This morning, it was announced that Thomas Sargent and Christopher Sims are the winners of the 2011 Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel (link to New York Times article here; link to official Nobel economics site here). Sargent and Sims’s approach is often thought to imply, among other things, that monetary or fiscal stimulus is unlikely to be of very much benefit to an economy, even one in deep recession.  Of course, the Levy Institute, as a proponent of the Keynesian approach, almost always disagrees strongly with this view on macroeconomic policy, though extreme pessimism about Keynesian stabilization policies is only one possible implication of Sargent and Sims’s extensive oeuvres.

Moreover, the technical aspects of Sargent and Sims’s work are also crucial to neoclassical macroeconomics, and their influence is felt in many ways. Of special interest to me as a researcher is their work on vector autoregressions (VARs), which has led to literally thousands of studies in academic journals, even some authored by heterodox economists. (Sims’s seminal contributions to the VAR literature are the main Sims accomplishment cited in the Nobel committee’s “scientific background” paper for today’s announcement.)

Nonetheless, as with any research in the social sciences, the VAR approach to empirical work in macroeconomics has been subjected to many critiques and revisions since Sims (and to some extent Sargent) got the VAR ball rolling in the late 1970s and early 1980s. continue reading…

The prevailing anxieties of elite opinion are focused relentlessly on the deficit and debt, with sporadic bouts of indigestion reserved for the slump in jobs.  This is a complete reversal of what ought to be the case.  But let’s say you really can’t get over the idea that there’s no major short-term economic problem currently being caused by high deficits.  Well then, if you are such a person, you ought to be deeply concerned that the economy is operating below potential.

Rep. Chris Van Hollen recently requested an estimate from the CBO (hat tip TPM) regarding what portion of the federal deficit can be attributed to cyclical factors—e.g. the non-recovery in the job market.  The answer:  roughly a third.  There’s nothing new here, but it is an excuse for futile repetition of the following upshot:  attempts to cut the deficit right now are self-defeating, to the extent that they drag down growth and employment.

Gennaro Zezza has been all over this.

By Gal Noir*

In his Congressional testimony on October 4th, Federal Reserve Chairman Bernanke uncharacteristically praised the benefits of fiscal policy, calling it “of critical importance” and conveying concerns with the looming deficit reductions. He cautioned: “an important objective is to avoid fiscal actions that could impede the ongoing economic recovery.”

Many economists expressed worry that such advocacy of fiscal policy will erode America’s (already) wavering confidence in the Fed and will further weaken their support for austerity measures. More troubling still, the economists said, was the possibility that the public may follow suit and start demanding from Congress bolder government action on the jobs front.

A few dissenting scholars thought that it was high time for Bernanke to put his money where his mouth was, so to speak. Among them was Dr. Tcherneva, who had studied Bernanke’s academic proposals for government action during crises and his actual policy moves as Fed Chairman during the Great Recession (2011).**   “I am not at all surprised that Chairman Bernanke is making the case for fiscal policy” Tcherneva said. “I am only astonished that it took him so long. After studying his policy prescriptions for the case of Japan, I am left with the nagging conclusion that Bernanke actually favors fiscal policy over monetary policy. And while the reasons for this position are tucked away in his 2000 paper,***  they were nowhere to be found in his testimony before Congress. This too was very surprising. Considering his scholarship, I was expecting a very different speech today” Tcherneva said.

And indeed Tcherneva may have been right. In a breaking development, housekeeping personnel at the Federal Reserve Board building in D.C. have found a crumpled draft of what appears to be the original speech Chairman Bernanke had intended to deliver. In an exclusive, we reprint the original draft below. Paragraphs in bold are the only ones that made it into the final version.
continue reading…

“It may come as a surprise to some, but the original scheme by Charles Ponzi did not make its money by providing seven decades of benefits to retirees before folding up shop and leaving town with a suitcase full of cash,” writes Benjy Sarlin.  In a new One-Pager Greg Hannsgen and Dimitri Papadimitriou display just how loopy it really is to compare Social Security to a Ponzi scheme.  The authors produce a graph tracing the long history of new taxpayers (“investors”), new beneficiaries, and those leaving the program (and this mortal plane); the picture that emerges is not one of a fraudulent money-making venture that is about to sneak out the back door with your savings.

But let’s leave Charles Ponzi alone for the moment.  What about the looming shortfall in the program, you ask?  Citing testimony delivered last year by their Levy Institute colleague James Galbraith, the authors suggest that there are reasons to be skeptical of these projections.  To see why, have a look at this critique by Galbraith, Wray, and Mosler of the intergenerational accounting methods used to forecast fiscal doom in programs like Social Security (highlights here).

I can tell by that glazed look in your eye that you’re still not convinced.  Alright:  even if the official projections pan out (and there is, as the authors point out, reason enough to be distrustful of them), Social Security would supposedly see a difference between what it takes in and what it puts out that amounts to about 0.6 percent of GDP.  That’s not nothing, but it’s manageable enough that no one should have any doubts that “investors” will be paid off.  Put aside trust funds and lock boxes.  The key point is this:  the solvency of Social Security is ultimately dependent on the solvency of the US government.  And as long as Social Security benefits are owed in US dollars, there is no reason to believe that the US government must default on its commitments to future beneficiaries.

Whether it will is, of course, another question.  Ultimately, in what is something of a depressing trend these days, the real problem, the real source of uncertainty, lies not in the fundamentals of the program, but with the potential decisions of political authorities.  As Papadimitriou and Hannsgen conclude:  “Looking at the figure, one begins to draw the conclusion that it would take an act of legislation—and a very foolish one indeed—to create a “Ponzi” generation of ordinary elderly people with virtually no retirement income.”  You can read the One-Pager here.

Since graphical information manages to fail less spectacularly at getting people to change their minds, here are three graphs; one addressing what we ought (not) to do, one addressing what we are doing, and the other what we can do.

The first comes from the IMF, compiling 30 years of evidence showing that fiscal contraction reduces both employment and incomes:

The second is a graph of changes in government purchases of goods and services in the US, showing dramatic fiscal contraction in a very crucial part of government spending:

The third is a graph of the real rates on 5-year Treasuries, showing that the federal government can borrow at negative real rates to reverse the above fiscal contraction:

I’d like to say more, but the research suggests that doing so in non-graphical form might be counterproductive.

Here is an excerpt from the most important article you will read this year, by George Lakoff:

Here’s how public intimidation by framing works.

The mechanism of intimidation is framing, not just the use of words or slogans, but rather the changing of what voters take as right as a matter of principle. Framing is much more than mere language or messaging. A frame is a conceptual structure used to think with. Frames come in hierarchies. At the top of the hierarchies are moral frames. All politics is moral. Politicians support policies because they are right, not wrong. The problem is that there is more than one conception of what is moral. Moreover, voters tend to vote their morality, since it is what defines their identity. Poor conservatives vote against their material interests, but for their moral identity.

All language activates frames in the brain. Conservative language activates conservative frames, which activate conservative moral worldviews in the brains of those who hear the language. The more those frames are activated, the stronger the conservative moral views get in people’s brains.

Please go to this link, read the article, and then we will discuss it.  (Continued at EconoMonitor…)

Well, I commented last night on President Obama’s speech to Congress on WGXC, my local radio station. I thought it worth putting down my thoughts on silicon, since I’ve already done all the thinking about it.

First of all, I thought that the delivery was one of the better that I’ve heard from President Obama since he took office. It reminded me more of candidate Obama. Maybe that’s because this speech, more than the official announcement that he was running for re-election a while back, was the kick-off to his re-election campaign. He had that whole preacher cadence down, punctuating sections of the speech with the phrase “that’s why you should pass this bill now.” A nice touch, but one that was clearly not directed at the politicians in front of him, many of whom wouldn’t support kibble for kittens if it was an Obama proposal.

Moving on to substance is a bit depressing. The American Jobs Act is equal parts weak tea and bitter pill. The weak tea is that as a job creation proposal it does too little, too ineffectively. Much of the proposal the President outlined in the speech sounds a lot like the American Recovery and Reinvestment Act, the stimulus passed early in 2009. I will talk about that bill’s effectiveness in a bit, because I think a lot of people think very lazily about how to assess that policy’s impact. But the parts are all there: lots of tax cutting; state aid; unemployment insurance; and infrastructure spending. There is also some mortgage finance relief thrown in for good measure.

Tax cuts will be welcome to most people, of course. Who doesn’t want more of their paycheck going directly into their pockets (other than Warren Buffet, of course)? The proposal to cut payroll taxes in half is great in a couple of ways. It will add some stimulus to the demand for goods and services (people will buy more stuff if they get their hands on a bigger chunk of their paychecks). And the payroll tax is one of the more regressive federal taxes, since people pay a flat rate on their first $100K or so of wage and salary income and nothing above that cap, which means that people who make less than $100K (most of us) put a bigger percentage of our salaries into the Social Security system than those who make more.

The employer reduction in the payroll tax isn’t going to be as helpful. Some small business owners will see that as a small bump to their bottom line, but it certainly isn’t going to create a lot of jobs. Nor will the tax credits for hiring the long-term unemployed or veterans, although those are certainly worthy targets for encouraging employment. But businesses aren’t making hiring decisions based on the tax implications of hiring more workers. Certainly, they take taxes they have to pay into account, but these are a small portion of the cost of hiring someone. The point is that businesses aren’t hiring people because there is not enough demand for goods and services in the economy. Until demand for the stuff businesses produce or provide goes up, hiring will remain slow.

State aid is a simpler case to make. continue reading…

Expect one thing from President Obama’s speech on Thursday: a mini ARRA, a smaller version of essentially the same stimulus plan as that of 2009. He will probably call for putting the unemployed construction workers to work on infrastructure projects, he will propose tax incentives to firms to hire the unemployed, he will keep pushing for the weatherization of buildings and more funding to teachers and schools. He will keep advocating a free trade agenda, whatever form that might take. And if informed pundits are correct, he will ask for about a third of the ARRA funds, around $300 billion.

In 2009 ARRA passed a total of $787 billion (which was extended to $840 billion). About a third was allocated to tax cuts, another third went to entitlements and the remaining third (about $275b of which $205b have been disbursed) went to finance various projects through grants, loans and contracts—yes, the same weatherization projects he was advocating at the beginning of his presidency, the same teacher retention programs, school renovations, the same subsidies to firms for (true, mostly green) energy production.

It does not appear that we will see much that is new tomorrow, but the approach will be much more timid, given the deficit phobia that has gripped Washington.  To be clear, the Recovery Act worked, but had a rather small impact on jobs for two reasons: 1) the actual direct job creation component was far too small (for the most part it was contained in that third, which went to grants, contracts and loans); and 2) it was poorly targeted (not all of these funds actually created new jobs for the unemployed—a topic for a different post).

With such a small direct job creation component, it is no surprise that ARRA created only 1.2 million jobs in direct employment. If we consider the secondary, tertiary and subsequent effects from the entire ARRA spending (including tax rebates and entitlements) and account for a multiplier effect, whose high estimate according to the CBO is $2.50, we are looking at 3.3 million jobs created from ARRA in 2 years (2009-q2 to 2011-Q1). So yes, the ARRA did create jobs, but too few and at a time when the economy was experiencing its fastest private sector job loss since the Great Depression.

In January 2009, I argued that what the president should do in his ARRA proposal is offer direct employment to the jobless immediately and without delay. If instead of all the tax cuts, subsidies, and entitlement extensions he had offered full-time employment to the unemployed in transitional public sector jobs at a living wage, we would have prevented the precipitous increase in the unemployment rate that followed. Furthermore, had we targeted the ARRA better (a topic for another discussion) we could have created 10-20 million jobs for the same price tag!

But we did not embrace the bold approach then and we will definitely not embrace it now. continue reading…

“There’s a 60 percent probability that most advanced economies will fall into a recession, while authorities are running out of options to provide emergency support.” — Bloomberg News today, describing the views of Nouriel Roubini

This forecast from a sometimes-prescient and widely quoted economist brings to mind a question that many people now find irrelevant.

Which should we policymakers choose, option A or option B? How about doing whatever is necessary to balance the government’s budget? Increasingly, policymakers believe that is their only option. In some countries, these policymakers may be right. For them, options A through Z are to raise taxes or cut spending. This is what happens when (1) tax revenues are weak, (2) money is needed to make payments on government debt, and (3) the country in question does not or cannot print its own currency and cannot make reserves for its own banks.

Here in the United States, point (3) above does not apply. Hence, the federal government can issue any amount of securities, with the Fed purchasing them if necessary, as long as Congress is willing to keep increasing the debt limit. Unfortunately, however, the stimulus package of 2009 is wearing off, and Congress and the President have not acted quickly enough to increase spending or reduce taxes. As a result, combined government employment at the local, state, and federal levels has been falling. Unemployment remains ultra-high. Hence, we look forward with great concern to President Obama’s upcoming address on jobs creation. Many constructive proposals are likely to be on offer.

On the other hand, all three points in the third paragraph of this post seem to apply to most of the countries in the Eurozone. They are in some kind of a trap, perhaps a debt trap. continue reading…

Economist:  “The economists who studied this were quite surprised to find that fiscal policy in recessions was reasonably effective.  It is just that folks tried a first punch that was too light and that generally we didn’t get big measures until well into the recession.”

Congressman:  “That is precisely my point.  That is why I like my porridge hot. I think we ought to have this income tax cut fast, deeper, retroactive to January 1st, to make sure we get a good punch into the economy, juice the economy to make sure that we can avoid a hard landing.”

The identities of these tiresome Keynesians?  Kevin Hassett of the American Enterprise Institute and Congressman Paul Ryan of Wisconsin—speaking in 2001.

From a purely predictive standpoint, it makes one wonder:  assuming that control of Congress doesn’t change much, are the odds of additional fiscal stimulus higher if there is a Democratic or a Republican President in 2013?