Friday, November 21, 2008

Am I Freaked Out?

. Friday, November 21, 2008

No I'm not. But I'm not happy. Here's a partial list of why:

1. We haven't had sustained deflation yet, but the fact that Core CPI -- excluding food and energy -- dropped by 1% in October rings alarm bells. But that's not the only data point [pdf]: the PPI (Producer Price Index) for finished goods dropped by 2.8% in October following smaller declines in August and September. Yes, that is seasonally adjusted. That is not the core figure (which is still positive) but firms in the energy and commodity sectors still employ people. To some extent CPI usually lags PPI, so it doesn't seem unreasonable to expect future drops in CPI as well.

2. Dr. Oatley advocates thanking the Lord for creating Keynes. I'll do that right after I'm done asking for my unicorn, but I'm a bit more pessimistic regarding the potential gains. As I see it, a drop in aggregate demand isn't the cause of this crisis: the credit crunch is. I can tell a story in which we issue a massive fiscal stimulus package, but citizens don't respond by boosting consumption. Instead they hoard it, anticipating deflation, or mounting unemployment, or foreclosure, or whatever else. Since this is going to be deficit-spending at a time when the government is already massively imbalanced, people should also expect future tax increases, which would also incentivize them to save it. And since credit is still locked up, there's no mechanism for steering those savings towards the businesses who need it. If they don't get cash, those businesses don't expand, unemployment mounts, deflation deepens, and we're spiraling.

There's actually some evidence for my story: Shapiro and Slemrod found that only 20% of people said they would spend their stimulus checks (in 2001 and 2008); the other 80% said they'd use them to pay down debt or boost savings. It's true that people don't always act as they say they will, but in this case Johnson, Parker, and Souleles found that they did (in 2001): each dollar of stimulus spending by the government resulted in roughly 33 cents of increased spending by consumers. Souleles also noted that that number might decrease in the present because the overall balance sheets of American consumers is worse off now than in the past because of declining home values.

I'm not saying it's not worth trying. All I'm saying is that if we can't unfreeze credit markets, it's probably all for naught.


Thomas Oatley said...

But, isn't this situation--hoarding or excess savings--exactly the situation that Keynes argued justified government expenditures? Government borrows to reduce savings in excess of investment?

You may be correct about consumer responses to receiving a stimulus check. But there's more than one way to skin a cat. Government need not send checks to citizens. It can invest in infrastructure; it can pay autoworkers to get retrained and find new work. It can bury money in coal mines and hire unemployed to dig it up.

Not saying fiscal policy is a magic bullet; just that it offers an additional instrument to address the crisis. Because even if the first wave is the credit crunch, the second wave will be aggregate demand shock as those firms who can't sell because they can't get credit starting laying off their workers...

Kindred Winecoff said...

absolutely right. this is what Keynes was talking about. the problem is that it isn't clear that we can actually solve the hoarding problem by pushing stimulus. if we give people money through rebate checks (or whatever) and they won't spend it, why should we think that they'll spend it if we give them money through public works projects? as far as i know, Keynesianism doesn't distinguish between types of stimulus; only stimulus or no stimulus.

in any case, infrastructure projects have a fairly large lagged effect, right? so does re-training of workers. if the goal is to boost AD quickly, then the policy choice is rebate checks, or gov't-issue debit cards, or something like that. i'm suggesting that that sort of stimulus might not work.

if the proposal is to boost AD in the medium-run rather than the short-run by increasing infrastructure spending, then that's a different story. but if we're targeting medium-run recovery rather than short-run recovery, maybe we should focus on boosting private investment rather than public works. after all, the epicenter of the crisis is in the investment sector; if you ignore that in favor of creating public works projects, you may be treating the symptom rather than the disease.

Alex Parets said...

I'm going to have to agree somewhat with Will's analysis of short run vs. long run AD stimulus. However, one qualification. At the very earliest, if checks/debit cards were to be sent out to taxpayers, the earliest they would receive them would be April 2009. Lame Duck Session I ended yesterday with nothing to show for it, and when they reconvene on December 8th, they will show up, take some pictures with constituents and then head home by the 11th.

That means that any Congressional package would not be passed until the new Congress convenes in January, and would not be able to pass any bill until at least January 15th. As we saw earlier this year, it took the feds 3 months to get the first set of checks out and 6 months to get all of them out, giving an expected timeframe for Stimulus II of arriving in American mailboxes as April-July 0f 2009.

Large scale public works projects (bridges, roads, etc.) will take at least a full year to get set up and roughly 2-3 years to see much of an impact.

It looks like the best thing we will be able to do is extend and increase unemployment benefits, freeze foreclosures, continue large scale deficit spending and hope that the economy can hold somewhat steady til Stimulus II kicks in. Not looking pretty.

Thomas Oatley said...

Not sure what you are saying other than fiscal policy won't work (either). My claim that it will rests on the belief that marginal propensity to consume rises as disposable income falls. People with zero income (unemployed) are thus quite likely to consume government stimulus. Extending and increasing unemployment benefits would thus provide stimulus.

I wonder if you both focus too much on the "real" impact of "public works" programs (do they incrase AD) and don't focus enough on their impact on expectations. The paradox of thrift and the resulting collapse of investment are problems of expectations and coordination. The relevant expectations concern future demand. Creating government programs that promise demand in the future, therefore, convinces business that investments made today will have a market tomorrow.

We even have the benefit of a Congress that is incapable of reneging on a promise to spend more in the future. How perfect is that?

Kindred Winecoff said...

true that the MPC is highest among those with the least disposable income. and i'm in favor of extending unemployment benefits (which has already been done, i believe). but we're trying to move a $14tn economy. increasing unemployment benefits isn't sufficient to do that. especially in the face of a credit freeze.

also, if your story about expectations is true then we should have seen some significant movement since the election. throughout the campaign Obama signaled that he'd boost infrastructure projects. he's now been elected with a sympathetic Congress, so you would expect some expectations of future spending to already be built in to markets.

Am I Freaked Out?




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