Opposition to the Stimulus Package

The economic news is grim:

The economy shrank at a 3.8 percent pace at the end of 2008, the worst showing in a quarter-century, as the deepening recession forced consumers and businesses to throttle back spending.

Although the initial result was better than economists expected, the figure is likely to be revised even lower in the months ahead and some believe the economy is contracting in the current quarter at an even faster pace.

Meanwhile, criticism of the Fiscal Stimulus package is growing even as it appears it may pass both house and Senate easily. Here's what NY Times columnist David Brooks has to say about the package:

But they’ve created a sprawling, undisciplined smorgasbord, which has spun off a series of unintended consequences. First, by trying to do everything all it once, the bill does nothing well. The money spent on long-term domestic programs means there may not be enough to jolt the economy now (about $290 billion in spending is pushed off into 2011 and later). The money spent on stimulus, meanwhile, means there’s not enough to truly reform domestic programs like health technology, schools and infrastructure. The measure mostly pumps more money into old arrangements.

The Stimulus Package and Protectionism

The Stimulus Package includes some protectionist measures. Economists have speculated that this might happen. The pitch makes for good political sound bytes.

Here's what ND Senator Byron Dorgan says:

"The 'Buy American' provision will help stimulate our own economy," Sen. Byron Dorgan, D-N.D., who wrote the provision, told CNNMoney. "When taxpayer dollars are used, we should urge that money to support the things produced here at home."

So why are Economists concerned? The infamous Smoot-Hawley bill passed in 1930 to protect American producers during the Great Depression serves as a classic reminder of what protectionism can do to an already struggling economy. Most economists believe the legislation only added to the depth and length of the depression. Here's what Wikipedia has to say:

The Smoot-Hawley Tariff Act (sometimes known as the Hawley-Smoot Tariff Act) was an act signed into law on June 17, 1930, that raised U.S. tariffs on over 20,000 imported goods to record levels. In the United States 1,028 economists signed a petition against this legislation, and after it was passed, many countries retaliated with their own increased tariffs on U.S. goods, and American exports and imports plunged by more than half. In the opinion of some economists, the Smoot-Hawley Act was a catalyst for the severe reduction in U.S.-European trade from its high in 1929 to its depressed levels of 1932 that accompanied the start of the Great Depression.

Notice the proud moment in history when 1,028 economists stood together against the bill. Unfortunately they were ignored.

The Economy and the Powell Doctrine

$825 Billion? Why is the fiscal stimulus package so big? The economic view: consumers must be convinced that the package is big enough to end the recession in order for consumer confidence to return. If consumers are confident recovery is in the works, they will feel more free to spend. As for as the size, think in terms of the Powell Doctrine:

The "Powell Doctrine" is a journalist-created term, named after General Colin Powell in the run-up to the 1990-1991 Gulf War. ..asserting that when a nation is engaging in war, every resource and tool should be used to achieve decisive force against the enemy, minimizing US casualties and ending the conflict quickly by forcing the weaker force to capitulate.

So, $825 billion is like economic "shock and awe". Thanks to Wikipedia for the definition.

Fiscal Stimulus

Mankiw on Fiscal Stimulus

Harvard Economist N. Gregory Mankiw was on CNBC again this morning discussing the stimulus package. The bill that is being hashed out in Congress is a combination of tax cuts and government spending, seemingly textbook treatment of expansionary fiscal policy. The textbooks say that spending has a more direct stimulative effect and a larger multiplier because the money is actually spent. Tax cuts are often saved. Mankiw, and several others, are beginning to argue that recent research shows that tax cuts have a higher multiplier, in spite of what the textbooks say (including his own). Also, one of the big concerns with government spending is the lag time involved. How long will it take before the government spending projects actually translate into income for consumers? Also, skeptics of the package accuse Democrats of using the current situation to load up the bill with all the unfulfilled Democrat "to-do-lists" that haven't gotten done in the past fifteen years. Let's hope the wisdom of crowds prevails and the bill that results is truly the best effort of our representatives in Congress.

Inauguration Day 2009

Economist John M. Keynes wrote about the effect of "animal spirits" in respect to the economy. The Economist magazine defines animal spirits this way:

The colorful name that Keynes gave to one of the essential ingredients of economic prosperity: confidence. According to Keynes, animal spirits are a particular sort of confidence, "naive optimism".

One of the best gifts President Obama can give the economy is a confidence boost - an attempt to lift our animal spirits. Will the new President use his gift of rhetoric to inspire hope and confidence?

Wheelan for Congress

It is typical when discussing wise public policy from the economic perspective, and the reasons that they do not often translate into legislation, to have a student ask why there are not more economists in Congress. I usually respond that a platform full of economic platitudes is not often a politically popular platform. For instance, it is often easier to earn votes by pressing for protection of American industry with trade barriers than to explain the benefits of free trade. It is often easier to earn votes by fighting for the common man by increasing in the minimum wage than to explain how the policy ends up hurting low skilled workers.

Well, one of our own is running for Congress. Charles Wheelan, formally of the Economist magazine and the author of Naked Economics (scary title, good book) is running for the Illinois seat vacated by Rahm Emanuel.

Here is his platform:

At a time of unique challenges to the global financial system, it is imperative to have members of Congress with a sophisticated understanding of economics.

Economic stimulus that includes government spending should be carefully designed to ensure that only projects that have social value are funded. Infrastructure projects, identified by an objective panel, that likely would have been pursued without special funds are good candidates. If there are insufficient projects meeting a high cost-benefit threshold, additional stimulus should come in the form of tax cuts.

Any mitigation of greenhouse gas emissions in the United States should be pursued through market mechanisms that raise revenue, which can be used to reduce the personal, corporate and/or payroll tax.

The U.S. should make long-term investments in human capital, particularly in early childhood education for low-income and disadvantaged children.

Congress should promote free trade and work to reduce trade barriers around the globe. The best way to deal with the political costs of trade and the economic dislocation caused by international competition is to create a meaningful safety net for displaced workers.

Tax reform is necessary to improve the equity, efficiency and simplicity of the tax code. A priority of tax reform should be a reduction in the number of special incentives that narrow the tax base, induce tax avoidance and increase compliance costs.

The U.S. must deal with the looming fiscal obligations created by our entitlement programs: Medicare, Medicaid, and Social Security. Our current economic situation justifies increased deficits now, but today's policy must be attentive to the need for fiscal balance over the next several decades.


Check out Wheelan's website, The Naked Economist. Also check out the website Economists for Wheelan. Thanks to the Mankiw site for the link.

In Defense of Sweatshops

We have discussed sweatshops and outsourcing in class in reference to labor markets and free trade. Of course trying to defend sweatshops is difficult, but one must look at the alternatives to see the benefits. Working in a sweatshop is often seen as climbing the ladder for many workers in developing nations. In fact NY Times columnist Nicholas D. Kristof makes the case that sweatshops may be the best hope for many people in developing nations. (Thanks to the Mankiw blog for the link)

The best way to help people in the poorest countries isn’t to campaign against sweatshops but to promote manufacturing there. One of the best things America could do for Africa would be to strengthen our program to encourage African imports, called AGOA, and nudge Europe to match it . . . among people who work in development, many strongly believe (but few dare say very loudly) that one of the best hopes for the poorest countries would be to build their manufacturing industries. But global campaigns against sweatshops make that less likely.

Mankiw on Government Spending

Harvard Econ Professor N. Gregory Mankiw is critical of the current stimulus plan. He poses some important questions about some of the assumptions we make about expansionary fiscal policy. He also proposes that tax cuts and monetary policy are more effective than the spending side of fiscal policy. Listen to his interview, click on the red "listen now" icon toward the top of the page.

The TED Spread and thawing credit markets

In an earlier post I wrote about the TED spread as an indicator of problems in the credit markets. The TED spread measures the difference between LIBOR which is the rate that banks pay when they take a three month loan and the yield on a three month treasury bill. Because interest rates are an indicator of risk, the large spread in the numbers revealed an increase in percieved risk in bank lending. Bloomberg reports today that the TED spread is narrowing, meaning that credit markets are beginning to return to normal. Check out the current chart here. As the cost of bank lending recedes, the volume of loans should also return to near normal levels. An important point to realize is that this crisis was caused by too much lending, so we should not want the volume of loans to return to pre-crisis levels.

Tell Me How You Really Feel

A visual history of the minimum wage. The light blue shadow shows the inflation adjusted minimum wage.

Students, now that you have debated the minimum wage as a public policy, tell me how you really feel about it. Click on the comment link below and leave your opinion. Be sure to support your opinion with clear reasoning. Also post a response to someone else.

Visual Guide to General Motors' Financial Woes

Gotta love these visual guides. Thanks to Flowing Data.

Visual Guide to the Financial Crisis

Nice visual map of the mortgage crisis.

The Candlemaker's Petition

Frederic Bastiat

All of the make work plans and whispers of protectionism remind me of Bastiat's Candlemaker's Petition. Read The Candlemaker's Petition here or you can listen to it here.

Expansionary Fiscal Policy

President-elect Obama's stimulus package looks like it will be a textbook example of expansionary fiscal policy. The blend of tax cuts for consumers and business as well as a healthy dose of government spending to build infrastructure combined with an aggressive monetary policy by the Federal Reserve should be just what the doctor ordered.

Remember, GDP = C + I + G + (X - M)

C = tax cuts for consumers should boost consumer spending
I = tax cuts for business should boost investments spending
G = infrastructure spending is an increase in "G"
(X - M) = the weak dollar should help net exports

Read this article from The Wall Street Journal for the full story on planned tax cuts.

The Fed's Battle Plan

The Federal Reserve has learned from the past and is taking on the current economic crisis in an aggressive fashion. Fed Chairman Ben Bernanke is one of the nation's foremost scholars on the Great Depression and is using his expertise to head off the threat of deflation. The fear on the flipside is inflation. All the extra liquidity being pumped into the system may cause inflation to spike as the economy comes out of the current recession. While this is a legitimate fear, pulling the economy out of the current crisis is what is necessary in the short run.

Here's what Business Week has to say out the Fed's current battle plan:

Will the new battle plan work? Most likely yes—eventually. The Fed's monetary weaponry, in combination with the fiscal artillery of the incoming Obama Administration, are so potent that if they are used to their full extent they can almost certainly generate an economic recovery, potentially starting in the second half of 2009. The problem is that today's all-out attack on recession may well generate a surge of unwanted inflation in 2010 or after. But the Fed seems to regard that as an acceptable price to pay to avoid disaster now...

Most economists think that inflation is the last thing the Fed needs to worry about right now. According to New York University economist Mark L. Gertler, who collaborated with Bernanke on research during the Fed chief's Princeton years: "We are in an incredibly dangerous situation. Now is the time to be aggressive. There's no danger of inflation. It's almost insane that people are talking about it now." Even with all the Fed's heroic measures, predicts Merrill Lynch (MER) senior economist Drew Matus, "the recession is going to be a long one, and the recovery is not going to be a big one."

One reason for optimism—mild optimism, anyway—is that Bernanke has learned from the mistakes committed by the Fed during the Depression and the Bank of Japan during that nation's Lost Decade of the 1990s. In 1999, when he could afford to be undiplomatic, Bernanke asked in a book he contributed to whether Japan's monetary policy was "a case of self-induced paralysis," and he praised President Franklin D. Roosevelt's "willingness to be aggressive and to experiment."