Friday, September 10, 2010

Uh Oh: Kevin Hassett Likes Obama's Business Tax Credit Proposal

How do I know Obama's proposed business investment tax credit won't do much to stimulate the economy? Kevin "DOW 36,000" Hassett thinks it's a great idea.

Indeed, Hassett makes quite the case for this latest round of giveaways to Corporate America growth-oriented tax policy:
Because the benefit of expensing depends on the time value of money and interest rates are currently quite low, one might think that expensing would have a small effect now. Nevertheless, all but the most prominent firms have to pay interest rates that are much higher than Treasury rates today when they borrow.
Actually, Hassett had it right the first time. This latest measure won't do much. Just ask incoming CEA chair Austan Goolsbee, whose academic work included looking at such tax credits:
Econometric research has commonly found that tax policy and the cost of capital have little effect on real investment. [...] For policy makers interested in using tax policy to stimulate investment or, especially, to smooth business cycle fluctuations, the results are not promising.
Which makes you wonder, who exactly is telling Obama this is good economic policy? Or (more likely) is this just a ploy to appear less "anti-business" with midterm season in full swing?

Thursday, September 2, 2010

Quantitative Easing Or Helicopter Drop? What Should Ben Bernanke Do?

A lonely nation turns its eyes to you, Ben Bernanke.

Double dip fears run rampant (despite a better than expected August ISM number). Fiscal stimulus is waning -- much of it undone by draconian cuts at the state and local level. Housing looks poised to go cliff-diving again now that the homebuyer's tax-credit has expired. And, of course, unemployment remains stubbornly high.

The high priests of economic orthodoxy assure us if we just embrace fiscal austerity or higher interest rates that we can ward off the dangers of debt deflation. Which is to say, they are incoherently grasping at any justification to foist contractionary policies onto a weak economy, all in order to fight the specter of incipient -- only in their minds -- inflation.

But with short-term rates up against the zero bound, what ammo does the Fed have left to support the fragile recovery? Here are the usual suspects of unconventional policy tools:

1) Resume quantitative easing. It's debatable how much banks substituting one non-interest bearing asset for another helps the real economy. Additional cash seems likely to either pile up as excess reserves, filter into the markets or get arbitraged via more Treasuries. Still, it's better than nothing.
2) Credibly commit to a higher inflation target in the medium-term. Targeting a 4% inflation rate over a prolonged period obviously not only makes holding cash less appealing, but also reduces real debt burdens. Of course, Messrs. Fisher and Hoenig would do everything in their power to undermine such a project to return to 1980s-level inflation.
3) Buy longer-dated Treasuries. Pushing down yields on longer-dated Treasuries makes other, riskier assets more attractive. Even just credibly threatening to buy up longer-dated Treasuries could be enough, if yields aren't already too low.
4) Eliminate IOER. The Fed currently pays out 0.25% on excess reserves, but why not cut that down to zero? Or even impose a penalty rate? Banks would pile into other short-term assets and increase their vault cash, but at least some of that otherwise idle money would leak into new loans (although there could be some unintended consequences vis-á-vis money market accounts).

Those are just the more conventional "unorthodox" measures the Fed could pursue. Another option would be quantitative easing to non-banks, i.e. direct lending. This is where monetary and fiscal policy meet. The key is that it would entirely eliminate the excess reserves problem, though it would introduce the question of favoritism -- an issue the Fed would be loathe to raise given the recent assault on Fed secrecy.

Still, the radical idea of the Fed giving money to businesses and households rather than to banks liable to sit on it holds some appeal. The so-called helicopter drop would accelerate the deleveraging process, effectively papering over bad household debt. Indeed, from what we know about lump sum tax rebates, we would expect households to save/pay down debts with their one-time check from the Fed. So a good portion of this newly minted money would still end up at the banks, just as with quantitative easing, though it would come at the cost of reducing the banks' claims on households.

But wouldn't this debauch the currency? If the Fed gave away free money, essentially accepting anything as collateral, they wouldn't have the assets to sop up the excess liquidity and prevent out-of-control inflation on the other side. This is the issue some have raised with the Fed accepting MBS as collateral: the Fed is holding MBS at inflated values, so when it comes time to sell that paper, the Fed won't take out as much money as it put into the system -- hence, inflation.

This is where the Treasury comes in. As MIT professor Ricardo Caballero points out, the Treasury could simply transfer T-Bills to the Fed to sell, basically the reverse of monetizing the debt. The Fed would never countenance such extreme action but it's worth remembering that Ben Bernanke circa 2002 was correct: a determined Fed should be able to reverse deflation. Too bad he's not running things nowadays.

Wednesday, August 4, 2010

Welcome To Tim Geithner's Recovery

In economics, as in war, simply declaring "Mission Accomplished" does not make it so. Reality is stubborn. But that didn't prevent Tim Geithner from taking to the New York Times to celebrate our "recovery" in a transparent effort to gin up increased confidence.

In effect, Geithner saluted policy-makers for avoiding a replay of the 1930s, settling instead for a prolonged period of stagnation, á la Japan's Lost Decade; what PIMCO dubs the "new normal". What a salutary result! Implicit was a rebuke of those worrying about the possibility of a double-dip: after all, the economy grew at a rate of 2.4% 1.7% in the second quarter of 2010. Modest but still tangible growth, no?

Of course not. The economy is clearing slowing. The inventory bounce is fading. Fiscal stimulus is waning. Republican obstructionism eliminates any hope of further spending. Cuts at the state and local levels will actually bring about fiscal contraction over the coming months. The Fed frets that further action could spike inflation. At best, Bernanke & Co. won't withdraw the little monetary stimulus they have provided, at least in the short term. In short, the second derivative is slumping. It's conceivable that the first derivative could reverse itself over the next few quarters. But even that is largely irrelevant. Whether the economy grows at a rate of minus or positive one-percent, there still will not be enough growth to add enough jobs to alleviate our now persistently high unemployment. We have simply arrested the freefall and called it a recovery.

And there are still, of course, rather massive tail risks to our fragile "recovery". Housing in the U.S. is on a downward trend again. Europe's banking/sovereign debt problems (they are one and the same) still hover like a specter over the continent. And China's housing bubble could pop to devastating effect.

Welcome to the recovery, indeed.

Monday, July 19, 2010

Paul Krugman, Iceland And The Council Of Foreign Relations: A Study In Conventional Incoherence

If there's one thing Serious People despise, it's being questioned. Never mind that the establishment has listed from one catastrophe to the next over the last decade; alternatively cheerleading the Iraq quagmire, financial deregulation, and -- now -- austerity. No matter the outcome, Serious People are always right; power absolves them of responsibility for the consequences of their actions.

So it shouldn't be too surprising that the "centrist" Council on Foreign Relations -- that venerable body that sees fit to employ know-nothing Amity Shlaes as an economic "specialist" -- has declared war on Paul Krugman. After all, as the leading Keynsian economist, Krugman has incisively and incessantly challenged the emerging conventional wisdom that budget deficits need to be immediately restrained and monetary officials should to be wary of incipient inflation. But even by their normally economically illiterate standards, their last attack is particularly baffling.

In their latest broadside, the CFR takes issue with Krugman's post on Iceland, which would have seemed relatively unobjectionable. Krugman merely pointed out that since Iceland controls its own currency, and can thus devalue it, they had fared much better during the financial crisis than other small, open economies. Indeed, the three countries Krugman compares Iceland to -- Ireland, Latvia and Estonia -- have been forced to maintain overvalued exchange rates, either because they're already a part of the Euro (Ireland), or have their currencies pegged to the Euro in hopes of joining (the recently admitted Estonia and Latvia), which has led them off an economic cliff. Unemployment has soared to Great Depression levels in the pair of Baltic states. Trimming their budget deficits and keeping their currency pegs in the face of the slump has starved their economies of any demand. Meanwhile, Ireland has suffered its own collapse and slide into deflation, thanks to the effective Gold Standard that is the Euro. That a quick devaluation is preferable to years of grinding deflation would seem obvious, yet it escapes the CFR.

Here, it's worth remembering too just how spectacular Iceland's bust was in 2008. Iceland's bankers quite literally bankrupted the country. After erecting their own mini-financial empires built on piles and piles of debt, Iceland's financiers left the country with a bill larger than its GDP when it all inevitably went bad. It's no exaggeration to say that Iceland suffered one of the worst financial collapses in history. And yet, just under two years later, Iceland is doing better than the aforementioned trio of Ireland, Latvia and Estonia, who have adhered to the economic orthodoxy of deflation and austerity with stunning zealousness. If ever there was proof that the large monetary shock of devaluation, which instantaneously makes exports more competitive, is an effective way to jump-start recovery out of severe recession, this would seem to be it.

But not so, says the CFR. See, if you just look at Iceland's performance compared to the others from a few months before the panic in see that Iceland only slightly outperforms the others, rather than clearly outpacing them. And if you go all the way back to 2000, Iceland has gained less in terms of GDP growth than the others! And if you go back to 1950....

Not only is this analysis misleading -- the question is how these countries have performed since the acute phase of the crisis hit -- but it entirely misses the point. By all rights, Iceland should be far, far behind the others; their banks owed more than their government could pay. As dire as the situations in Ireland, Latvia and Estonia were, they weren't quite that bad. But obstinate policy-makers have crucified their economies on a cross of Euros, which has condemned them to zero or negative growth and spiking unemployment. Meanwhile, Iceland has bounced back towards the beginnings of a recovery; something inconceivable two years ago. Of course, devaluation is not a panacea, but it's the best bad option in this context. This is rather elementary stuff.

It's as if the CFR is bellowing at Krugman for presuming to question the great Oz, not realizing that the curtain has been drawn on their intellectual bankruptcy. Eventually, the truth always wins out.