Felix Salmon

A topological mapping of explanations and policy solutions to our weak economy

September 21, 2011

This was originally posted at Rortybomb

For the next few posts I need to allude to an ongoing battle of ideas about what is troubling our economy and what solutions are available. I figured it might be a good idea to try and create some sort of topological map of the various clustering of ideas and policies that constitute these arguments as well as the overlap among them. This is a preliminary version of this map: I’d really appreciate your input about what is missing and how to make this better.

From those who think that the problem is related to demand and Keynesian ideas, there tends to be three areas of focus: fiscal policy, monetary policy and the debt hangover in the broken housing market. One can think all three are important – I certainly do – but most think one has priority over the others. Many will think one of the three isn’t in play or particularly useful as a focus of policy and energy. Here’s a rough map. Quotations are ideas, non-quotes are policies and parentheses are people associated with each:

This war of ideas is being fought in white papers and articles, and at academic institutions, policy shops and the blogosphere. As a general resources, here are the best one-stop resources online for most of the bulletpoints above:

Fiscal Policy as Expectation Channel: Woodford on Monetary and Fiscal Policy, Paul Krugman.

Quantatitive Easing: The World Needs Further Monetary Ease, Not an Early Exit, Joe Gagnon.

NGDP Targeting: The Case for NGDP Targeting: Lessons from the Great Recession, Scott Sumner.

Mass Refinancing: Economic Stimulus Through Refinancing — Frequently Asked Questions, R. Glenn Hubbard and Chris Mayer.

Inflation to help Deleveraging: U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff, Bloomberg. Overcoming America’s Debt Overhang: The Case for Inflation, Chris Hayes.

Higher Inflation Target: A 2% Inflation Target Is too Low, Brad Delong.

Bankruptcy Reform/Cramdown: January 22nd, 2008 Testimony, Adam Levitin.

Foreclosure Spillovers: Foreclosures, house prices, and the real economy, Atif Mian, Amir Sufi and Francesco Trebbi.

Balance Sheet Recession: U.S. Economy in Balance Sheet Recession: What the U.S. Can Learn from Japan’s Experience in 1990–2005, Richard Koo.

Housing Backlog: There is a Boom Out There Somewhere, Karl Smith. Yes, Virginia, Our Housing Stock Is Now Way, Way Below Trend, Brad Delong.

Debt-for-Equity Swaps: Why Paulson is Wrong, Luigi Zingales.

Debt, Deleveraging, and the Liquidity Trap: Debt, deleveraging, and the liquidity trap, Paul Krugman. Sam, Janet and Fiscal Policy, Paul Krugman.

The flip-side to a demand crisis is a supply crisis, and there’s been a large effort to explain our high unemployment and below-trend growth as the result of supply-side factors. Having surveyed the arguments, I’ve split them into two categories. There are those who think that the government has created an increase in uncertainty. This is from a combination of deficits that scare bond vigilantes/job creators, new regulations that have killed all the potential new jobs as well as the government creating disincentives to work. The second area of focuses is on the productivity of the labor force, with special emphasis on skills mismatch, the characteristics of the long-term unemployed and the idea that something has changed fundamentally in our economy that will keep so many unemployed for the foreseeable future.

I’m making the productivity circle conceptually expansive enough to include “recalculation” stories, though I suppose I could add a third circle in the next version. I tend not to find these arguments convincing, but here are the arguments made in full as best as I could find them online:

European Policies: The U.S. Recession of 2007-201?, Robert Lucas. The classical view of the global recession, Gavyn Davies.

Expansionary Austerity: A Guide for Deficit Reduction in the United States Based on Historical Consolidations That Worked, AEI. Large changes in fiscal policy: taxes versus spending, Alesina and Ardagna.

Liquidate the Homeowners: Are Delays to the Foreclosure Process a Good Thing? Charles Calomiris and Eric Higgins.

Stimulus is Sugar: Geithner Finds His Footing: Zachary Goldfarb.

Two-Deficit Problem, Bond Vigilanties: Spend and Save, Noam Scheiber.

Great Vacation: Compassionate, But Inefficient, Casey Mulligan. The Dirty Secret of Unemployment, Reihan Salam.

Long-Term Unemployed: Potential Causes and Implications of the Rise in Long-Term Unemployment, Andreas Hornstein, Thomas A. Lubik, and Jessie Romero. 10 Percent Unemployment Forever?, Tyler Cowen, Jayme Lemke.

Great Stagnation: The Great Stagnation, Tyler Cowen.

Patterns of Sustainable Specialization and Trade (PSST): PSST vs. the Aggregate Production Function, Arnold Kling.

Labor Mobility: Housing Lock is not a Major Part of this Crisis, Plus Scatterplots of Deleveraging!, Mike Konczal.

So what did I miss? What should go in the next version of this chart?

Read the original post here

6 comments so far | RSS Comments RSS

The main cause for the weak economy is the hoarding of profits. An economy can only be sustained when a percentage of profits are re-used and recycled, and that’s not happening. Every asset needs to be maintained, or else it loses value; a national economy (a financial system, a monetary system, transportation, communications, education, health care, food distribution, etc.) is a national asset, and if enough of the profits it generates are not cycled back into the economy, it will stagnate or die.

Cutting taxes has not proved to be a driver of investment, nor has low interest rates, mainly because people and businesses only invest when they think they will make money. Low tax rates or low cost capital is irrelevant if you don’t think the investment will pay off, and that’s where we are at today. We have cut taxes with the hope (or prayer) that the beneficiaries of tax cuts will voluntarily risk their tax savings on new ventures, and surprise, it isn’t happening.

We need to change our tax policy from one that simply hopes for investment to one that rewards investment. Low effective tax rates should be effective only AFTER an investment has been made, and the best way to insure this happens is higher tax rates combined with significant tax credits for investment. There has to be a feedback path from profit to investment, and it can’t just be wishful thinking. To make it more likely, we need to let investment drive tax rates, not the other way around.

This is allegedly a market driven economy, which means demand drives supply, not vice versa. Increasing the supply of money only enables demand, it does not cause it to happen. Since the debt criss occurred, demand has not recovered, as people are either not confident they can maintain their income, or they don’t have enough income to increase spending. If the small segment of society that has been accumulating profits is given the choice of paying more taxes or re-investing those profits, they will most likely choose the latter. And the net result will be more jobs, and ultimately, more profits. Cutting tax rates without conditions will result in less growth, as those profits will just gather dust (not even interest these days), when they are not being distributed as bonuses.

Or was this in there somewhere?

Posted by KenG_CA | Report as abusive

Great project and a great start in aggregating ideas. A small comment about the placement of the higher inflation target dot. One of major effects of higher inflation is that it inflates away the real value of debt. Thus, an increase of inflation at this time would be to reduce the debt overhang.

Also, higher inflation, if it bleeds into housing prices, will increase the nominal value of houses especially with respect to the underlying debt. A higher inflation target could also reinvigorate the housing market.

As such, the dot locating higher inflation target should be moved to the right such that it is closer to, or within, the Housing Policy and Debt Hangover circle.

Posted by Kosta0101 | Report as abusive

I’m convinced that politics will not allow a tax increase until January 2013. So what are we left with? Government needs to back off, as it is creating more uncertainty that is encouraging this “hoarding”.

These policies have create the unintended consequence of uncontrolled positive and negative feedback loops, and even mundane policies are having this perverse effect creating outsized winners and losers. The biggest loser is main street.

Posted by marantz | Report as abusive

I’m missing something in your graphs: some people (see Econbrowser blog) suggest that high/volatile oil prices have had a significant effect on weakening the economy so much.

I don’t know how you want to call this, but I have seen the following idea floated in the blogosphere: the problems we are having now are in several ways similar to the ones in the oil crisis in the seventies, with the difference that monetary policy has avoided inflation. In the seventies, credit was expensive and job security was relatively high, so the extra expense due to high oil prices was passed into the prices of products and services, creating inflation and a wage-price spiral. In this crisis, credit was very cheap and job security was low, so the extra expense due to high oil prices was converted into extra debt, and when this failed, wages were cut.

There’s an argument that says that the origin of the current problems can be traced to the huge oil imports of the States. A lot of the trade deficit of the States is oil. And many currencies are, or were until recently pegged to the dollar, which creates a situation very similar for the States as if there was a gold standard. There is, de facto, something similar to a dollar standard. A trade deficit with a gold standard is recessionary, but Greenspan avoided that recession by lowering interest rates and creating the housing bubble as a result. (Some people say that there wasn’t enough money in the dot-com bubble to have caused the recession that was blamed on the dot-com bubble).

For people that believe that peak oil is here, there isn’t an easy solution to that problem, because high/volatile oil prices will continue to throw sand on the wheels of the economy. I’ve seen suggestions for infrastructure spending that will reduce the cost or need of transport, and calls for localisation (the opposite of globalisation). None of those things are likely to produce results quickly, though. And with the huge wage difference between the States and China, localisation doesn’t look like it would work well for many products.

Posted by Doly | Report as abusive

Legalizing the money drop has to be looked at seriously to accommodate the debt liquidation that is occurring rather than attempting to reverse it. The loss in wealth must be made up and a money drop is the fastest, surest, route. Interfluidity and Modern Monetary Theorists talk about these.

Posted by MyLord | Report as abusive

The world is flat. I know that Friedman’s concept is simplistic, overused, and dated, but I am intrigued by the notion that the education and industrialization of the developing economies are leveling the production playing field, lowering barriers to entry for just about any productive or intellectual endeavor, and evening out wealth across much of the world. Some of this may be refected in your long term unemployed category, but I think it’s broader than that.

Posted by Curmudgeon | Report as abusive

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