December 30, 2006
Arthur And I
I was admittedly sticking my neck out when I attempted to lend some respectability toward the late President Ford's ill-fated WIN campaign. Sure enough, Jim Hamilton was all over it, and in fact I find it hard to argue with very much of what he has to say (as usual):
...I think one great disservice of [the Whip Inflation Now] campaign was to cultivate the misperception that inflation is somehow the responsibility of ordinary U.S. citizens. In my view, maintaining the purchasing power of a dollar is instead exclusively the responsibility of the people who control how many dollars get printed.
As I hope my first post on the issue made clear, I really do agree with that. To quote myself:
Seen through contemporary eyes, it is clear that the President Ford's speech hopelessly entangled shocks to relative prices with ongoing inflation of monetary origins.
Where I think the Econbrowser/macroblog debate might get interesting is here (sampling again from the Hamilton post):
The current academic consensus, which has emerged from some very well done research such as Northwestern Professor Giorgio Primiceri's forthcoming study in the Quarterly Journal of Economics or respected Fed researcher Athanasios Orphanides' 2002 paper in American Economic Review, has concluded pretty clearly that at least part of the cause of the 1970s inflation was bad data and a misunderstanding of how the economy works. But I am forced to conclude also that, in the face of such uncertainties, Nixon and Burns appear to have been wanting to err on the side of doing whatever would most help them win the next election.
I don't think that is a mischaracterization of the academic consensus, but what I am not so sure of is the leap to the conclusion that Burns was largely, and inappropriately, motivated by political concerns.
In part, the consensus that mistakes were an inevitable consequence of the state of knowledge at the time makes the appeal to other motivations almost unnecessary. And I would add to the list of the real-time uncertainties the unsettled question of how the Federal Reserve fit into the overall scheme of government policy making. The primacy of central bank independence was an idea that was at least a decade away -- the first systematic study cited in Carl Walsh's New Palgrave entry on central bank independence is Robin Bade and Michael Parkin's 1984 working paper (although Parkin's CV does contain a reference to an early version from 1978). It is also worth noting that Wright Patman was fully devoted to bringing the Fed under the Congressional heel, a reality that any good steward of the central bank could not have ignored.
On top of that, the conclusion that Burns spent a good part of his time in Nixon's hip pocket is not a slam dunk. Consider this passage from Martin Mayer's excellent book, The Fed (page 144):
Wright Patman, the shrewd, charming, lazy populist from Texarkana, was chairman of the House Banking Committee from the 1950s into the 1970s. He was no friend of the Federal Reserve, which he felt had extended the Great Depression by reducing bank credit in 1937... In the 1970s, when I knew him, he liked to say that the Constitution gave the House of Representatives the power to "coin money and regulate the value thereof" -- and that Congress farmed out its power to the Federal Open Market Committee."
One notes the exactitude of Patman's placement. Not the executive branch, for there is no law requiring or even suggesting that the Fed report to the president or the secretary of treasury, and the most either of them can do is bitch about the Fed's failure to be a team player -- as Harry Truman and Lyndon Johnson and Richard Nixon did. (Nixon, typically, did it through an unprecedented campaign of personal vilification of Chairman Arthur Burns, anonymously out of the White House.)
That does not sound like the stuff of wink-wink political accommodation.
Honestly, I don't know the truth of Burns' tenure. I don't even know what I think the truth to be. What I do know is that it is a lot more complicated than is often suggested.
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December 28, 2006
Still Dodging Bullets
Another month, another indication that the much anticipated total economic meltdown has yet to arrive. Calculated Risk nicely sums up today's report on November existing home sales, as Felix Salmon nicely summed up both CR's and Jim Hamilton's reactions to yesterday's report on November new home sales. Says Felix:
November new home sales hit a seasonally-adjusted rate of 1.047 million, and the numbers for August, September and October were all revised upwards as well. If you squint, you can almost see an upwards trend...
And prices, too, while not exactly rising don't really seem to be falling, either.
In today's post, Calculated Risk does warn...
As I've noted before, usually 6 to 8 months of inventory starts causing pricing problems and over 8 months a significant problem. With current inventory levels at 7.4 months of supply, inventories are now well into the danger zone and prices are falling in most regions. Nationwide prices were off 3.1% from November 2005.
... and we may as well add that some of the forward looking statistics from earlier this month were mixed (with housing starts positive, building permits negative):
Still, Felix is sounding almost upbeat...
Whether we go back to 98-01 or merely to 02, however, the fact is that home sales will still be reasonably strong on an absolute level even if they're below the peak of the past few years. The economy was fine then, and it should be fine now.
... as is Jim:
When I suggested two months ago that we'd seen the worst for home sales, many or our readers responded with derisive skepticism. But so far, my analysis seems to be holding up. November now marks the fourth month in a row that home sales have come in above the value from last July.
There are, to be sure, plenty of risks, including this one:
I expect to see a drop in construction employment, and that could itself generate other problems for the economy, particularly if it appears in conjunction with other bad news such as more job losses from the struggling domestic auto sector.
Right, but the signs of these problems are still nowhere to be found. Consider this picture, from the Job Openings and Labor Turnover Survey:
Though this data is only available from December 2000, both employer hire rates and job posting rates were falling into and through the 2001 recession (represented by the shaded bar). There is simply no indication that such dynamics are currently in play. It could happen of course, but to appropriate Professor Hamilton's comments:
... so far, I think we have to say, it hasn't happened yet. And a replay of 1994-95 looks like the narrow favorite on which to place a bet.
UPDATE: Barry Ritholtz says not so fast with the bottoming-out meme. Similar thoughts can be found at The Nattering Naybob Chronicles, at The Housing Bubble Blog, at the Housing Doom Housing Bubble Blog (hat tip to keith at Housing Panic), and at Nouriel Roubini's Blog. Murat Tasci and Laura Kleinhenz have more on the JOLTS data, at the Cleveland Fed website.
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December 27, 2006
Don't Count Your Broken Eggs Before They're Scrambled
If you simply insist on looking for the worst in the early returns on holiday retail sales, there are dismal headlines galore posted at The Big Picture and at the Nouriel Roubini Blog. But might I suggest that it is a bit premature to be drawing conclusions? From the Chicago Tribune:
As gift cards gain in popularity, the week after Christmas has taken on greater importance for retailers keen on meeting year-end financial goals.
This year, gift cards are providing a glimmer of hope that stores will be able to make up for what has so far been a slower-than-expected holiday season...
Consumers are expected to spend a record $24.81 billion on gift cards this holiday season, up from $18.48 billion for the same period last year, a 34 percent spike, according to the National Retail Federation. Consumers spent an estimated 20 percent of their holiday gift-giving budget on gift cards this year, up from 6.6 percent in 2003, the Washington-based trade group said.
The change in shopping habits has forced retailers to re-evaluate the way they look at post-Christmas sales. They want to encourage shoppers to redeem gift cards right away because a gift card doesn't count as a sale until it is exchanged for merchandise.
And some similar thoughts from MSNBC.com:
Marshal Cohen, industry analyst with NPD Group, said his research shows that 51 percent of consumers planned to give someone a gift card this holiday. That’s up from 39 percent just a year earlier...
As more people turn to gift card giving, analysts say gift cards are starting to change how retailers think about their all-important holiday sales strategy, especially after Dec. 25.
“It also means that the holiday season really is longer than this November-December" time period, said Michael Niemira, chief economist with the International Council of Shopping Centers. "It really is a November-to-January story, with January being more important in recent years."
And from ABC News:
Robert Drbul, retail analyst at Lehman Bros., said that Dec. 26 to New Year's Eve now represents 10 percent of holiday sales, while January makes up 20 percent of holiday sales for the season...
The International Council of Shopping Centers, a retail trade group, estimated in October that gift cards in 2006 would account for $30 billion to $40 billion in holiday sales. Last holiday, customers redeemed nearly 40 percent of gift cards between Dec. 26 to Dec. 31st. In January, 38 percent more were redeemed.
The National Retail Federation, however, estimated that gift card sales would be slightly less, reaching just under $25 billion, for this holiday season. That represents 8 to 9 percent of holiday sales for the year.
Daniel Horne, a professor at Providence College who has studied gift cards extensively, estimated that the average gift card value would be around $37-$38 this year but could vary depending on the retailer. More important, Horne calculates that people spend about 40 percent more than the value of the gift card.
Horne believes that 25 percent of gift cards are redeemed the week after Christmas and that two-thirds are used by the end of January.
All of which is to say, it ain't over 'til it's over.
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Was WIN A Loser? Part 2
I closed my previous post asking this question: Is there anyway to characterize President Gerald Ford's "Whip Inflation Now" campaign as anything other than a waste of effort wrapped up in a bad idea?
One answer might be: "Yes, if you are willing to extend a little sympathetic goodwill toward those doing a tough job at a tough time." For some time I have been in a sporadic but ongoing informal debate about the record of Arthur Burns, the Chairman of the Federal Reserve Board during the Ford (and most of the Nixon) administration. I have become increasingly drawn to the possibility that many of the mistakes attributed to the Burns-era Fed -- sometimes with the added charge of overtly political manipulation by Burns himself -- were the inevitable consequence of trying to learn how to conduct monetary policy in the aftermath of the collapse of the Bretton Woods global monetary system. A generous interpretation might be that the right thing to do was only obvious with the benefit of hindsight. And if so great an economist as Arthur Burns struggled with how to get inflation under control, can you really blame Gerald Ford for not getting it quite right?
Even so, you might say, the WIN button publicity campaign was a ridiculously naive misfire. But I wonder. Consider this thoroughly modern idea, described by Lawrence Christiano and Christopher Gust:
An expectations trap is a situation in which an increase in private agents. expectations of inflation pressures the central bank into increasing actual inflation.
There are different mechanisms by which this can happen. However, the basic idea is always the same. The scenario is initiated by a rise in the public's inflation expectations. Exactly why their inflation expectations rise doesn't really matter. What does matter is what happens next. On the basis of this rise in expectations, private agents take certain actions which then place the Fed in a dilemma: either respond with an accommodating monetary policy which then produces a rise in actual inflation or refuse to accommodate and risk a recession. A central bank that is responsive to concerns about the health of the economy could very well wind up choosing the path of accommodation, that is, falling into an expectations trap.
Christiano and Gust continue:
In an appearance before the House of Representatives, Committee on Banking and Currency, July 30, 1974, Burns said:
One may therefore argue that relatively high rates of monetary expansion have been a permissive factor in the accelerated pace of inflation. I have no quarrel with this view. But an effort to use harsh policies of monetary restraint to offset the exceptionally powerful inflationary forces of recent years would have caused serious financial disorder and economic dislocation. That would not have been a sensible course for monetary policy.
What is the way out? There are two possibilities. One, a change of heart, policymakers, or circumstances that alters the perceived trade-off between inflation and the real consequences of monetary restraint. Two, change expectations.
In the end, we took the first route, but it would be the end of the decade before the right circumstances, the right public mood, and the right people would arrive to get the job done. Changing expectations would surely have been the less painful route, but how to do that? The idea of institutionalizing a commitment to price stability -- by way of inflation targets, for example -- was essentially unthinkable at the time. (It was, in fact, viewed as barely respectable in 1991 when I took up residence at the Cleveland Fed, one of the few places in the United States where such ideas were taken seriously.) And when it gets right down to it, what do today's inflation targets really amount to beyond public statements that we think inflation is bad, and we really, really mean it?
Maybe President Ford's anti-inflation PR initiative was indeed hopelessly naive, and it certainly didn't work. But the basic idea was arguably on the right track. And in the context of the times, wasn't it worth a shot?
UPDATE: William Polley has items on the situation Ford inherited (also emphasizing the collapse of Bretton Woods) and an extensive discussion of the proposals in the WIN speech. He also has links to others, including a sympathetic post from King at SCSU Scholars (who also notes that policy credibility then ain't what it is now) and pgl at Angry Bear (who also noticed that Ford called for monetary restraint without a restriction in credit).
UPDATE II: pgl has more thoughts, at Angry Bear. I like to think he is right when he says I would have counseled for more monetary restraint had I been asked at the time, but in truth I'm not so sure. As pgl says, "the 1970’s was a very difficult period for policy makers and their economic advisors."
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Was WIN A Loser?
Beyond the heartfelt thoughts and prayers directed to family and friends, the death of an important public figure inevitably elicits reflections on those times when our lives were inextricably linked to theirs. So it is with Gerald R. Ford, the 38th president of the United States. In the realm of economics inhabited by this weblog, that legacy is probably most associated (unkindly) with the infamous WIN -- Whip Inflation Now -- campaign. Explains a modern-day grassroots effort:
Whip Inflation Now (WIN) was an attempt to spur a grassroots movement to combat inflation, by encouraging personal savings and disciplined spending habits in combination with public measures, urged by U.S. President Gerald Ford. People who supported the mandatory and voluntary measures were encouraged to wear "WIN" buttons...
The buttons were snazzy...
... but the idea itself is nowadays viewed as, well, kind of foolish:
"WIN" buttons immediately became objects of ridicule; skeptics wore the buttons upside down, explaining that "NIM" stood for "No Immediate Miracles," or "Nonstop Inflation Merry-go-round," or "Need Immediate Money."
Seen through contemporary eyes, it is clear that the President Ford's speech hopelessly entangled shocks to relative prices with ongoing inflation of monetary origins. From the Whip Inflation Now speech, delivered to Congress on October 4, 1974:
... Food prices and petroleum prices in the United States are primary inflationary factors. America today partially depends on foreign sources for petroleum, but we can grow more than enough food for ourselves....
To halt higher food prices, we must produce more food, and I call upon every farmer to produce to full capacity..
Number two: energy. America's future depends heavily on oil, gas, coal, electricity, and other resources called energy. Make no mistake, we do have a real energy problem...
Number three: restrictive practices. To increase productivity and contain prices, we must end restrictive and costly practices whether instituted by Government, industry, labor, or others. And I am determined to return to the vigorous enforcement of antitrust laws.
And on it goes. Monetary policy proper commands all of two sentences in the speech, and the message was decidedly mixed at that:
... Prudent monetary restraint is essential.
You and the American people should know, however, that I have personally been assured by the Chairman of the independent Federal Reserve Board that the supply of money and credit will expand sufficiently to meet the needs of our economy and that in no event will a credit crunch occur.
My colleague Mike Bryan explains why this whole discussion is essentially misguided:
A rise in the cost of living means that one’s ability to maintain a certain level of well-being has diminished. Prices may or may not have risen, but people’s income relative to prices has fallen. The other concept, inflation, refers to the deterioration in the purchasing power of money—a rise in prices that comes when the central bank has created too much money, leaving people’s income relative to prices unchanged. Inflation does not mean it is more difficult to maintain a particular lifestyle, only that its cost in terms of money is “inflated.”
... it is useful to appreciate the distinction between these two ideas. The causes of inflation and a rising cost of living are fundamentally different, as are their remedies.
Lest anyone thought he wasn't talking about diminishing well-being, Mr. Ford added this plea:
Here is what we must do, what each and every one of you can do: To help increase food and lower prices, grow more and waste less; to help save scarce fuel in the energy crisis, drive less, heat less. Every housewife knows almost exactly how much she spent for food last week. If you cannot spare a penny from your food budget--and I know there are many--surely you can cut the food that you waste by 5 percent.
The misfire on emphasizing inflation's true source turned into mealtime for satirists with the whipping out of the WIN buttons:
There will be no big Federal bureaucracy set up for this crash program. Through the courtesy of such volunteers from the communication and media fields, a very simple enlistment form will appear in many of tomorrow's newspapers along with the symbol of this new mobilization, which I am wearing on my lapel. It bears the single word WIN. I think that tells it all. I will call upon every American to join in this massive mobilization and stick with it until we do win as a nation and as a people...
Are there are any kind words to be found about all of this? More thoughts to follow.
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December 26, 2006
When the final tally on third-quarter U.S. GDP was released last Thursday, the story was once again the stumbling residential real estate sector and the seeming willingness of US consumers to just shake it off:
The trillion or so dollar question is, of course, will it (indeed, did it) last? Barry Ritholtz takes a peek at the early returns on retail sales activity and doesn't like what he sees:
Back in November, we noted that Retail Sales were the Canary in the Coal Mine...
But the early data has come in, and it is decidedly unimpressive: Despite early forecasts of double digit sales gains for this holiday season -- and some surprisingly strong but questionable data for November -- it appears that the 2006 season's sales will be disappointing.
That's according to data culled this past weekend from VisaUSA, and from ShopperTrak. Each used very different methodologies for forecasting retail sales.
Adds The Wall Street Journal (page B1 of the print edition):
Holiday spending between Thanksgiving and Christmas rose a disappointing 6.6% over last year, according to SpendingPulse, a retail-sales data service from MasterCard International's MasterCard Advisors Unit. Last holiday, sales climbed 8.7%. "People were expecting a lot more momentum," said Michael McNamara, vice president of research and analysis for MasterCard Advisors. "Retail sales are growing, but at a more moderate pace compared with last holiday."
Surmises Calculated Risk, things are "definitely not 'just right'."
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December 22, 2006
'Tis The Season
The global saving glut in song (with a big giant tip of Santa's stocking cap to Axiom Management's Stan Jonas).
And in case I forget, blessings to each and every one of you.
UPDATE: Well, I see Greg Mankiw beat me to the punch. So, in case you are in the mood for something a little less lighthearted, here's a rundown of various musings about global interest rates and such, from the bloggy wonderland:
Barry Riholtz points to Paul Kasriel's musings on many things, including the ongoing role of global demand in "explaining" the low long-term interest rates in the US. (See page 5 of the December 15 article "Festivus Flow-of-Funds Stocking Stuffers." I'm still not too sure I buy into implicit "market segmentation" theory of the term structure, but the whole thing is interesting reading in any event.)
Jim Hamilton discusses a paper by the San Francisco Fed's Glenn Rudebusch, Eric Swanson, and Tao Wu, on the disappearing term premium in long-term bonds (and offers the hopeful possibility that "perhaps there is another little chunk of that inverted yield curve that's maybe not so scary"). At Angry Bear, pgl has some thoughts on the topic too. Jon Rotger is apparently unmoved by claims that yield curve inversions ain't what they used to be. Neither is Nouriel Roubini.
Looking to the great world beyond, Brad Setser has lots of interesting things to say (as usual) about the role of Asian central banks in the year behind and the year ahead. At Bonobo Land, Edward Hugh has the premium on emerging market interest rates (and much more) on his mind. While you're on that topic, check out Felix Salmon at Economonitor as well. At Alpha.Sources-CV, Claus Vistesen considers Japan's widening trade surplus, and suggests the country's current dependence of export production willimit the Bank of Japan's options on policy rates. At Eurozone Watch, Sebastian Dullien is bullish on Germany and colleagues, unless "the hawks in the ECB get their way and rise their interest rates overly quickly." The Skeptical Speculator adds the UK to the higher-rates-in-07 clan.
Calculated Risk takes a calculated risk and predicts "the Fed to start lowering rates later next year", but conjectures "long rates will start to rise."
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December 21, 2006
How To Characterize Economic Policy In The 90's
A comment made by pgl in one of yesterday's posts at Angry Bear caught my attention:
And [why is chairman of Bush's Council of Economic Advisers Ed] Lazear opposed to my suggestion of easy money with tight fiscal policy, which was the 1993 approach?
What got me thinking was this: Was the policy in the period referenced by pgl really one of "easy money" and "tight fiscal policy"?
Answering that question requires answering the prior question of what, exactly, do those terms mean. That is not a straightforward task, but let me give it a shot. I'll start by suggesting -- as I have done before -- that a characterization of the stance of monetary policy -- as tight or easy, restrictive or stimulative, contractionary or expansionary -- can be found in the yield curve, or the spread between short-term interest rates and long-term interest rates.
What about fiscal policy? I suppose that what many people have in mind is the government surplus of revenue over expenditure relative to GDP or, alternatively, the "standardized" or "cyclically-adjusted" budget surplus relative to "potential" GDP. As explained by the Congressional Budget Office:
The size of the budget deficit is influenced by temporary factors, such as the effects of the business cycle or one-time shifts in the timing of federal tax receipts and spending, and the longer-lasting impact of such factors as tax and spending legislation, changes in the trend growth rate of the economy, and movements in the distribution and proportion of income subject to taxation. To help separate out those factors, this report presents estimates of two adjusted budget measures: the cyclically adjusted surplus or deficit (which attempts to filter out the effects of the business cycle) and the standardized-budget surplus or deficit (which removes other factors in addition to business-cycle effects).
With that background, here are pictures of the difference between the yield on 10-year (constant-maturity) Treasury securities and the effective federal funds rate...
...and various measures of the government surplus:
Is pgl right? Does it look like, let's say the Clinton years, were a period of tight fiscal policy and easy monetary policy?
You are not surprised, I presume, to see that there is a pretty good case on the fiscal policy characterization -- though it is interesting that the G.H.W Bush years look every bit as good as the Clinton years by the standardized surplus measure. (I haven't checked this carefully, but I suspect this may have something to do with smoothing out expenditures and receipts associated with the activities of the Resolution Trust Association created to manage the aftermath of the S&L crisis of the 80's, as well as adjustments for extraordinary capital gains taxes in the latter 90s.)
The case for easy money is a bit tougher. If you accept the 10-year/funds-rate spread as being related to the relative ease of monetary policy, then the period from 1993 to 1995 looks relatively stimulative. But the latter part of the decade is not so readily characterized in that manner -- and that is precisely the time when the budget deficits really shrink.
The story can get complicated if you throw in the proposition that the relationship between short-term and long-term interest rates changed in the past 10 years or so, an idea that is currently in favor as a rationale for not worrying about the inverted yield curve today. And, of course, you might reasonably object to my whole exercise by arguing that fiscal and monetary policy are really as much about what people expect to happen as they are about what is actually happening at any point in time.
I can readily agree to the proposition that fiscal policy ought to "tighten" up - though I would emphasize entitlement and tax reform in that definition, as opposed to any particular stand on how fast or how far deficits should recede. As for monetary policy, I'll appeal to higher authority:
Price stability plays a dual role in modern central banking: It is both an end and a means of monetary policy.
As one of the Fed's mandated objectives, price stability itself is an end, or goal, of policy...
Although price stability is an end of monetary policy, it is also a means by which policy can achieve its other objectives. In the jargon, price stability is both a goal and an intermediate target of policy. As I will discuss, when prices are stable, both economic growth and stability are likely to be enhanced, and long-term interest rates are likely to be moderate. Thus, even a policymaker who places relatively less weight on price stability as a goal in its own right should be careful to maintain price stability as a means of advancing other critical objectives.
If that ends up being "easy" money, well, so be it.
UPDATE: pgl responds in his usual intelligent fashion, noting (as he does in the comments below), that the high-growth late 1990s did indeed call for a tighter fiscal policy. What this suggests to me (as I also note in the comments below) is that it is not so clear that we ought to think of the stance of monetary policy in relation to fiscal circumstances. My inclination is to suggest that something like the Taylor rule -- with its emphasis on inflation goals and the level of economic activity relative to its potential - is a more robust approach to characterizing the appropriate course of monetary policy.
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December 19, 2006
Is Pay-As-You Go A Good Idea?
Democrats are taking sides in what is shaping up as one of the party's biggest divides -- its identity on economic issues.
The brewing debate has been overshadowed by the national focus on Iraq. But at stake is the legacy of Bill Clinton and his treasury secretary, Robert Rubin, who in the 1990s redefined the formerly protectionist, free-spending party as a champion of free trade and balanced budgets. That "establishment" view now is under challenge from party populists and organized labor, who have been emboldened by gains in last month's elections to press their case against globalization and fiscal austerity.
My own leanings are probably no secret to anyone who reads this blog on a regular basis -- I'm solidly in the "free trade and balanced budgets" camp. But there is at least one counterpoint about which I might have some sympathy:
While liberal groups believe they have the party establishment on the defensive on trade, they complain that on budget and spending issues, fiscal conservatives have the upper hand. That stems in large part from Democrats' 2006 campaign promise to restore a "pay as you go" budget rule, which would require that any new spending, or tax cuts, be accompanied by offsetting revenue increases or spending cuts to avoid widening the deficit.
Robert Borosage, co-director of the liberal Campaign for America's Future, objects that by insisting on a pay-as-you-go approach Democrats are tying their own hands as they turn toward addressing "decade-old pent-up demands" for domestic spending.
Republicans, he says, never worry about deficits when they cut taxes. "What pay-go says is that the nation's first priority is the budget deficit, and that's just not true," Mr. Borosage says, citing instead the war in Iraq, global warming, energy dependence and trade deficits as bigger problems than the budget shortfall. "When you have a national crisis, you spend the money."
I'm a fan of pay-go rules, but there is a reasonable case to be made for the proposition that deficits have their place. Tom Sargent explains:
Robert Lucas and Nancy Stokey, as well as Robert Barro, have studied this problem under the assumption that the government can make and keep commitments to execute the plans that it designs. All three authors have identified situations in which the government should finance a volatile (or unsmooth) sequence of government expenditures with a sequence of tax rates that is quite stable (or smooth) over time. Such policies are called "tax-smoothing" policies. Tax smoothing is a good idea because it minimizes the supply disincentives associated with taxes. For example, workers who pay a 20 percent marginal tax rate every year will reduce their labor supply less (that is, will work more at any given wage) than they would if the government set a 10 percent marginal tax rate in half the years and a 30 percent rate in the other half.
During "normal times" a government operating under a tax-smoothing rule typically has close to a balanced budget. But during times of extraordinary expenditures—during wars, for example—the government runs a deficit, which it finances by borrowing. During and after the war the government increases taxes by enough to service the debt it has occurred; in this way the higher taxes that the government imposes to finance the war are spread out over time. Such a policy minimizes the cumulative distorting effects of taxes—the adverse "supply-side" effects.
Or consider policies that have short-term costs but long-run benefits. Think growth-promoting free trade policies that nontheless displace some domestic jobs and production today. Or, perhaps, a health-care program (prescription drug benefit?) that immediately raises spending, but offers the promise of better health and less expensive remedial treatments down the road. In cases such as these, you might think that because the benefits accrue to future taxpayers it would be sensible to have them bear some -- maybe even most -- of the costs as well. And that is exactly the nature of deficits -- they shift the tax burden from today to tomorrow.
That is also, of course, the problem. You might have noted the "under the assumption that the government can make and keep commitments " clause in the Sargent quotation above. That is one big "if" in this discussion. And you might suggest that it would be awfully easy for a government to claim that there are big future benefits to some set of policies, even when said benefits are suspect or highly speculative. Or you might reasonably argue that the burdens of future taxation are already inappropriately skewed to future generations (and getting more so by the minute).
For all these reasons, I lean to the pay-go solution. But the contrary view is at least worth considering.
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December 18, 2006
Still Bad... But Not Getting Worse
In case you are unfamiliar with the NAHB-Wells Fargo Housing Market Index -- the latest installment of which being released today -- you can find a very nice description at the National Association of Homebuilders website. A few highlights:
The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the housing industry, especially the single-family industry. The survey asks respondents to rate general economic and housing market conditions.
- The HMI is a weighted average of separate diffusion indices, calculated for three key single family series in the survey: Present Sales of New Homes, Sale of New Homes Expected in the Next 6 Months and Traffic of Prospective Buyers in New Homes...
- This formula puts each diffusion index on a convenient scale. If all respondents answer “Good/High” then the index is 100. If all respondents answer “Poor/Low” then the index is 0. If equal numbers of respondents answer “Good/High” and “Poor/Low” then the index is 50.
If, like me, you live in the Midwest, your neighborhood breached the 50 threshold in the middle of 2005. The country as a whole followed suit, but not until May of this year:
Note that the index values for both the Midwest and Northeast, having entered below-50 territory before the South and West, are actually improving (the East region for several months now). The West, the last region to register a more-bad-than-good index value -- and clearly the hottest of the hot markets according to the HMI -- in fact remains the only part of the country where things are continuing to deteriorate.
Given the low values of these index numbers this may be a weak reed to clutch, but doesn't that look like the very picture of bottoming out?
(Thanks to Brent Meyer for a big assist on this one.)
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