking over time. Karl’s post follows up on Ezra Klein’s post “The world desperately wants to lend us money,” and my grad school professor Larry Summers’s post “It’s time for governments to borrow more money.” Ezra and Larry want the government to pay ahead on things it is going to buy anyway and make other productive investments.  

Larry, coming from his experience as Secretary of the Treasury makes a strong argument that the U.S. government should be borrowing long rather than short, in order to lock in amazingly low interest rates on long-term government bonds. Since the U.S. government’s position in relation to the bonds it has issued depends on what the Fed does as well as what the Treasury does, this argues against the Fed buying long-term government bonds when Larry’s argument says we should be selling long-term government bonds on net. Larry has convinced me by what he writes in “It’s time for governments to borrow more money.” The Fed should not be buying long-term government bonds.

But for the sake of stimulating the economy, the Fed needs to be buying large quantities of some type of asset. This is not just my view, implicit as a possibility in my post “Balance Sheet Monetary Policy: A Primer,” but the the official view of the Fed itself, since even the mostly stay-the-course policy the Fed announced at its last FOMC monetary policy making meeting involves buying large quantities of assets. (“Large” is less than “massive.”) So it is unfortunate that the legal authority of the Fed to buy assets is limited to a relatively narrow range of assets. See Mike Konczal’s interview with my undergraduate classmate Joseph Gagnon on the legal constraints the Fed faces. Short of buying foreign assets or otherwise going outside the Fed’s comfort zone, that probably means that the Fed should be buying mortgage-backed securities such as those issued by Fannie Mae. In general, when it uses balance-sheet monetary policy (what the press calls “quantitative easing”), the Fed should lean towards buying assets that have a high interest rate.  

It is important to note that many of the objections to more vigorous use of balance sheet monetary policy in the U.S. are really objections to buying long-term Treasury bonds, not objections to buying other assets. Anytime you see an argument against balance sheet monetary policy, check whether it is an objection to buying any kind of asset or only to buying long-term Treasury bonds. And sometimes there are objections to buying Treasury bonds and other objections to buying mortgage-backed securities that even combined do not apply to other assets. So I wish the Fed had the kind of authority the Bank of Japan has to buy a wide range of assets, including commercial paper (CP), corporate bonds, exchange traded funds (ETF’s), and real estate investment trusts (REIT’s). I got this list of assets from the Bank of Japan’s own website on the range of assets it is buying. See also my post on how the Bank of Japan should use this authority quantitatively: “Future Heroes of Humanity and Heroes of Japan.”

Given the low interest rates the U.S. government is facing, even aside from stimulating the economy it should be spending more–mostly on things it would buy later anyway and other productive investments. On stimulating the economy, my proposal of Federal Lines of Credit is gaining some traction: you can see my posts on what Brad DeLong and Joshua Hausman and Bill Greider have to say recently, as well as what Reihan Salam said early on. In what I write myself on Federal Lines of Credit, including the academic paper “Getting the Biggest Bang for the Buck in Fiscal Policy” that I flag at the sidebar, I emphasize the importance of not ultimately adding too much to the national debt as it will stand, say ten years from now. This is actually consistent with saying that the government shouldbe spending money now on things the government is going to spend money on sooner or later anyway, regardless of which party is in power, such as maintenance of military assets and stores, and the government should be spending money now on things that will add to the productivity of the economy so much that they will generate more than enough tax revenue to pay for themselves.

The existence of government investment that has this property of generating more tax revenue in the future than needed to make the payments on the money the government borrowed to make the investment is the spending counterpart to being on the wrong side of the Laffer curve so that you could cut taxes and get more revenue. I am not sure how many government investments meet this stringent test, but if any do, everyone should be in favor of them, regardless of their political viewpoint.  To have that statement be true, I am assuming that the investment is something noncontroversial that everyone would be glad to have for free (not something like a national stem-cell laboratory). The reason everyone should be in favor of such a self-financing investment is that the American taxpayers would be getting a better deal than “free.”  

Now, a government investment being self-financing in this sense is quite hard because for this, it is not good enough to have benefits great enough to pay for the direct cost to the government (the naive cost-benefit test). The extra payments to the U.S. Treasury alone (typically a minority of the total benefits) must be enough to pay for the investment. If on net the U.S. Treasury is out money at the end of the day for the sake of other benefits, then the dollars from the U.S. Treasury have to be counted as costing more than dollar for dollar since each dollar of government spending typically has a deadweight loss from tax distortion on top of it. (See for example Diewert, Lawrence and Thompson’s paper on this. There is a good discussion in this paper accessible to anyone even before the first equation.) As long as the U.S. Treasury is out money at the end of the day, the sophisticated cost-benefit test can easily flip from thumbs up to thumbs down depending on how big the tax distortions are–and economists don’t agree on that. I am on the side of believing there are relatively large tax distortions. (See my first post, “What is a Supply-Side Liberal,” which is also now at the sidebar.)

Interest rates won’t stay low forever, and the U.S. government, unlike the government of the United Kingdom of Britain and Northern Ireland, does not sell consols that would lock in a low interest rate forever (though maybe it should in the current environment). Moreover, extra debt probably raises the interest rate on existing debt. So the cost of extra debt is higher than the interest rate itself. (This is the monopoly problem from Economics 101: the U.S. government is a monopolist in the original issuance of its own debt, and so has to consider the effect of issuing more debt on the price and interest rates of existing debt.)

The last words in this post are is in response to Karl Smith’s post, which motivated the lamb and lion illustration. (Karl’s “lamb” is the U.S. government, while the “lion” is the bond traders in the financial markets). If, as I think they will, interest rates will some day go above not only inflation, but above the long-run growth rate of the economy as a whole (which matters among other things because it is the growth rate of the tax base), and the government cannot lock in a lower rate forever using consols, then any money the government borrows will cost us sometime in the future. The low interest rates now prevailing will make government borrowing now cost less in the future, but it won’t make the cost zero. Doesn’t that mean that we should do all our taxing later, when the amounts of money will have shrunk rather than now? It would if the cost of getting an extra dollar of tax revenue were constant over time. But a basic result from public finance is that the cost of getting an extra dollar of tax revenue goes up as you try to get more and more tax revenue as a fraction of GDP. That is why I was so confident in my post “Avoiding Fiscal Armageddon” that there is some limit of government spending as a fraction of GDP that we shouldn’t go beyond, even if that limit is higher than the 50% that I used as an example (and as a reasonable representation of my own judgment given my current knowledge.) Given the pressures on the government budget that I talk about in “Avoiding Fiscal Armageddon,” I will be shocked if tax rates are not higher in the future than they are now. So if the cost of getting an extra dollar of tax revenue goes up with the rates you already have, then there is an argument for moving toward raising tax rates at times such as now when tax rates are low compared to what they will be later. This “tax smoothing” argument counterbalances the implications of current lower interest rates, which favor lower taxes now. On balance, given the low interest rates the U.S. government is paying, tax rates should certainly be lower now than we expect them to be in the future, but there is a question of how much. 

Why is this called a “tax smoothing” argument? The reason is that raising tax rates when you think tax rates will be higher in the future–or following similar logic, lowering tax rates when you think tax rates will be lower in the future–tends to equalize tax rates now relative to expected tax rates in the future. I have not personally done any research on tax smoothing, but I learned about it from proofreading all of the math in Greg Mankiw’s paper “The Optimal Collection of Seigniorage: Theory and Evidence,” when I was Greg’s research assistant in graduate school, and I have heard more about it from my colleagues at the University of Michigan.