Archive for January 2009

Eugene Fama gets at the real issue

January 28, 2009

Bailouts and Stimulus Plans – Addendum 1/28/09 – Fama/French Forum

Again, here is my argument in three sentences.

1. Bailouts and stimulus plans must be financed.

2. If the financing takes the form of additional government debt, the added debt displaces other uses of the same funds.

3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.

Are any of these statements incorrect?

In his attack on me Krugman implicitly assumes that sentence 3 above is true; that is, the stimulus plan will on balance move resources from less productive to more productive uses. This is indeed the focus of the issue.

That always is the issue.

You can make coherent theory arguments either way, but you need to make a case for point #3. There is nothing fancier, or more subtle. It is a magnitude issue.

Although I am not ‘pro-stimulus’

January 28, 2009

I am in favor of spending government money right now.  I think that simply giving a check to everyone with income below some threshold is the right thing to do, right now.

The devil is in the details–how big a check and what threshold?

Perhaps you want to slowly phase out the payment so there is not a discrete jump at some income level, to minimize the implicit tax on incomes for those crossing the threshold.

We already do this with food stamps and welfare payments.  Increase them, right now.  (That is a large part of the stimulus package).

Is this fiscal or monetary stimulus?  I am not so sure.

But today I read in the Wall Street Journal that the dairy board wants to kill cows to increase the price of milk.  I can only hope that this is a bargaining position.  There are people starving, yet they want to destroy food sources to prop up milk prices.  God help us.

Iliquid versus insolvent

January 27, 2009

Here is an example to explain illiquidity versus insolvency.

You have an asset that has cash flows of 0.5 today and 1.0 in one year.

Ignore interest rates.  The asset is worth 0.5 + 1.0=1.5

You are illiquid if you have a loan with a payment of 1.10 today–you only have 0.5 cash to pay off your loan, so you need to get an extra 0.6.  If you can get a new loan,  then borrow 0.6  in a new loan.

Your position is
today: 0.5 + 0.6 new loan – loan payment of 1.10 = 0
one year 1.0-0.6 loan repayment = 0.4

Your net value today is 0+0.4 = 0.4

You are illiquid, but solvent if you cannot find anyone to lend you the money.

Now suppose that your loan is 2.00 today.  Your assets are only worth 1.5,so your nett value is 1.5 in assets  minus  2.00 in original loans  or -0.5 so no one will lend you any new money to pay back the original loan.  You are insolvent because your assets are worth less than your liablities.

I can’t resist

January 27, 2009

The prominent Keynesians are pretending that they don’t understand the basic resource constraints, or that resources are free on the margin, so that the government can reallocate with little cost.

The prominent non-Keynesians are viewing resources as costly, and claiming that the resource constraints bind, but also pretending that there are no frictions that the stimulus will fix. That is, we cannot fix the problems in resource allocation by stimulating.

The Keynesians don’t have a good economic explanation for the frictions, nor do they really know the magnitudes. But neither do the non-Keynesians, nor do they have a empirically founded model yet.

All this is like a bad dream of when I was a graduate student. Arguments about big things, based on little empirical evidence on either side. At least in those days, we were learning about new channels that could drive things, and knocking out inconsistent explanations.

The Keynesian model broke down in the 1970s–it stopped working. There is no non-Keynesian model that works for policy work with any fiscal stimulus, yet.

Good luck.

Worth reading

January 26, 2009

Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?

Keynes as Public Works Skeptic « ThinkMarkets

I say it again: I believe that many of the people wanting fiscal stimulus want it for reasons other than fiscal stimulus. Fair enough–maybe we do need better infrastructure, etc. etc, but calling it stimulus is going to be costly in the future, when it becomes clear that it does not stimulate, and we need to cut spending again or face some budgetary crises or another.

It is a bit amazing that so much of the discussion is ‘blackboard economics’ when the real question is surely one of magnitudes. My sense is that they are small.

Quantitative Easing

January 24, 2009 You must be Brave or Foolish to go against UChicago econ

Finally, Robert Lucas. Lucas at least includes price and velocity — thank you for that! — but again misses the key element:

MV = Py

Given that V is going to zero (as people demand more savings) you need to increase M by a large amount so y can stay where it given that P is fixed. In the long term, P will fall and we will return to the 10 cent hamburger, but in practice the US is simply not going to be allowed to enter a 1930s style protracted and deep deflation.

The obvious solution at this point would be to talk about how we can increase M rapidly, in a way that is equally rapid to reverse! The obvious candidate, and it would be obvious to Keynes if he was alive today, would be a payroll tax holiday. It would avoid all the fiscal problems that all three economists mention, while still handling the money supply in a way that gets us to a rebalanced economy without having to do things the hard way and increase the deficit through unemployment.

Nice post.

Here, M is the money supply, V is velocity, P is the price level, and y is real GNP, so that Py is nominal GNP. If V is dropping, then Py must fall.  In one extreme with y fixed, P must fall, or deflation.  In the other, with P fixed, y must fall, or a drop in GNP.    Right now, prices and GNP are falling.  We have to crank up M, and try to get V back up, too (This is all kind of definitional, but to start the Great Depression, the Fed brought M down on purpose.  So there is some bite here.)

I think that effectively buying up new risky assets the way the Fed is doing now is probably the fastest way to crank up M. I hope that is what the lump sum tax cuts in the stimulus are trying to achieve as well.  If we can credibly commit to some future inflation, we can drop V as well.  (I recall that was Professor Krugman’s original prescription for Japan, so maybe it is not so easy to do given what happened there.  One sign it is working might be that our currency depreciates.)

But I don’t think that Professor Lucas missed the point, since he started out his talk pointing out that we can increase nominal spending by cranking up the printing presses and doing the famous helicopter drop of money, or by following Keynes and burying dollar bills in the ground to be dug up.

Cranking up M by buying more assets is the basis of the Fed’s policy of ‘quantitative easing.’  We need some faith, since monetary policy can  have long and uncertain lags.  It probably will act faster than fiscal stimulus by building infrastructure, though.

Here is how I think the fiscal stimulus should be analyzed

January 23, 2009

TRUTH ON THE MARKET » Kevin Murphy models the stimulus–and the results aren’t pretty

At bottom, Murphy has this equation (I don’t know how to write Greek letters in WordPress, so bear with me):

[added by me: the left hand side should be bigger for the stimulus to make sense]

f(1-L) > a+d

f = how much comes out of idle (as opposed to currently employed) resources

L (Lambda) = the value of idle resources (so 1-L is the gain from moving idle resources into production)

a = government inefficiency cost

d = deadweight loss

[added by me: d is the deadweight cost of taxation]

Iff the left-hand side is greater, the stimulus would be worthwhile

Murphy’s bottom line, given his parameters (f=.5, L=.5, a=positive, and d=.8):

[added by me: d=0.8 might be a bit high, but it is roughly what tax economists would estimate]

Unless government is 55% more effective, more productive, than private output, it’s not looking good.

I am really puzzled when I read statements that say most economists want a fiscal stimulus. Not true, at least in my experience.

There are good reasons to transfer money to people being most hurt by the recession–increase unemployment insurance, increase food stamps, etc. But that is not the same as building more bridges/infrastructure. Which won’t do much since the bridges to be build are shovel-ready, meaning things that would have been done anyway. My guess is that the non-shovel ready stuff should come online about the time that we will be out of the recession anyway.